Natural Gas Services Group Inc Q2 FY2020 Earnings Call

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group Second Quarter 2020 Earnings Call. At this time, all participants will be in a listen-only mode. Your call leaders for today's call are Alicia Dada, IR Coordinator and Stephen Taylor, Chairman, President and CEO. I would now like to turn the call over to Ms. Alicia Dada. Alicia, you may begin.

Thank you, Ross, and good morning listeners. Please allow me a moment to read the following forward-looking statement prior to commencing our earnings call. Except for the historical information contained herein, the statements in this morning's conference call are forward-looking and are made pursuant to the Safe Harbor provisions as outlined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements, as you may know, involve known and unknown risks and uncertainties, which may cause Natural Gas Services Group's actual results in future periods to differ materially from forecasted results. Those risks include, among other things, the loss of market share through competition or otherwise, the introduction of competing technologies by other companies, and new governmental safety, health or environmental regulations, which could require Natural Gas Services Group to make significant capital expenditures. The forward-looking statements included in this conference call are made as of the date of this call, and Natural Gas Services undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. Important factors that could cause actual results to differ materially from the expectations reflected in the forward-looking statements include but are not limited to factors described in our recent press release and also under the caption Risk Factors in the company's Annual Report on Form 10-K filed with the Securities and Exchange Commission. Having said all that, I will turn the call over to Steve Taylor, who is President, Chairman and CEO of Natural Gas Services Group. Steve?

Thank you, Alicia, and thank you, Ross. Good morning, everyone, and welcome to the Natural Gas Services Group's second quarter 2020 earnings review. I appreciate all of you tuning into our call. Despite ongoing challenges in energy demand and fluctuating energy commodity prices mainly due to the COVID-19 pandemic, NGS achieved solid financial results in the second quarter. Our swift response to reduce costs and meet customer needs minimized the impact on our income statement and financial condition compared to others in the industry. We successfully addressed customer requests for pricing and shut-in assistance while maintaining a strong financial position. Although our revenues decreased during the quarter, we achieved sequential growth in both gross margin and EBITDA. Importantly, we continued to enhance our balance sheet and liquidity, even in this challenging market. NGS generated free cash flow for the quarter and increased our cash balance to $15.5 million from $13.1 million at the end of the first quarter. Our liquidity improved further into the third quarter, with approximately $17 million in cash at the end of July. While commodity prices have rebounded from the lowest points, they are still far from levels that would trigger significant oilfield activity. Business has picked up, but at a slow and inconsistent pace, a trend we anticipate will gradually improve for the rest of the year. Nevertheless, we are identifying new opportunities for which we are especially well-suited, and we believe our fabrication capabilities, excellent service, and strong financial position will enable us to take advantage of these. As you know, we postponed the filing of our second quarter report because of the COVID-19 pandemic's impact on the Midland community and our company. We remain committed to safeguarding our team's health, which has led us to continue working remotely whenever possible. Our Midland headquarters is operating with a reduced in-person staff, and we encourage our team members to take necessary precautions to stay safe and healthy. Our field teams continue to follow appropriate social distancing and health guidelines while working with customers on site. Although these practices have added some costs to our operations, we are committed to protecting the health and well-being of our team and our customers during these unprecedented times. Before going into the specific quarterly financial and operational results, I want to highlight several key aspects of the quarter. Our rental gross margins rose to 56%, marking an improvement from both year-over-year and sequential quarters. Overall, total gross margins also increased. We recorded positive GAAP net income for the quarter, and adjusted EBITDA showed growth compared to both year-over-year and sequential quarters. NGS achieved positive net cash flow from operating activities of $6.5 million, which represents 38% of our total revenue for the quarter. Free cash flow was also positive, and we grew our cash balance to $15.5 million, thereby maintaining one of the strongest balance sheets in the industry. Now let’s discuss the details. NGS reported total revenue of $17.4 million for the second quarter of 2020, reflecting a 12.5% decrease from the same quarter in 2019. This decline was primarily due to a drop in sales and service and maintenance revenues. On the positive side, NGS saw an 11.5% increase in rental revenues compared to the same quarter in 2019. Sequentially, total revenue dipped by 3%, influenced by a 5.5% decline in rental revenues. However, sales revenue increased sequentially in the quarter, partially offsetting the slight total revenue decline. Our customers' capital spending remains constrained, and we expect sales revenues to stay soft in upcoming months as companies prefer short-term rental commitments over longer-term capital expenditures. Nevertheless, I anticipate some recovery in our service and maintenance revenue due to specific activities we observe in that segment. Given the persistent challenges in our industry and the overall economy, we are satisfied with our operational performance in the second quarter of 2020. Our rental revenue displayed resilience during the quarter, only slightly declining despite a substantial reduction in overall oilfield activity. We generated adjusted EBITDA of $6.5 million, representing a 13% increase over the first quarter of 2020. Our operating cash flow for the quarter was also $6.5 million. The total adjusted gross margin, excluding depreciation, for the three months ending June 30, 2020, increased by 1% to $8.8 million from $8.7 million in the same period last year. Adjusted gross margin as a percentage of revenue for the same period was 51%, an increase from 44% year-over-year. Sequentially, adjusted gross margin for the second quarter of 2020 rose by 8.5% to $8.8 million from $8.1 million in the previous quarter. The adjusted gross margin percentage increased to 51% in this quarter compared to 45% in the prior quarter. These adjusted gross margin increases clearly indicate that our cost-reduction efforts made a positive impact during this quarter. Selling, general, and administrative expenses for the second quarter of 2020 were $2.7 million, remaining flat compared to the same period in 2019 and increasing from $2.2 million in the first quarter of 2020. The sequential rise of $500,000 in SG&A was driven by a variation in the mark-to-market value of deferred compensation, a non-cash adjustment between the two quarters. SG&A as a percentage of revenue rose to 15%, slightly above our usual range of 13% to 14%. This slight increase is attributed to the previously mentioned mark-to-market variations. The operating income for the second quarter of 2020 was a loss of $148,000, in contrast to a positive income of $302,000 in the same quarter of 2019. This operational loss mainly resulted from lower sales revenues and margins, alongside higher depreciation expenses, but was offset by increased rental revenues and lower associated costs compared to the same quarter in 2019. Sequentially, our operating income improved from a loss of $273,000 last quarter to a loss of $148,000 in the current quarter. NGS reported net income of $165,000 for the second quarter of 2020, compared to $327,000 for the same period in 2019. Sequentially, net income from the first quarter of this year was $4.1 million compared to $165,000 this quarter, driven in the previous quarter by a favorable tax benefit of $4.9 million due to net operating loss carrybacks permitted under the government’s CARES Act. NGS reported earnings per diluted share of $0.01 for the second quarter of 2020, down from $0.02 in last year's comparable quarter and significantly lower than $0.30 in the first quarter of this year. EBITDA, or earnings before interest, tax, depreciation, and amortization, along with our adjusted EBITDA, which includes any increase in the inventory allowance, improved in both comparative quarters. Adjusted EBITDA for the three months ended June 30, 2020 was $6.5 million, reflecting a 5% increase from $6.2 million during the same period in 2019. Adjusted EBITDA increased by approximately $749,000 or 13% sequentially from $5.8 million in the first quarter of 2020. Total sales revenues, including compressors, flares, and product sales, fell by $3.8 million to $2 million on a year-over-year basis. This decline is mainly attributed to reduced compressor sales, with lesser impact from decreases in flare and part sales. In sequential terms, sales revenue grew to $2 million from $1.5 million, largely due to increased compressor sales. Year-over-year, total sales gross margins dropped from $1.4 million to $148,000, primarily due to declining sales revenues and margins, alongside higher unabsorbed costs from underutilized compression fabrication facilities resulting from the industry's severe downturn. The total sales gross margin for the second quarter of 2020 was positive at $148,000, compared to a loss of $289,000 in the first quarter of 2020. Second quarter 2020 compressor-only sales were $1.4 million, down from $4.8 million in the second quarter of 2019 but increased from $852,000 in the first quarter this year. Compressor-only gross margins were $990,000 in the second quarter of 2019, compared to losses of $127,000 this quarter and $435,000 last quarter. These losses can primarily be attributed to unabsorbed fabrication costs caused by underutilized facilities. Our sales backlog as of June 30, 2020 was approximately $1.3 million, down from around $1.4 million in the first quarter of 2020. However, we added an additional $400,000 to the backlog in August, bringing our current total to $1.7 million. Rental revenue in the second quarter of 2020 reached $15.1 million, compared to $13.6 million in the same quarter last year and $16.1 million last quarter. Rental revenue was up by 11.5% year-over-year but slightly dipped by 6% sequentially. In comparison to the first quarter of 2020, our average rental rates per unit increased by just over 3% and remained flat on an average per horsepower basis. Reported rental gross margins this quarter stood at 56%, an improvement from the first quarter of 2020 where rental gross margin was 51%, as well as an increase from last year’s second quarter also at 51%. As of June 30, 2020, we had 2,335 compressor packages in our fleet, down from 2,572 units a year prior due to the retirement of 327 units, equating to roughly 40,000 horsepower during the third quarter of 2019. Despite this reduction from retiring some smaller units, our total fleet horsepower grew by 8% to nearly 447,000 horsepower as of June 30, 2020, compared to about 414,000 horsepower a year earlier. This growth includes the addition of 58 high horsepower compressors, representing 68,500 horsepower to our fleet in the past 12 months. 40% of our utilized fleet horsepower is now classified as large horsepower equipment, providing stability in downturns compared to smaller units. Our horsepower utilization for the second quarter of 2020 was 64%, down from 68% in the first quarter, and up from 60% in the second quarter of 2019. Our unit base utilization of 55% this quarter compares to 60% last quarter and 53% a year prior. To illustrate the volatility in the second quarter, our churn metric was 0.1 in April, 0.6 in May, and 1.9 in June. A number above 1.0 indicates unit growth, showing significant variation over just three months. Equipment was rapidly shut in and returned, then later, activity picked up significantly a couple of months later. By the end of June, over half of the rental units that were shut in have resumed service, and we expect the rest to come back over the next year. This downturn was particularly atypical due to its intensity and pace; we typically have time to adjust to declining markets, but there was no time to adapt this time as revenue vanished almost overnight. The worst appears to be behind us, and we are observing a lifting of shut-ins, though we believe it will take the rest of the year to recover what we lost. The speed of the downturn and recovery showcases the resilience of our field organization and our capacity to adjust to unforeseen circumstances. While the situation has been difficult, we have emerged in a stronger position with our customers. Our financial flexibility and ability to accommodate the majority of requests for discounts and shut-ins have positioned us favorably for future business. For the first half of this year, we invested a total of $11 million in capital expenditures, with $9.9 million allocated to rental equipment. Looking ahead, we expect to invest an additional $8 million to $10 million in capital expenditures for the remainder of the year, which is a couple of million more than we projected in our fourth quarter 2019 call. We have a clear line of sight to approximately $6 million in upcoming capital expenditures intended for rental fleet additions of properly sized compressors that we currently need, along with a minor sale-leaseback program with a customer. All of this capital will be invested in long-term contracts at above-market rates. From a balance sheet perspective, our total bank debt is minimal at just over $400,000 as of June 30, 2020, and we are in a strong cash position of $15.5 million. This is an increase from $13.1 million at the end of the last quarter and has grown to around $17 million at the end of July. Additionally, we have a largely untapped credit line of $30 million, providing ample liquidity in almost any situation. This does not include the previously mentioned anticipated $15 million cash tax refund we have applied for. We generated positive net cash flow from operating activities of $6.5 million this quarter, which represents 30% of our quarterly revenue. Free cash flow for this quarter was $2.4 million. In summary, few companies in the oilfield services sector have a recurring rental revenue stream, practically no debt, substantial cash reserves, and the capability to continue generating cash. Before I open the floor to questions, I want to express my gratitude to the entire NGS team for their commitment during this challenging time. Our employees have exhibited professionalism and dedication, managing not only health risks but also providing continuous service to our customers. They deserve commendation. While the remainder of 2020 is expected to remain challenging, we believe it cannot exceed the difficulties from the first half of the year, and there are some encouraging signs on the horizon. More importantly, NGS is well positioned with a robust balance sheet, a solid customer base, and a team dedicated to delivering excellent service. With an operating environment that is stable or slightly improving, we foresee opportunities in the latter part of this year and even more as we move into 2021. Ross, that concludes my prepared remarks, so please open the phone line for questions.

At this time, we’ll conduct the question-and-answer session. Our first question comes from Robert Brown from Lake Street Capital.

Just want to get a little further color on the CapEx you're projecting for the rest of the year and really that sounds like a new contract and maybe what area is that contract covering in the entire horsepower business again, and maybe just some color on what that business is?

Well, just like about everything else in the world, it's centered around the Permian. So the majority of that $6 million we're looking at is Permian base. And probably half of it is, well, 50% to 60% is what we classify as large horsepower and the balance being medium horsepower, where I guess that we're essentially out of but that are required also. So it's a smattering but it still continues along the Permian route and then the large horsepower route.

And then maybe just digging in a little bit into the gas versus the oil market. Are you seeing any recovery or were you seeing kind of the spotty recovery? Is it basin driven or resource driven, or maybe some color on how the recovery is taking place?

Yeah, Permian is providing probably the majority of it. But we have seen more activity in some of the scoop stack stuff, Texas Panhandle along there. So it's a little spread. And actually, we're seeing a little more in the Rockies somewhat. So, the resurgence in activity we've seen is not just concentrated in the Permian from the point of all the CapEx we just talked about, but that's smattering in two or three geographies. So Permian, Mid Continent, and the Rockies would probably be the primary ones that we're seeing most of the regrowth from.

And then the last question on the tax refund. You said $15 million tax refund you’ve applied for. Do you expect that this year and what's the status of that?

I've been chastised about trying to put a timeline on the tax refund from the U.S. government in these times. So I'll diplomatically say that we hope for it this year, but there are no guarantees. We think it should be, but there are no guarantees to it. Of course, the IRS didn’t give you any help as far as timing and the stuff. And obviously, they're busy printing checks for other things, but we're hoping for this year but there's no guarantee on that.

And Stephen, at this time, there appears to be no further questions.

Okay, Ross. I appreciate it. Thank you everybody for joining us on this call. I think we had a good quarter, but we appreciate your time this morning and look forward to visiting with you again next quarter. Thanks.

This concludes today's conference call. Thank you for attending.