Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group's Third Quarter 2020 Earnings Call. At this time all participants are in listen-only mode. Your call leaders for today's call are Alicia Dada, IR Coordinator; Steve Taylor, Chairman, President and CEO. I'll now turn the call over to Ms. Dada. You may begin.

Thank you, Erica, and good morning, listeners. Please allow me a moment to read the following forward-looking statements 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 outlined in the Private 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, 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.

Thank you, Alicia and Erica, and good morning, everyone, and welcome to NGSG's third quarter 2020 earnings review. Thank you for tuning in to our call. In my nearly 40 years in the energy industry, I've never experienced a more challenging environment in which to work. Pervasive weakness in energy demand and volatile commodity prices have created unprecedented financial and operational challenges for all of Natural Gas operators, and as a result, the suppliers and service providers are working alongside them. While NGS is fortunate to have been well-positioned during this period of extraordinary pain for the energy industry, no company is entirely immune from the impact of these sharp and prolonged challenges. That said, and as we noted last quarter, our ability to act rapidly to reduce our cost structure and respond to our customers' needs resulted in less impact than many of our peers on both our financial and operational condition. While sales and service revenues declined in the quarter, our rental revenues were solid and grew on a year-over-year basis, only very modestly affected this quarter. Though gross margins came in at 50% and adjusted EBITDA was 35% of revenue. Although not unusual, especially in downturns, we've seen a higher degree of volatility in our compressor sales business. This is primarily due to customers' budget cuts and the current reluctance to restore them in any appreciable manner. Compressor sales are already at a relatively low level from last quarter and were severely impacted this quarter by customer redesigns, push delays to completion of compressor sales jobs, and capacity constraints due to committed higher-margin contracts displacing sales projects. As noted in our financial statements, we did not have any material compressor sales in the third quarter. Though we have not had any cancellations to work and our backlog carries forward, we are confident our compression sales business will strengthen as the market begins to firm. More importantly, in such a challenging operating environment, NGS continues to strengthen its balance sheet and liquidity position. The company generated positive net cash flow from operating activities of $13.1 million and a free cash flow of $12.1 million during the quarter. At the end of the September quarter, NGS had a cash position of $27.6 million, compared to $15.5 million at the end of the second quarter. Our cash position continued to increase through October.

Ladies and gentlemen, at this time we will conduct a question-and-answer session. Our first question comes from Rob Brown from Lake Street Capital. Please state your question.

Good morning, Steve. Nice execution in a pretty tough environment, as you laid out, I think. My first question is really around the CapEx and Q4. Maybe characterize kind of what's driving the type of projects that you're filling, high horsepower, what comprises it, maybe just clarify that the CapEx of Q4?

Yes, it's made up of primarily two components. One is we have a pretty good order for some 400 to 600 horsepower equipment, and that's what I mentioned; our high horsepower utilization was at 9% at the end of Q3, but it's actually timed about 93% already because the equipment that was idle temporarily at the end of the quarter has now been utilized and committed, and then we're building some more. So it's primarily that, and then we've also got discussions in the past regarding the potential for some leaseback purchases, purchasing some new equipment from customers and renting it back to them. So those two pieces are the biggest part of that. I think the leaseback is pretty interesting from the point of view that it provides some capital to a customer. It's equipment that we actually built for them in the past, and we get to convert it into rental revenue with good ranks and long-term contracts. It's interesting, especially in this environment, that there's at least one customer looking to monetize equipment they own and just lease it back. Probably the two biggest components, with the biggest risk to that CapEx number, is really timing; it's not that the projects will happen, but this is mid-November, we have holidays coming up and everything else, and that's always a crunch time to get into the year-end to see whether projects get done or whatever it is. So the numbers are pretty solid, we think. If there's any wavering to it, it would be timing, not commitments. So, those two components are the biggest parts of that.

Thanks, Stephen. And then in utilization and kind of the bottoming in the industry. You said utilization was sort of stable quarter-to-quarter here. How much visibility do you have on sort of units coming back and going out, and maybe a sense of how the utilization plays out over the next few months? I know it's hard to predict exactly, but do you sort of feel like it's bottomed here?

Yes, I think it's bottomed, but I think there are still going to be some fits and starts in this situation. The discussion everywhere is never a straight line up; it's pretty jagged, you'll have some downs and ups and everything else. I think the bias is positive. We still have some shedding of equipment that we anticipate coming back on, a few analysts' reports are based fairly positive on oil prices next year, but of course, those reports are good the day they're written, and anything can change them. So yes, I think the bias for positive utilization is good. But there's going to be some ups and downs to it. I think 2021 is actually going to be a fairly good year. This year has actually been a lot better than I would have guessed back in March when all this stuff happened, because it was down pretty fast. But our team has done a great job of taking care of recovering it and continuing on while managing costs, obviously. So, I think we'll see a trend upwards, but it's hard to say what that slope will be.

Okay, and then the last question is really on the competitive environment and how this plays out. Are you seeing any changes there? Is it about what you expected and pretty similar to historical cycles?

Yes, it's what I expected and it is in line with historical trends that we tend to see. Some questionable pricing in the market. So both of those, where you typically see those in downturns, especially from players who aren't as financially strong as we are. We're able to pick and choose the jobs we want at the prices we want, stuff like that. If we want to hold prices, we can; if we want to get aggressive, we can, but we've got the choice to do that. A lot of competitors don't have a choice due to their financial issues. But we see some weaker pricing out there. It's probably not as much as you would have guessed six months ago due to just the rapidly changing circumstances. But we still see select challenges now. I mentioned our prices are down 2% to 3%. You'll get a little drag in pricing as we put more larger horsepower out there, because bigger horsepower costs less dollars per horsepower. So your rental looks like it's down, but actually, it's good pricing. The decrease we saw on a unit basis was, as I mentioned, primarily due to pricing from Q2, coming into full force and being felt throughout the quarter. So we expect to regain some of that over the next two or three quarters anyway, as operators start, number one, putting the equipment back to work from a standby basis. And also, as things solidify going into the new year, we want to approach those customers to provide some discounts too and discuss potentially reclaiming those lost revenues. The 2% to 3% decrease is explainable and reasonable and expected, but I don't think that'll continue. We do see some awkward pricing from time to time but again overall, probably not as bad as you would have thought six months ago. But it's still a little more than I would like.

Okay, great. Thank you. I'll turn it over.

Thanks, Rob.

Our next question comes from Tate Sullivan. Please state your question.

Thanks. So, thank you, Steve. Good morning. Can you talk a little more about the leaseback purchases? I was just looking at your sales. $60 million of sales of compressors and other equipment understandably since the end of 2016. Is this an active market historically in the natural compressor and natural gas compressor industry? Or is this new? I have not heard you talk about this before. And are you uniquely situated to take advantage of customers that want to monetize some of their equipment?

Yes. I admit that probably over the last couple of quarters, we are uniquely situated to take advantage just because we have the funds. When a customer wants to monetize, you have to pay them something. So we have the flexibility to do that. It's not a big market. Typically, when someone approaches you on that stuff, it's equipment we don't want. There's a reason why they're trying to monetize it; they don't want it either, and not because of financial issues, but maybe the equipment is older than they want or in worse shape or something like that. So most of these things don't take very long to look at and assess whether we're interested, or they don't fit our fleet makeup, or they're smaller horsepower—there are all kinds of reasons. This opportunity came to us because of a customer we've dealt with for a long time and do a lot of work with over the years. And it's not really a situation of a customer having to have cash, I guess, from the perspective of being financially in bad shape or something like that. This is good. It's more about customers now looking at, 'You know what, I've got a finite amount of dollars. I can spend it on drilling or I can spend it on equipment. Drilling generates my revenue. That's where my return comes from, that's my expertise. Why don't I go ahead and spend money on that and rent equipment?' Renting provides some advantages—not only avoiding the CapEx you have to spend but also operationally, we take care of all this equipment. If you need to downsize or upsize it, we can accommodate it. The customer doesn't have to go out and buy another unit and try to figure out what to do with the old equipment. I think when you start to see downturns as severe and rapid as this, along with the market demanding cash returns from operators, they lean more towards rentals. We don't actively market this capability, but as I mentioned, I think we can take advantage of them as they come along. We have $3 million or $4 million allocated to it, and I think it will happen. The only question is timing to operate and getting the necessary equipment quick enough.

Okay, thank you. And you answered my question earlier on some of the timing of that CapEx in the quarter. And the good order you mentioned for the 400 to 600 horsepower. If you can share roughly, that size horsepower, the average rental term lengths versus your larger horsepower? Have you talked about that before, Steve?

We're getting two to three years on those on the 400 and 600 horsepower. So we're getting good terms on them and market-leading rates on them too. So just like any other CapEx, we're not spending any CapEx on deals—we're not trying to use our money to gain market share or anything else. We're aiming to use our funds to generate profit. So we want longer terms and we want better rates, so we don't have to spend money unnecessarily. We know this, and that's what we consider from those standpoints. But that's the other $7 million to $9 million this year. It's all pointed to and dedicated to longer terms and higher rates.

The larger horsepower units, particularly the equipment that you've built in the last year and a half, are they typically more than a year in rental terms as well? And I understand that can change based on...?

Yes. The biggest ones, say, the 1,400 horsepower units, yes, we typically go for three to five years on those. We want a good long term on that equipment, and it's not too hard to get that sometimes. It depends on the customer, obviously. But the equipment is so big and so expensive, takes so much time to install and operate, and the customers are paying for a lot of this—the installation, the freight, and all this other stuff—that I would dare say you couldn't rent it on a one-month term. It's going to stay out there for a long time. But obviously, we like the security of contracted rentals. Generally, the bigger the equipment, the longer we go on terms, and then that kind of mid-horsepower will be mid-term of two to three years. Smaller equipment typically is on 12-month terms. Not only do we try to extend terms overall for all equipment, but we also aim for longer rental periods and security with it.

Thanks. And last one for me. I know the whole industry is shifting more towards renewable energies going forward. Have you ever discussed that? More utilities are mentioning trying to integrate renewable natural gas into pipelines, and I think some of that process needs compressors. Has that market ever been an opportunity for you, or can it be going forward?

Yes. I guess it hadn't been a big market in the past just because the focus hadn't been on the SG part of it as much. Now, obviously, that's growing. And natural gas, by virtue of being a cleaner fuel, is going to gain traction in some of that and contribute to a better environment, cleaner air, etc. But I think there are opportunities to capitalize on that. Yes, we feel like we've already got some real clean equipment from the standpoint of the engines, which are tightly controlled from an emissions perspective. Every one of our engines in the fleet meets or exceeds the most stringent state regulations. I hesitate to say—we exceed all state regulations, but certainly the vast majority. We decided to adopt that standard some time ago. So we have really clean engines. The skin itself is different; it gathers fluids, etc., and we have some recycling components on the units to conserve oil and capture gas, and so on. But I think there is more opportunity to improve not only mechanically and physically regarding the equipment but also to adequately market that to customers so they're informed. I believe customers are becoming more and more sensitive to clean equipment versus not-so-clean equipment. I think we've got an advantage and can gain market share in that segment. However, there is more to do, and you'll see us placing more emphasis on that area.

Thank you, Steve, for all the comments. Have a great rest of the day.

Okay. Thanks, Tate.

At this time, we have no further questions.

Okay. Thank you, Erica, and thanks, everyone, for joining me on the call. I appreciate your time this morning. Hope your holidays are healthy and happy, and wish each of you a more prosperous new year. I look forward to speaking with you about NGS in 2021. Thank you.

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