Natural Gas Services Group Inc Q2 FY2025 Earnings Call

Good morning, everyone, and welcome to the Natural Gas Services Group, Inc. Quarter 2 Earnings Call. I will now hand the call over to Ms. Anna Delgado. Please go ahead.

Thank you, Luke, and good morning, everyone. Before we begin, I would like to remind you that during the course of this conference call, the company will be making forward-looking statements within the meaning of federal securities laws. Investors are cautioned that forward-looking statements are not guarantees of future performance, and those actual results or developments may differ materially from those projected in the forward-looking statements. Finally, the company can give no assurance that such forward-looking statements will prove to be correct. Natural Gas Services Group disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. Accordingly, you should not place undue reliance on forward-looking statements. These and other risks are described in yesterday's earnings press release and in our filings with the SEC, including our Form 10-Q for the period ended June 30, 2025 and our Form 8-K. These documents can be found in the Investors section of our website located at www.ngsgi.com. Should one or more of these risks materialize or should underlying assumptions prove incorrect, actual results may vary materially. In addition, our discussion today will reference certain non-GAAP financial measures including EBITDA, adjusted EBITDA and adjusted gross margin, among others. For a reconciliation of these non-GAAP financial measures to the most directly comparable measures under GAAP, please see yesterday's earnings release. I would now like to turn the call over to Justin Jacobs, Chief Executive Officer. Justin?

Thank you, Anna. Good morning, everyone. Joining me today is Ian Eckert, our Chief Financial Officer. Before I begin with my formal remarks, I want to start by thanking the entire NGS team, including our first-rate team of field service technicians. Your unwavering dedication to our customers and the company is driving these results. I appreciate each member of the NGS team. Now, let’s discuss the second quarter. We had a record quarter across several key metrics driven by exceptional field service, the performance of our smart-enabled large horsepower fleet, and disciplined execution by the NGS team. Rented horsepower finished the quarter at an all-time high, reflecting fleet growth and improved utilization. Furthermore, rental revenue and rental gross margin were strong due to increased rented horsepower, a continued shift to larger horsepower units, and higher pricing. Second quarter adjusted EBITDA was a record $19.7 million, and first half adjusted EBITDA was $39 million. These results, along with a favorable outlook for the second half supported by new large horsepower unit deployments, led us to increase our 2025 adjusted EBITDA guidance to between $76 million and $80 million. In July, we initiated our first quarterly dividend, another measure to enhance shareholder returns. Our Board also authorized a share repurchase program, which we will discuss shortly. Both moves emphasize our strong cash generation and the confidence we hold in our outlook. It’s crucial to understand that returning capital does not exclude growth. With ample liquidity and balance sheet flexibility, we can continue to support our organic growth strategy while being poised for accretive M&A opportunities as they arise. As we expand, increase cash flow, and further strengthen an already robust balance sheet, we aim to enhance our capital return programs in ways that will boost shareholder value. We are also laying a strong foundation for 2026 with new contracted units and an active pipeline of opportunities, including several that position us to displace competitors and continue capturing market share. In short, we believe NGS is in the strongest position in the company’s history. Turning to the broader market, we delivered strong results throughout the first half of the year despite ongoing market volatility and global macroeconomic uncertainty. While these conditions continue, we are confident in raising our 2025 outlook, driven not only by our results but also by feedback from our customers. To us, that is the best indicator for planning. This brings me to the macro factors driving our optimism despite market uncertainty. First, our customers. As they focus on enhancing production uptime, they work together to reduce costs, aware that any market challenges need to be offset by efficiencies. This trend was evident among operators reporting this quarter and aligns with our discussions with them. Second, even if WTI prices decline further and investments slow, our oil-related business is linked to production, which is expected to remain stable with rising demand for compression. Third, demand for natural gas is projected to grow by over 30% in the next five years, significantly higher than our historical experiences. Market expectations indicate substantial growth in LNG exports, AI data centers, and overall power generation, making natural gas compression crucial for supporting this growth across major oil and gas basins in the U.S. Compression is vital for production throughput, and with the enhancements we’ve made to our platform, infrastructure, and technology, as well as the upgrades to our team, we believe NGS can compete effectively in today's market. Our market share gains reflect this. We believe customers will keep their focus on capital discipline while prioritizing throughput, reliability, and emissions performance, conditions that favor outsourced compression and the advanced technology of the NGS fleet. Finally, regarding tariffs, we do not anticipate a significant impact at this time. Our vendors and suppliers are predominantly based in the U.S., and our exposure will largely involve second-order effects through raw materials and components. Given these factors, we maintain confidence in 2025 and expect ongoing momentum into 2026, bolstered by contracted large horsepower units and several large-scale opportunities and RFPs tied to both rising energy demand and the requirement for better competitive solutions. Now, let’s move to the key growth and value levers I’ve mentioned in previous calls. First, we’re optimizing our fleet assets, making solid progress last quarter. We're enhancing our systems platforms to elevate our smart and other unit technologies. We're leveraging operational data more effectively to optimize resources, improve uptime, and identify further growth and cost-saving opportunities. Second, related to asset utilization, we finished the quarter with approximately 30 days sales outstanding. For historical context, we've reduced accounts receivable by $25.4 million, and considering the larger scale of our current business, we've cut working capital by roughly $31 million. We still believe that monetizing noncash assets in 2025 and early 2026 can match or exceed the cash we unlocked in 2024. Our income tax receivable is under review by the joint committee on taxation, and we anticipate providing further updates next quarter. Lastly, our Midland fabrication facility is now classified as held for sale, and we remain focused on monetizing our real estate. As I've told our team, we are in the rental compression business, and I want all our owned assets deployed in the field. Additionally, monetizing noncash assets will provide extra capital for our fleet expansion. To illustrate how we evaluate organic growth, we can divide growth CapEx by EBITDA. Based on public disclosures, our larger peers are expected to invest an average of about 30% of EBITDA in growth for 2025. Our guidance suggests around 140%. This significant gap highlights the strength of our balance sheet and emphasizes that we are gaining market share. I should mention that our market share gains also took place in 2023 and 2024. We continue to add contracted gas engine and electric motor-driven large horsepower units, and our existing large horsepower fleet assets are operating at very high utilization. The M&A market remains active, and we foresee more activity in the second half of the year. We believe we’re operating from a position of strength and will remain disciplined in our M&A approach, targeting strategic accretive opportunities at fair valuations. Before I turn it over to Ian, I want to address a personnel transition mentioned in our release. Brian Tucker, our President and COO, will transition out of these roles with an expected conclusion at the end of October 2025, with a possibility for an extension. His transition is solely due to an unexpected family loss, the passing of his wife. I want to share a brief message I sent to all NGS employees. After unexpectedly becoming a single parent to five wonderful kids, Brian has endured a tremendous personal and logistical burden while maintaining leadership in this company with integrity and purpose. I can’t express how challenging this burden has been, and I know I could not have managed it with the same level of courage, grace, and optimism that he has shown. We will miss Brian, both personally and professionally. We are confident in the strong leaders who will take on his responsibilities, and we anticipate a smooth transition based on the team’s capability and Brian’s integrity and character. Thank you, Brian. You will always be part of the NGS family. Now, I’ll turn the call over to Ian to review detailed financial and operating results.

Thanks, Justin, and good morning, everyone. From a financial standpoint, the second quarter played out as follows: Total revenue was $41.4 million, up 8% from $38.5 million in the prior year quarter. Sequentially, total revenue was flat as the first quarter benefited from inventory liquidation tied to the Midland fabrication wind down. Rental revenue increased 13% compared to the prior year quarter to $39.6 million and was up 2% sequentially. Total adjusted gross margin was $24.2 million, up $3.2 million year-over-year and down $0.1 million sequentially. The sequential change primarily reflects idle facility costs related to the Midland closure. Net income was $5.2 million or $0.41 per diluted share, up $0.9 million year-over-year and $0.3 million sequentially, driven primarily by rental equipment retirement activity in the first quarter, partially offset by higher depreciation associated with new unit sets in the second quarter. Adjusted EBITDA was $19.7 million, up $3.2 million year-over-year and $0.4 million sequentially. Operationally, our fleet expansion continues. Rented horsepower ended the quarter at approximately $499,000, up from roughly $455,000 in the prior year quarter and $493,000 in the first quarter of 2025. Year-on-year, total rented horsepower increased 10%. Fleet utilization was 83.6%, an improvement of 130 basis points year-over-year. Essentially, all large horsepower equipment is 100% utilized. Rental revenue per average horsepower per month was $26.62 versus $25.91 a year ago, up 2.7%. As of June 30, about 80% of total rented horsepower is on term contracts, up from about 67% a year ago. The average remaining tenor of contracted units is 2.5 years. These new fleet assets helped to deliver cash from operations of $11 million in the quarter, supported by continued collections improvement as our DSO was roughly 30 days at the end of the quarter. Capital expenditures totaled $25.8 million, including $22.1 million of growth CapEx and $3.7 million of maintenance CapEx. Sequentially, growth CapEx rose by $5.4 million, reflective of the new horsepower planned for the back half of the year. We ended the quarter with $182 million outstanding on our upsized revolver and $172 million in available liquidity. Our leverage ratio was 2.3%, up modestly from 2.1% in Q1. Despite what some of our large competitors may claim, this is the lowest leverage level of any of the public comparables, and it is the lowest by a significant amount. Finally, the held-for-sale designation for the Midland fabrication facility reinforces our intent to monetize real estate. As it relates to capital returns, our approach remains disciplined and balanced. We recognize that market expectations for our dividend are for a profile that is flat to up. While we are not providing specific dividend guidance today, our objective is to deliver a growing dividend over time, supported by cash generation. With respect to share repurchases, we would like to set expectations. The approach to a repurchase program can be on a spectrum. On one end, it's programmatic, for example, buying x percent of shares outstanding each quarter, and on the other end, it's highly opportunistic and valuation sensitive. We will very much be on the opportunistic and valuation-sensitive side of that spectrum. Therefore, you should not expect frequent repurchases, but we will be happy to reward our shareholders if the market discounts our future performance. Overall, the second quarter reflects strong execution and healthy demand, and our balance sheet positions us well for organic growth and disciplined M&A. Justin, back to you.

Thanks, Ian. Looking ahead, here is our outlook for 2025. Based on our year-to-date performance and a strong second half deployment schedule, we are raising our 2025 adjusted EBITDA outlook to $76 million to $80 million from $74 million to $79 million, a 2% increase at the midpoint. We expect 2025 growth capital expenditures of $95 million to $115 million, a slight tightening of the range due to increased visibility on specific timing. I would note that more than half of the full year guidance will be deployed in the second half. Looking beyond 2025 and into 2026, we're going to refrain from providing guidance at this point as it's simply too early in the process. However, I would like to provide some perspective using the growth to CapEx to EBITDA framework I discussed earlier. As of today, with what we already have contracted for 2026. We expect again to outpace our larger peers when looking at growth CapEx to EBITDA. As we are only in August, I expect the contracted number for 2026 to go up. Once again, this is but one more indication to me that we have taken market share over the last several years, and we will continue to do so in 2026. Our 2025 maintenance CapEx is expected to be $11 million to $14 million, and our guidance on return on invested capital is unchanged. To summarize our comments today, contracted growth is strong. Rental demand is healthy, our capital allocation framework remains focused on creating long-term shareholder value. We are optimistic about the second half of 2025 and beyond. We continue to make enhancements to our technology and our service offerings. We plan to utilize our strong financial position to capitalize on growth opportunities that add value for our customers and our shareholders. Operator, I'm ready to open up the line for questions.

And our first question comes from Rob Brown with Lake Street Capital Markets.

I would like to start by discussing the opportunity pipeline. You mentioned that you're pursuing new growth contracts and potential opportunities. Can you provide some insight into the areas where you're seeing activity and what the expected timing might be for these, possibly considering 2026?

Sure. To address the timing first, we are focused on 2025, which is pretty much secured at this point. When it comes to new units, the emphasis is primarily on 2026. We're actively continuing our work on existing units for 2025. However, for new units, the significant focus will be in 2026. The majority of our business is in the Permian, where we are identifying a lot of opportunities from a revenue standpoint. We are also discovering prospects in various other basins across our business, so it’s a broad-based situation with the proportion of opportunities aligning closely with our current business mix.

Well, go ahead, please.

I'm sorry, Rob, did we lose you there?

Sorry. I'm here. And second, I just wanted to touch base on the gross margins, strong in the quarter again. Just wanted to get a sense of your view on the sustainability of the rental gross margins and how you see that sort of trending.

Sure. So I think they are sustainable when you look over the last number of quarters as you look over the last year, all the quarters have been in kind of those low 60s, we believe those numbers are sustainable.

Our next question comes from Selman Akyol with Stifel.

Firstly, I appreciate the kind words for Brian; they are heartfelt. That was very nice. You mentioned taking market share multiple times, and I would like to know why you believe that's happening. Additionally, in your opening comments, you spoke about emissions. I'm curious if that is influencing your market share gains.

Sure. The simplest way to assess our position in the market is by examining publicly available figures. The three largest companies account for approximately 75% of the rental compression market. When I analyze the growth capital expenditures from both them and us over the past few years, it seems mathematically impossible for us to have done anything other than gain market share. This provides a clear framework for my assessment. Additionally, we observe various opportunities, including the potential to displace competitors, both with our existing units and with new growth. Regarding emissions, we have a relatively new fleet, particularly on the large horsepower side, and the emissions profiles of these units are appealing to our customers. We believe this is one of several factors that influence their decision to choose us for additional equipment.

Got it. I understand that you’re not providing guidance for 2026. However, can you share how 2026 compares to what 2025 looked like a year ago? Are customer conversations taking longer, staying about the same, or is there anything else you can mention?

It's a bit challenging for me to make a good comparison. This is largely due to the significant numbers we've experienced in the past, particularly related to specific customer orders. Therefore, I don't have anything from a timing perspective to draw any year-over-year conclusions.

Got it. And then just in terms of leading-edge pricing, still up and to the right, but at a slower pace?

I think we're seeing kind of expectation of certainly, inflation is not at 9%. I didn't see what the report was this morning, but it's more modest levels of inflation, at least more closer tied to historical norms is our expectation and what we're seeing out there.

Our next question comes from Connor Jensen with Raymond James.

Justin, saw that the total horsepower fell while the rented horsepower continues to rise. Were there any divestments or retirements out of the noncore fleet during the quarter? And how should we expect the kind of divestments to go as the year progresses?

We are continuously reviewing our fleet to determine where to invest our capital. We previously mentioned that we would assess the fleet regularly, particularly focusing on small and medium horsepower. This involves small transactions related to the sale or retirement of some equipment. This ongoing review has included a slightly larger component in the second quarter.

Got it. That makes sense. You mentioned new opportunities from gassy basins as operators aim to increase volumes to satisfy LNG needs. Are you considering pursuing many of these opportunities, or is there currently sufficient demand in the Permian with rising associated gas and gas-to-oil ratios to meet your requirements for now?

We are exploring new opportunities in all the basins where we operate. In previous calls, I've mentioned that we are noticing some positive signs in certain gas-rich basins, which presents an opportunity for our smaller horsepower operations close to the wellhead. This is generating additional demand for larger horsepower and increased gathering and midstream services.

Our next question comes from John Daniel, Daniel Energy Partners. Go ahead, please. Let me try that again. Go ahead, Mr. Daniel.

All right. Sorry. Can you hear me okay, Justin?

Yes, we got you, John.

First one on the inquiries, how much of the inquiries today are coming from potential new customers versus existing customers?

If I look at the dollar basis overall, I would say it clearly skews to existing customers. With that being said, there are a number of new customer opportunities that we're looking at and the consolidation, or I should say, kind of M&A that's occurring on the operator side in terms of both acquisition and divestiture is creating really new customer opportunities for us. And so it's across the board, although I would say overall, clearly, the dollar amount is weighted to existing customers.

Okay. Got it. And then this is sort of a housekeeping question. I probably should know the answer to this, but can you remind me on sort of the useful life of the equipment and some of your competition has been around for a long time. I'm curious, is there a replacement cycle about to hit everyone on the head 3, 5, 7 years from now?

The answer that is if you properly maintain the equipment and Ian, you can correct me here. I think the book life that we have for small horsepower is 15 years, mediums 20 and large is 25. You're getting into these large assets, assuming that the equipment is maintained properly with both the engine or drive capital plan and the compression frames. I think you can clearly see equipment that lasts longer than 25 years. With that being said, that requires significant capital, which is baked into all of our different projections and guidance to make sure that we do that.

Okay. Fair enough. The last question might seem easy, but it’s not intended to be. With everything going so well and you continuously delivering strong results, what would you say is your biggest stress point?

I think as I look at the risks across the business, or maybe I put it differently and say, challenges, I'd put them in two buckets, those which we can control and those which we can't. Those which we can't are obviously macro and commodity prices and volumes. And we can plan and scenario analysis around that, but we can't control those. So I try to focus both myself and the organization on what are the things that we can control. I think the challenges that we see in the business are ones that we've been talking about for a number of quarters, and those are labor first and foremost, especially in the Permian Basin, that's right at the top of the list. We have opportunities in our business in terms of better utilization of the fleet, and I think we are starting to see some results around that opportunity. As Ian mentioned, large horsepower is effectively 100% utilized. So this is an opportunity in the small and medium where I think we're taking some steps there. I think we have more work to do, which I think we're going to do over time. So those are a couple, and then what happens in terms of '26 and demand. We stay in close contact with customers, obviously, and we just plan for different scenarios and control what we can control.

And our last question comes from Selman Akyol with Stifel.

All my questions have been answered. I'm good.

Thank you very much. We don't have any other questions.

Thank you, Luke, and thank you for all of your questions and your continued interest in NGS. We sincerely appreciate your support, and we look forward to updating you on our progress next quarter.

And this concludes today's conference call. Thank you, everyone, for attending.