Natural Gas Services Group, Inc.

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group, first quarter 2020 earnings call. At this time, all participants will be in the listen-only mode. Operator assistance is available at any time during this call by pressing star zero. Your call leaders for today's call are Alicia Dada, IR Coordinator, and Steve Taylor, Chairman, President, and CEO. I would now like to turn the call over to your host, 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 risk and uncertainties, which may cause Natural Gas Services Group 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 captioned risk factors in the company's annual report on Form 10-K filed with the Securities and Exchange Commission. Having all this stated, I will turn the call over to Stephen Taylor, who is President, Chairman, and CEO of Natural Gas Services Group. Steve?

Thank you, Alicia and Ross. Good morning, everyone, and welcome to the Natural Gas Services Group's first quarter 2020 earnings review. Thank you for tuning in to our call. The COVID-19 pandemic has had an impact on our industry and business activity. but NGS continues to provide quality service to our customers and we have seen no material impact on our supply chain or critical vendors. We have adopted remote and staggered work processes at our Midland headquarters and have adapted our field and fabrication work to meet the new realities from the COVID virus. We have implemented guidelines intended to keep our employees, our customers, and suppliers as safe as possible. We have managed to do so without adding significant costs to our operation. We continue to be vigilant to find ways to remain as efficient as possible in this environment of new operating challenges. The impact of COVID-19 and the resulting oil demand destruction continues to cloud our visibility for short-term business prospects. In April, as expected, we experienced more unit returns and shedding notices from customers, and we anticipate and are prepared for additional volatility in our business over the course of the next several months. Nevertheless, unlike many other oilfield service companies, NGS has the balance sheet to withstand this environment. With $13.1 million in cash on hand, minimal debt, a $30 million credit line, and an expected $15 million cash tax refund, we have adequate liquidity and are well positioned to emerge intact when a more normal industry and economic environment returns. We anticipate impact to our business going forward from equipment being returned, the associated lower utilization rates and revenue, and margin pressure. Our larger horsepower installations are faring relatively well, but the medium horsepower equipment will be impacted the greatest. Interestingly, our smaller horsepower units, which are generally oriented towards the production of natural gas, now a relatively valuable commodity, may get by relatively unscathed. That's not a promise. There are no promises anymore, but we're seeing some isolated instances where that might be the case. We've implemented various cost-cutting measures with respect to operating and capital expenses, including reductions in our headcount from layoffs and attrition, wage freezes, centralization of certain processes for better cost control, and the enlistment of our suppliers in our cost-cutting efforts. We continue to review additional opportunities to become more efficient, including combining and reorganizing field operations to reduce the number of operating locations. Our rationalization of costs is a multifaceted process that has started, is continuously being implemented, and will not go away for the foreseeable future. I also want to remind everyone of the flexibility and resilience of the NGS business model. Being on the production side of the energy business, as opposed to the drilling side, conveys an inherent advantage. We are the last vestige of an operator to make money when they stop drilling. Wells that need compression never unneed compression, and although wells can be shut in, some production has to be maintained to keep even a minimal amount of revenue rolling in. Does this insulate us from this downturn? Absolutely not, but it does give us a preferred position in the oil field services structure hierarchy. That's our macro advantage, but we also have a number of microeconomic, company-specific advantages. As you know, if you followed NGSE in a short time, Our model is demonstrably different from our competitors. We have operated for years throughout all kinds of cycles, essentially without debt, and we typically have an appreciable amount of cash on a balance sheet. We retain the ability to generate cash for a rental business, and we have always been one of the first to cut capital expenses to an extremely low level in an accelerated manner. Our playbook is the same this time, but it is being implemented in an even quicker manner due to the extreme downward slope in the industry. In spite of the pressures on the industry and our business, I feel certain we will emerge in a preferred position, both financially and as a superior provider of equipment and services to our customers. So, with all that said, I'll discuss the financial results as well as pertinent operating and market comments. Given the challenges in our industry and the overall economy, we are pleased with our operational performance in the first quarter of 2020. Our rental revenue increased 5% sequentially and 20% when compared to the first quarter of 2019. It was driven by increased rentals of our large horsepower units. Our unit and horsepower utilization remained solid, and we generated an adjusted EBITDA of $5.8 million, an increase of 11% over the fourth quarter of 2019. Our operating cash flow for the quarter was $8.3 million. Looking further at revenues, NGS reported total revenue of $17.9 million for the first quarter of 2020, a $100,000 decrease from the same quarter in 2019. We experienced an increase in rental revenues of 20% that decreased in both sales and service maintenance revenue streams. Sequentially, total revenue decreased by 9%. More importantly, rental revenues increased 5% sequentially. Not unexpectedly, sales revenues decreased due to a drop in compressor sales. In a capital constrained environment, we would expect sales revenues to remain soft in the coming months as companies have significantly reduced capital spending. Toll adjusted gross margin for the three months ended March 31, 2020 increased by 3% to $8.1 million from $7.9 million for the same period ended March 31, 2019. Adjusted gross margin, which does not include depreciation, as the percentage of revenue for the three months ended March 31 was 45%, an increase from 44% year-over-year. Sequentially, adjusted gross margin for the first quarter of 2020 also increased by 3% to $8.1 million from $7.9 million from the prior quarter. Adjusted gross margin as a percentage of revenue increased to 45% in this quarter compared to 40% in the prior quarter. Selling, general, and administrative expenses were $2.2 million. A year-over-year decrease of approximately $330,000 and a decrease of approximately $580,000 sequentially. The main reason for the year-over-year decrease is due to a credit of $350,000 related to the company's reduced deferred compensation liability. Without this, the first quarter of 2020 SG&A would have been relatively flat compared to the first quarter of 2019. Sequentially, the $580,000 decrease is also related to the lower deferred compensation liability and lower stock compensation expense. Our adjusted SG&A expenses generally run at 13% to 14% of total revenue and continue to do so. Operating income for the first quarter of 2020 was a loss of $273,000 compared to a loss of $145,000 in the first quarter of 2019. The adjusted operating loss this quarter was due to lower sales, lower rental margins, and higher depreciation expenses on our lowered horsepower equipment. Sequentially, operating income increased $608,000 from an adjusted operating loss of $881,000 in the fourth quarter of 2019. This increase was primarily driven by higher rental revenue, lower SG&A, and higher rental margins. Our adjusted net loss after tax for this quarter was $808,000. This compares to a net income of $98,000 in last year's first quarter and a $1.4 million adjusted net loss in the fourth quarter of 2019. Quantifying the loss for this quarter, our net loss before tax was $461,000, So almost $350,000 of the bottom line net loss this quarter was attributable to deferred taxes, with another $300,000 related to a loss in our fabrication facilities. As far as reported net income, our net income will be a positive $4.1 million. Fortunately, due to our recent change in tax laws, were able to claim net operating loss carrybacks and recoup some past cash income taxes. This will result in a total of $15 million in actual cash tax refunds, of which $4.9 million is the income tax benefit recorded this quarter. NGS reported earnings for the losing share of $0.30 for the first quarter. EBITDA is Earnings Before Interest Taxes, Depreciation, and Amortization, and our adjusted EBITDA also excludes any increases in inventory allowance. Adjusted EBITDA for the three months ended March 31, 2019 was $5.8 million, a slight increase from $5.7 million the same period in 19. Adjusted EBITDA increased approximately $580,000 sequentially from $5.2 million, primarily due to higher rental revenues and lower SG&A. Total sales revenues, which include compressors, flares, and product sales, decreased 65% or $2.7 million on a year-over-year basis. Sequential sales revenue decreased to $1.5 million from $3.9 million. Approximately 70% to 80% of these declines, depending on the quarter, were driven by lower compressor sales. First quarter 2020 total sales gross margin was a loss of $289,000. This was a result of unabsorbed costs in our fabrication facilities. primarily due to lower plant throughput and our retention of incremental personnel and compared to positive gross margins of $426,000 in the first quarter of 2019 and $358,000 in the fourth quarter of 2019. First quarter 2020 compressor-only sales decreased from $2.7 million in the first quarter of 2019 and $3 million in the prior quarter to $852,000 this quarter. Again, due to unabsorbed costs, compressor-only sales margin posted a loss of $435,000 for the three months ended March 31, 2020, compared to a loss of $30,000 for the same period a year ago and a profit of $76,000 last quarter. Our sales backlog as of March 31, 2019 was approximately $1.4 million compared to approximately $2.2 million in the fourth quarter of 2019. I'm sorry, that backlog of $1.4 million was this quarter. Our rental revenue continued to grow in the year-over-year sequential quarters. Rental revenue in the first quarter of 2020 was $16.1 million compared to $13.4 million in the first quarter of last year and $15.3 million last quarter. This is a rental revenue increase of 20% and 5% respectively. Compared to the fourth quarter of 2019, our average rental rates on a per unit basis increased 7% and we're at 4% on average per horsepower basis. Rental rates increased by an average of 18% per unit in the year-over-year quarters, mainly due to our continued penetration into the larger horsepower market. This is a large per-unit rental rate increase over the past year. Now, I'm going to brag about it, but remember that almost all the rental fleet equipment added last year was large horsepower and carries much higher rates per unit than our average unit. Reported rental gross margins this quarter were 51%, an increase from fourth quarter 2019 rental gross margins of 47%, and a decrease from last year's first quarter of 54%. Fourth quarter rental margins were negatively impacted by the previously mentioned $620,000 bad debt charge. Without the bad debt charge, gross margins sequentially would have been flat at 51%. Fleet size at the end of March 2020 totaled 2,316 compressors or 437,750 horsepower in addition of 12 units or 8,100 horsepower during the first quarter. As of March 31, 2020, 37% of our utilized horsepower is classified as large. Over the past 12 months, we have added 86 new fleet units totaling just above 72,000 horsepower with 94% of those units classified in our large horsepower category. The 37% of our utilized horsepower being classified as large is important. Large horsepower as compared to small and medium horsepower tends to fare better in a downturn. and this is the first time we've had this kind of backstop when entering a period of depressed activity. Our horsepower utilization is 68% and unit base utilization was 60% as of March 31, 2020. Overall, we had 25% more horsepower generated revenue this quarter compared to last year's quarter and had a small 1% decrease sequentially. I noted on a year-end call that we thought our capital expenditures would decrease approximately 75% when compared to 2019 levels, which suggests a CapEx budget of about $17.5 million for this year. We spent about $6.7 million in the first quarter, including $5.8 million on rental equipments. We have approximately $5 to $7 million of additional capital commitments for the year, which suggests a total 2020 capital expenditure budget of only $12 to $14 million, appreciably below the capital expenditures we estimated just last quarter. On August 12, 2019, NGS announced that our board had approved an authorization to invest up to $10 million directly into the company through a stock buyback. And as of March 31, 2019, the company has repurchased almost 38,000 shares at a cost of almost $490,000.