Natural Gas Services Group, Inc.

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group Second Quarter 2020 Earnings Call. At this time, I'll participate in a listen-only mode. Operator assistance is available anytime during this conference by President Starr Zero. Your call leaders for today's call are Lisa Datta, IR Coordinator, Steve Taylor, Chairman, President, and CEO. I'll now turn the call over to Ms. Datta. 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 statement and 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, Actual results and future peers 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 follows the Securities and Exchange Commission. Having all that stated, I will now turn the call over to Mr. Steven Taylor who is President Chairman and CEO of Natural Gas Services Group.

Thank you, Alicia and Erica, and good morning, everyone, and welcome to NGSG's third quarter 2020 earnings review. Thank you for turning 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 oil and natural gas operators. and, as a result, the suppliers and service providers who work alongside them. While NGS is fortunate to have been well-positioned entering this period of extraordinary pain for the energy industry, no company is entirely immune from the impact of these sharp and protracted 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 have resulted in less impact than many of our peers on both our financial and operational conditions. While sales and service revenues declined in the quarter, our rental revenues were solid and grew on a year-over-year basis and were only modestly affected this quarter. Total adjusted gross margins came in at 50% and adjusted EBITDA was 35% of revenue. Although not unusual, especially not in downturns, we have seen a high 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, already at a relatively low level from last quarter, were severely impacted this quarter by customer redesigns, which delays the completion of compressor sales jobs, and capacity constraints due to committed higher margin rental contracts displacing sales projects. As noted in our financial statements, we did not have any material compressor sales in the third quarter, but we have not had any cancellations of work and our backlog carries forward. We are confident our compression sales business will strengthen as the market begins to firm. More important, 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. We continue to be vigilant in protecting our financial strength during this period of remarkable industry stress, and our cash position provides NGS with significant flexibility and opportunity in any market environment. NGS continues to have one of the best balance sheets in the industry. While we are beginning to see initial signs of a trough in oilfield activity, commodity prices remain below a consistent level that will result in meaningful new oilfield activity. We expect the trend to remain choppy through the end of 2020 and into early next year as operators remain cautious in their approach to growth as they address capital constraints. In spite of that caution, or maybe because of it, As we said last quarter, we continue to see new opportunities for which we believe our fabrication capabilities, superior service, and strong financial position will allow us to capitalize, and we believe those are likely to materialize in the new year. As you are aware, we extended the time period to file our third quarter report to the impact of the COVID-19 pandemic on the Midland community and our firm. We remain vigilant in protecting the health of our team and, as a result, continue to work remotely when possible. We are operating our Midland headquarters with a severely reduced in-person staff and urge our team members to take steps to remain safe and healthy. Our field team continues to exercise appropriate distancing and health practices while working with customers on location. While these practices have added incremental cost and inefficiencies to our effort, we remain dedicated to protecting the health and welfare of our team and our customers in these unprecedented times. With that, let's move into the details. NGS reported total revenue of $15.8 million for the third quarter of 2020, a 24% decrease from the same quarter in 2019. This decline was driven by a decrease in sales revenues and, to a lesser extent, lower service and maintenance revenue. Conversely, NGS experienced an increase in real revenues of 3% when compared to the same quarter of 2019. Sequentially, total revenue decreased by 9%, driven primarily by a decrease in sales revenues by almost three quarters, as well as a decrease in real revenue of 2%. Our service and maintenance revenue exhibited strength this quarter, increased by over one-third due to a good increase in service and maintenance work we won this quarter. Our customers' capital budgets continue to be constrained due to the commodity price uncertainty surrounding the macroeconomic backdrop. Therefore, we expect total sales revenues to remain soft into the new year. Thank you for joining us today. In fact, rental revenue for the first nine months of 2020 is up 11% when compared to the same period of 2019. Given the unprecedented challenges in turmoil in the oilfield services sector, we are pleased with this performance, which provides support for our position as a leader in energy compression rentals. Total adjusted gross margin, which does not include depreciation, for the three months ended September 30, 2020, decreased by 18% to $7.9 million for $9.6 million for the same period ended September 30, 2019. Adjusted gross margin as a percentage of revenue for the three months ended September 30, 2020, was 50%, an increase from 46% year-over-year. Sequentially, adjusted gross margin for the second quarter of 2020 decreased 11% to $7.9 million from $8.8 million from the second quarter of 2020. Adjusted gross margin as a percentage of revenue slightly decreased to 50% in this quarter compared to 51% in the prior quarter. The predominant cause of the decline in gross margin dollars in both comparative periods is due to the unabsorbed cost of our fabrication facilities due to our lower volume of work going through those plants. Selling general and administrative expenses in the third quarter of 2020 were $2.5 million, a decrease of 11% when compared to the same period of 2019 and 6% lower when compared to the second quarter of 2020. SG&A as a percent of revenue for the third quarter of 2020 was 16%, slightly above our general run rate of 13% to 14%. Operating income for the third quarter of 2020 was a loss of $941,000,