Natural Gas Services Group, Inc.

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group second quarter 2021 earnings call. At this time, all participants are on listen-only mode. Operator assistance is available anytime during this conference by pressing star zero. Your call leaders for today's call are Alicia Data, IR Coordinator, Steve Taylor, Chairman, President, and CEO. I'll now turn the call over to Ms. Data. You may begin.

Thank you, Erica, 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 up 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 all that stated, I will now turn the call over to Steven Taylor, who is President, Chairman, and CEO of Natural Gas Services Group. Steve?

Thank you, Alicia and Erica, and good morning, everyone. Welcome to Natural Gas Services Group's second quarter 2021 earnings review. Thank you for tuning into our call. As noted in our quarterly earnings press release, the second quarter represented an important inflation point for our company. We set 80 compression packages in this quarter, including a record 28 new high-horsepower units, with the majority of the high-horsepower units being deployed off of standby status. Not only do all of these units represent additional future revenue and profits for NGS, but the deployment of these high horsepower units continue to reinforce the success of our strategy to evolve toward a higher horsepower fleet. Clearly, higher energy commodity prices, a return to new production activity, especially in West Texas, and overall oil field activity provide a positive environment for our business. While we are carefully watching new variants of the coronavirus and any impact it may have on the overall economy, we are cautiously optimistic that the macro environment will provide continued opportunities in the second half of the year. We are pleased with the progress in our rental fleet during the quarter. Of the 80 compressor packages set, over 50 of those were in the Permian Basin, and of that, more than half were large horsepower units. Certainly progress, but progress does not come without cost. many of which occur ahead of realizing full quarterly rental revenues on new set equipment. Setting a record number of higher horsepower units had such an impact. The setting, commissioning, and starting of this many units increased our parts and labor costs as well as the cost of everyday consumables such as oil and antifreeze. This resulted in some mismatch between revenues and expense, which are timing issues that will naturally resolve themselves over the next couple of quarters. The third quarter, which we anticipate to be active but not at the level we saw this quarter, will give us an opportunity to deliberately manage those operational expenses. In addition, some repair and maintenance costs were higher than normal in the quarter, a result of catching up on non-critical maintenance that was deferred at customer's request during the pandemic. We have also seen inflationary pressures which we plan to mitigate by adjusting our rental rates in the last half of this year. As we noted in previous discussions, we worked tirelessly with customers during the past year to ensure we met their safety protocols, as well as protecting our own team members, which resulted in some cases in lighter preventive maintenance schedules, which we are presently addressing. Significant progress was made in the first half of the year, with a more modest level lingering into the third quarter. While our total revenue decreased 4% sequentially, driven by a decrease in sales revenue, both our rental and service and maintenance revenues improved this quarter. Rental revenues increased 2% sequentially due to the higher deployment of rental units, and service and maintenance revenues grew over 60%. Additionally, we generated adjusted EBITDA of $4.5 million and $5.4 million of operating cash flow during the quarter. Now, let's look at the financial details of the quarter in greater detail. Looking further at revenues, NGS reported total revenue of $17.7 million for the second quarter of 2021. This is a 2% increase from the same quarter in 2020, or about $345,000, and is a result of a 3% increase in rental revenues balanced against a 22% decrease in sales revenues. As you know, the largest component of our sales revenue is compressor sales, and it is historically volatile. This decrease in sales revenue was primarily due to the absence of realized compressor sales during the period. When comparing consecutive quarters, we had a decrease in total revenues of 4%, or about $648,000. This was driven by a $1.1 million decrease in sales revenue, which was only partially offset by rental and service and maintenance growth of nearly $500,000. While our sales revenues fluctuate with our customers' capital needs, our rental revenues have grown 2% and 3%, respectively, in both sequential and year-over-year quarters. Significantly, and contrary to industry trends, NGSS had increases in rental revenue in both quarters of this year. Total adjusted gross margin for the three months into June 30, 2021 decreased to $6.6 million from $8.8 million for the same period into June 30, 2020. Adjusted gross margin, which does not include depreciation, for the three months into June 30 was 37% of total revenue. As noted earlier, margins were impacted by higher repair and maintenance costs, increased labor costs, and setting commissioning and startup expenses related to the growth in rental compression deployment. Sequentially, adjusted gross margin for the second quarter of 2021 decreased to $6.6 million from $8.6 million in the prior quarter. As a percentage of revenue, adjusted gross margin decreased to 37% this quarter compared to 47% in the prior quarter. SG&A, or sales, general, and administrative expenses were down 2% in both year-over-year and sequential periods. Operating loss for the second quarter of 2021 was $2.3 million, compared to a loss of $148,000 in the second quarter of 2020. Sequentially, operating loss decreased by $1.9 million from an operating loss of $369,000 in the first quarter of 2021. Operating losses increased in both comparative quarters, primarily due to the aforementioned higher rental and commissioning expenses, and a greater loss in our compressor sales product line. Our net loss after tax for this quarter is $1.9 million. This compares to a net income of $165,000 in last year's second quarter and a net loss of $394,000 in the first quarter of 2021. We reported a loss per diluted share of 14 cents for the second quarter of 2021 compared to an income of 1 cent per diluted share in the second quarter of 2020. Sequentially, we reported a loss of 3 cents per diluted share in the first quarter of this year. EBITDA is defined as earnings for interest, taxes, depreciation, and amortization, and our adjusted EBITDA excludes inventory allowances, charges incurred due to fleet retirements, and stock compensation expense, all of which are non-cost expenses. Adjusted EBITDA for the three months into June 30, 2021 was $4.5 million. It decreased from $7.1 million for the same period last year. Adjusted EBITDA decreased approximately $1.8 million sequentially from $6.3 million last quarter to $4.5 million in this quarter, primarily due to higher expenses resulting in lower margins. Beginning in the first quarter of 2021, we have also added back non-cash equity compensation to our calculation of adjusted EBITDA and have adjusted comparable quarterly data to provide for accurate comparisons. Total sales revenue, which, as a reminder, includes compressors, flares, and product sales, was $1.6 million this quarter. This is a decrease from $2 million year-over-year and is down from $2.7 million last quarter. The decrease in both comparative quarters was primarily driven by lower compressor sales. For the current quarter, we had a total sales adjusted gross margin loss of $204,000. This compares to positive gross margins of $148,000 in the second quarter of 2020 and positive gross margins of $95,000 in the first quarter of this year. Although we have some longer lead projects being currently worked on, we recorded no compressor sales revenue in the second quarter of 2021. This compares to compressor sales revenues of $1.4 million in the second quarter of 2020 and $1.9 million last quarter. Due to the absence of any recorded revenues this quarter and unabsorbed costs, compressor-only sales margins posted a loss of $641,000 for the three months into June 30, 2021, compared to a loss of $127,000 for the same period a year ago and a loss of $136,000 last quarter. Our sales backlog as of June 30, 2020 was approximately $2 million compared to approximately $400,000 in the first quarter of this year. Interestingly, approximately three-quarters of this current backlog is for gas compression equipment that will be employed in energy transition projects. Not surprisingly, we are seeing more inquiries for this type of work than we have in the past, and currently those inquiries exceed those of our traditional wellhead natural gas type fabrication work. The development of these markets over time will come with quite a bit of volatility, but NGS does possess the in-house technical expertise to participate, and that is becoming known in these markets. Real revenue in the second quarter of 2021 was $15.6 million compared to $15.1 million, an increase of 3% since the second quarter of last year. For the sequential quarters, real revenue grew to $15.6 million from $15.3 million last year. While compression industry revenue trends have generally been negative this year, this is our second consecutive quarter of rental revenue growth and is a testament to our high horsepower efforts and adaptation from our customers. If you recall, rental revenues in the second quarter of 2020 were the last quarter of pre-pandemic growth and prior to the related revenue impacts recorded in Q3 of 2020. The fact that our rental revenues over the last 12 months have exceeded that level is significant and attests to our success in growing this primary strategic part of our business. Rental rates increased by an average of 4.2% per unit in the year-over-year quarters and 3.2% sequentially, mainly due to our continued penetration into the larger horsepower market. In this quarter, we set a total of a little over 41,000 horsepower. Terminated horsepower was almost 12,000 horsepower, which resulted in a net gain of around 30,000 horsepower. You may notice that the amount of horsepower set does not coincide with the change in our quarter-to-quarter utilization numbers. That's because we were already carrying the majority of the newly set horsepower as utilized on a standby basis, so there is no additional horsepower added to the fleet or the utilization calculations. Just units moved from the yard to location and set and commissioned. With this much new horsepower being set, commissioned, and started up, our expenses increased while only some of the rental revenues recorded due to incremental rate increases in partial quarters. We therefore had a timing mismatch between many expenses incurred and partial quarterly rental revenues. As such, our gross margins were lower than anticipated. reported rental adjusted gross margins this quarter were 42% and decreased from both comparative quarters of 56% year-over-year and 53% sequentially. To explain the expense scenario of this quarter in a little more detail, the majority of which was experienced in the Permian Basin, we weren't able to record a full quarter of full revenue from units set later in the quarter, while we did experience a full quarter's worth of expense. We set over 50 units in the Permanent Basin alone in the second quarter. As a company, this is the most horsepower we have set in a single quarter and it drove a lot of expense. Setting, commissioning, and starting this amount of equipment takes a lot of manpower, parts, oil, and antifreeze, which are not insignificant expenses in volume. Along with that, we've been hiring a number of technicians and adding service vehicles to the fleet. Some of our costs have been delayed from last year. For example, engine emissions testing that had been delayed by our customers in 2020 were resurrected with a large number performed this quarter. This expense was exacerbated by large parts cost increases due to the precious metals contained in these catalysts. This also points out the inflationary pressures we are facing, from parts to fluids to labor. Oil alone is 30% higher than a couple quarters ago, and the freeze has shown a similar magnitude of increase. For perspective, although the bear expenses show a large expense over quarters, The dollar cost per horsepower increased approximately 30%. Still substantial, but a little more in perspective. This expense anomaly should correct itself in the next couple quarters when we will have full quarters of revenue and these set and commission expenses are largely behind us. That said, we have a backlog of rental units to set in the third quarter and we will experience the same timing phenomena. but the volume of equipment being commissioned isn't as high, and we anticipate margins climbing back to our traditional levels over the next couple quarters. Setting a larger horsepower, of which most of this is, entails higher initial expenses, but this is a good-news scenario. Revenues are up, contracts are long, and these expenses are mostly behind us. Each size at the end of June 2021 totaled 2,257 compressors, or 446,803 horsepower, which includes a net addition of 19 units, or 4,892 horsepower during the second quarter. As of June 30, 2021, 37% of the utilized horsepower is classified as large. Over the past 12 months, we have added 42 new fleet units totaling just under 13,000 horsepower, with 61% of that horsepower being classified in our large horsepower category. Our horsepower utilization is approximately 64%, and unit-based utilization was a bit over 55% as of June 30, 2021. Our capital expense for completed rental fleet units, which does not include work in progress, in the second quarter was approximately $5.9 million for rental equipment. We previously projected a capital expense budget of $15 to $20 million this year, and with the $5 million capitalized in the first quarter, we're pretty well on track with our projections for the first half of this year. Moving to the balance sheet, as mentioned last quarter, we established a new credit facility with a $20 million borrow and base, but with no borrowings outstanding. Our cash balance at the end of the second quarter was $26.2 million. This compares to cash a year ago of $15.5 million and last quarter of $30.7 million. The combination of our cash balance and untapped credit line continues to provide ample liquidity in nearly any conceivable scenario. We generated positive net cash flow from operating activities in this quarter of $5.4 million, or 30% of our quarterly revenue. We also reinvested $1.9 million back into the company through common stock buybacks this quarter. We will continue to repurchase shares as we believe the fair value of the enterprise is well above that currently reflected in the public markets. In conclusion, NGS remains one of the few companies in the oil field with a strong recurring revenue stream, no debt, a significant cash position, and the ability to consistently generate positive operating cash flow. As we emerge from the trough of the cycle, our new business should provide opportunities for new revenue and profit growth. While we are cautiously optimistic about the second half of the year, as underlying energy demand has helped stabilize energy markets, we remain vigilant in our watch of macro trends that can impact our industry and business. We will continue to focus on balance sheet strength and opportunities that will create long-term value. As I've said before, our success is a result of the commitment of all members of the NGS team to make certain our customers are satisfied and appreciated. Our ability to meet challenges of the past year have proven our team is among the best in the business. They deserve our thanks and appreciation for a job well done. We look forward to continuing our pattern of responsible growth, balance sheet stewardship, and responsiveness to our stakeholders as we look forward to the second half of 2021. Erica, that's the end of my prepared remarks, so if you would, please open the phone lines for any questions.

Ladies and gentlemen, at this time, we will conduct the question and answer session. If you would like to state a question, please press star 1 on your phone now, and you'll be placed into the queue in the order received. Once again, to ask a question, please press star 1 now. Our first question comes from Rob Brown from Lake Street Capital. Please say your question.

Good morning, Steve. Hey, Rob. Just wanted to get a little bit into the pricing environment. You talked about some of the costs going up. Are you able to pass that into the pricing, or it seemed like your pricing was kind of moving up, but maybe how is the pricing environment at this point?

Well, we're going to have some price increases, the balance of the year.

We've been

Moving some up slightly, but the inflationary environment has really started to take effect pretty quick. So we're planning on, and I don't know the magnitude right now, but we are planning on rental increases pretty well across the board, the balance of the year. We're seeing everything. Steel is going up. Steel doesn't matter too much except on new builds. Like I mentioned, oil is going up, obviously. That's an expected one. Antifreeze, the exact metals, these catalysts, that stuff has been especially impacted by supply chains. and hopefully some of this stuff mitigates itself, but I'm not so sure. From an inflationary standpoint, we'll have to take a wait and see attitude from that standpoint, but we're not taking a wait and see on some prices we've got to increase, which is what we're going to do.

Okay, great. And then you talked about some new unit placements coming in Q3, maybe at a lower rate than Q2, but how is kind of the new unit placement demand market happening now, and what do you sort of see after Q3 in terms of units entering the fleet?

You know, Q3 is going to be a lower level than Q2, which actually is – Not bad, you know, because Q2 was, you know, such a high volume of equipment going out that, you know, everybody was just extremely busy and, you know, took lots of people and parts and manpower, et cetera, to do that. So, you know, Q3 being a little lower level is not a bad thing, kind of gives us a little chance to, Take somewhat of a breath and get concentrated on revenue increases and managed costs. We think Q3 is going to have good level. Beyond that, certainly from a sales standpoint, sales are still pretty constricted from standard wellhead natural gas sort of businesses.

I mentioned we're actually seeing more energy transition projects

and anything and that's not a real high level yet. We think they'll grow over time but the sales perspective is pretty muted right now from a traditional aspect. Now from a rental point, we think Q4 is going to be busy. It's a little hard right now to put a finger on it. We don't have a whole lot of projections for Q4 and that kind of sounds funny when we're sitting here in August but We know of some big equipment going out, some little equipment going out, but certainly between now and Q4, we anticipate more being added, more being scheduled, and stuff like that. The operators have, I think, surprised a lot of people with their their constraints on activity and drilling and things like that. Where we're picking up activity, we think, is certainly from projects that were put on hold last year that are going forward now. Certainly the commodity level, even though it's so little softened lately, is still a lot better than what it was. So we anticipate a good balance of the year. It's just hard to put a finger on Q4 right now until we get a little closer to it. Okay, good.

And then I just want to look back at that energy transition project comment. What types of projects are you doing in that world, and can that be a rental market as well?

I'm not going to tell you exactly what kind of project, just from a competitive standpoint. It could be a rental market. We'll see. It's pretty nascent in its evolution, so it's hard to tell right now. The jobs we've got and the inquiries we've received have pretty well been just off relationships and kind of out of business. Thank you for joining us. Thank you for joining us. A fairly long time from engineering to procurement to build on some of that stuff. So we see long lead projects. Rental, maybe. We're not necessarily opposed to it. It kind of depends on the term and the rates, but certainly the sales thing is here right now. at least this quarter is pretty substantial. It's going to be volatile. Maybe once we finish each project we don't get anything for another quarter or two or whatever. But it's certainly focused us on some of those markets and what we can do. And I think the customers out there are starting to see some of that too. So that's my best prognostication on a market that's really just started the last couple quarters for us.

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

Our next question comes from Tate Sullivan from Maxim Group. Please say your question.

Hi. Thank you. Hi, Steve. Following up your last comment on the energy transition, just to clarify, most of the $2 million backlog Is that what you referred to as energy transition or are away from the wellhead? Is most of that those kind of projects?

Yeah, three quarters of it. The backlog is about $2 million, so approximately a million and a half dollars of it is energy transition projects. Obviously, I'm using the energy transition for coverage. Number one, it's a great buzzword right now. Number two, I don't have to tell you exactly what the projects are.

No, just to clarify that. Yep, understood. And then is in a more, well, I don't know if the right word is normal operating environment or excluding all what's happened with the COVID timing in the last year, is parts replacement work that you usually do fixed at the time of the contract or is it a lower margin business usually compared to the rental business?

Now, which part of the business? You said parts?

You mentioned replacement, some backup work related to replacing parts or service work on the compressors. Or is that the emission standards that you talked about?

Yeah, that was more customer-requested deferred maintenance. Obviously, a lot of things slowed down last year just from the point of – primarily COVID and everybody being a little careful and stuff. And some of this maintenance that wasn't absolutely necessary, either through equipment requirements or anything else, some customers just all opted to push it back. And now that we're in a little different environment and kind of coming into a stronger year, we rescheduled some of these things. And a lot of it was emissions testing. which drove a lot of catalyst purchases which are, I'd say, expensive to start with but we've seen quite an inflationary hit on that just due to the metals in it. So it was just primarily catching up on some deferred maintenance, some parts costs there, and some labor too.

Okay.

And then did I hear correctly that quarter over quarter Prices were down, but is that your calculation based on not earning the full rates on the deployed equipment from the second quarter? Or did I mishear that?

Now, prices, you're talking about rental prices?

Yes, yeah. The average rental price per unit across your fleet.

Oh, no, it went up. It was up, I remember, at 3% to 4% year-over-year and sequentially. And again, that's primarily driven by the large horsepower going out.

And then with the hiring efforts, and maybe it's related to that deferred maintenance, are you back to levels where you were before COVID? Or can you comment on that?

As far as headcount?

Headcount, please, or hours worked in the field.

Yeah, we're above that from a headcount standpoint. You know, so revenues were, what, about 3% above last year, your headcount. Well, The field count is higher. The fabrication facility count is lower just because of the differences in activity. I would guess that our overall head count is lower due to the Q2 2020 being pre-pandemic and then Q2 now.

But it's been shifted a little.

Fabrication employment down some and field employment up. Okay.

Great.

Thank you, Steve. Have a great rest of the day. Yeah. Thanks, Dave.

Once again, to ask a question, please press star 1 on your phone now. At this time, we have no further questions.

Okay. Thanks, Erica. And thanks, everyone, for joining me on this call. I appreciate your time this morning and look forward to visiting with you again next quarter. Thank you.

This concludes today's conference call. Thank you for attending. You may now disconnect. The host has ended this call. Goodbye.