Natural Gas Services Group, Inc.

Good morning, ladies and gentlemen, and welcome to the Natural Gas Service Group fourth quarter 2021 earnings call. At this time, all participants will be in a listen-only mode. Operator assistance is available at any time during this conference by pressing star zero. Your call leaders for today's call are Alicia Dotto, IR Coordinator, and Steve Taylor, Chairman, President, and CEO. I would now like to turn the call over to Ms. Datto. You may begin.

Thanks, Paul, and good morning, everyone. 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 groups 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 caption risk factors in the company's annual report on Form 10-K fought with the Securities and Exchange Commission. I will now turn the call over to Mr. Steven Taylor, who is Chairman, President, and CEO of Natural Gas Services Group.

Thank you, Alicia and Paul, and good morning, everyone. Welcome to Natural Gas Services Group's fourth quarter 2021 earnings review. Thank you for tuning in to the call. As noted in our earnings release, our overall business is growing both sequentially and on a year-over-year basis. Year-over-year, total revenue grew 6%, with our flagship rental business growing 12%. Sequentially, total revenue slipped 1%, primarily due to quarterly fluctuations in sales and our service and maintenance businesses. On a four-year comparative basis, every one of our business lines grew, with overall revenues up 6% and rental revenues increasing 5%. Our core compression business continued to recover from the pandemic-induced decline and again grew in the fourth quarter, our fourth consecutive quarter of rental revenue growth. Compression of rental revenue grew nearly 2% sequentially and approximately 12% on a year-over-year basis, primarily driven by an increase in active rental horsepower. While I'm pleased we continue to show gains in revenues across the board, expenses related to our rental compression business were also significant. The expenses were largely concentrated in the second half of the year and were primarily a result of new large horsepower compression installations. I'll expand on these later in the call, but they were primarily due to mobilization, commissioning, and startup costs related to large horsepower units, increased labor and hiring costs, and catch-up on deferred maintenance from last year. In short, while these expenses had a material impact on our bottom line, many are one-time transient startup costs that will result in better margins and potential for improved income over time and have further solidified our relationship with key long-term customers. It is also worth noting that general maintenance increase was higher than our traditional run rate, a result of increased maintenance costs as well as a level of maintenance catch-up that was necessary as our business and the business of our customers recovered from the pandemic. Now let's look at the financial details. NGS reported total revenue of $18 million for the fourth quarter of 2021. This is a $1 million, or 6.1%, increase from the same quarter in 2020 and is a result of a $1.7 million increase in rental revenues with an offset from sales and third-party sales and maintenance revenue. When comparing consecutive quarters, we had a slight decrease in total revenues of 1%. This is driven by an almost $500,000 decrease in sales and third-party revenues, partially offset by a rental revenue increase of $280,000. While our sales revenues fluctuate quarter to quarter, our rental revenues have grown consistently, 1.7% and 11.8% respectively in both sequential and year-over-year quarters, and 5% when comparing full-year results. Significantly, NGS has increased rental revenue in every quarter of 2021. Total adjusted gross margin, which does not include depreciation, for the three months into December 31, 2021, decreased to $4.3 million from $7.8 million for the same period into December 31, 2020. Adjusted gross margin for the three months into December 31 was 24% 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 and rental compression deployment, not to mention inflationary costs driven by lubricants and emissions and repair parts. Sequentially, adjusted gross margins for the fourth quarter of 2021 decreased to $4.3 million from $7.5 million in the prior quarter. As a percentage of revenue, adjusted gross margin also decreased to 24% this quarter compared to 41% in the prior quarter. The majority of the decline in gross margins resulted from increased rental costs, a significant portion of which impacted the fourth quarter. As noted earlier, the expenses include higher mobilization, commissioning, and startup costs, and to a lesser extent, an increased level of unabsorbed costs in our manufacturing shops. While rental revenue still grew in the fourth quarter, our expense profile was higher than anticipated. While many of these expenses are the result of new equipment mobilization, we are not immune from inflationary pressures seen in raw materials and supplies and supply chain challenges. We are working diligently to mitigate inflationary pressures and will be vigilant in our material and supply sourcing to improve efficiencies. We also believe that positive industry momentum will provide opportunities to selectively improve pricing and expense recovery. Sales general and administrative expenses decreased over 13% and increased almost 4% respectively in the over-year and sequential periods. Year-over-year, we realized lower executive comp expenses and professional fees, partially offset by increased health insurance costs. Sequentially, our fourth quarter SG&A was impacted by increased health insurance costs. Operating loss for the fourth quarter of 2021 was $8.2 million compared to a loss of $2.2 million in the fourth quarter of 2020. This increase is due to a decrease in margins across our operating activities, as well as a loss on retirement of units from our rental fleet of $3.1 million and an inventory write-off of just over $200,000. Sequentially, operating loss increased to $8.2 million in the fourth quarter of 2021 from an operating loss of $1.6 million in the third quarter of 2021. This increase in comparative quarters is primarily due to the affordments in lower margins, loss on retirement of the units from our fleet, and inventory write-offs. Our net loss after tax for this quarter was $5.6 million. This compares to a net loss of $1.9 million in last year's fourth quarter and net loss of $1.3 million in the third quarter of 2021. We reported a loss per diluted share of 44 cents for the fourth quarter of 2021 compared to a loss of 14 cents per diluted share in the fourth quarter of 2020 and 10 cents per diluted share in the third quarter of 2021. EBITDA is defined as earnings before interest, taxes, depreciation, and amortization, and our adjusted EBITDA excludes inventory allowances, fleet retirements, and stock compensation expense, all of which are non-cash items. Adjusted EBITDA for the three months into December 31, 2021 was $2.3 million. It decreased from $5.4 million for the same period in 2020. Adjusted EBITDA decreased approximately $3.1 million sequentially from $5.4 million last quarter to $2.3 million in this quarter, primarily due to higher rental expenses resulting in lower margins. On a four-year comparative basis, adjusted EBITDA decreased $6.2 million to $18.7 million from $24.9 million in 2020. Total sales revenue, which, as a reminder, includes compressors, flares, and product sales, was $1.1 million this quarter. This is a decrease from $1.7 million year-over-year and from $1.5 million last quarter. The change in both comparative quarters is due to the volatility in the various sales components. On a four-year comparative basis, however, sales increased 22% from $5.7 million to $6.9 million. For this current quarter, we had a total sales adjusted gross margin loss of $750,000. This compares to a positive gross margin of $48,000 in the fourth quarter of 2020 and negative gross margins of $91,000 in the third quarter of 2021. Although we have some compressor fabrication projects in progress, our compressor sales business continues to be slow, with no compressor sales revenues recognized in all comparative quarters. As noted by our backlog, however, this does not mean the business doesn't generate any revenue, but with the long lead items associated with our current products, there are quarters that we are fabricating equipment but not recognizing revenue on that equipment yet. Due to the absence of any recorded compressor sales revenues this quarter and unabsorbed costs, compressor-only sales margins posted a loss of $1 million for the three months into December 31, 2021, compared to a loss of $713,000 for the same period a year ago and a loss of $557,000 last quarter. Approximately half of the current quarter's loss was due to inventory adjustment and obsolescence and unabsorbed costs. Our sales backlog as of December 31, 2021 was approximately $1.5 million compared to approximately $2 million in the third quarter of 2021. Rental revenue in the fourth quarter of 2021 was $16.5 million compared to $14.7 million in the fourth quarter of 2020, an increase of 12%. For the sequential quarters, rental revenue grew to $16.5 million from $16.2 million last quarter. Average rental rates increased approximately 14% per unit in the year-over-year quarters. While certainly positive, this is skewed due to the effect of setting more and more higher horsepower equipment that contributes in an outsized manner to a higher average rental rate. Rates were essentially flat sequentially. Rental adjusted gross margins this quarter were 30%, a $2.6 million decrease from a 51% gross margin year-over-year, and a $2.5 million decrease from the 46% gross margin last quarter. While rental revenues improved throughout the year, our expenses, largely related to new compression units which lead to increased revenue over time, were above expectations. In addition to the non-repetitive deployment and commissioning expenses, we did experience maintenance and supply expenses such as initial oil and antifreeze fills, which can be significant, especially in large horsepower units. While we eventually recover those costs, the recognition of the expense and the reimbursement of such will from time to time result in cost revenue mismatches like we experienced in the fourth quarter. These are, of course, necessary expenditures, but we can and do experience various expenses before revenue is generated. This is a transient problem and the initial expenses are recovered in time, but it does affect current operations and margins. In addition to the above, while we are encouraged by all of the activity, it has created significant additional personnel expense. Not only has our headcount increased to meet new equipment demand, wages are rising and overtime is prevalent, as finding qualified employees, especially in the Permian, is challenging. Hiring rotating employees from outside the Permian also results in higher training, living, we have to provide room and board, and travel costs, as well as new equipment and transportation expenses. In addition, to meet this concentrated demand, we have had to contract third-party field labor, which in itself was a $1.7 million expense in 2021. We also experienced over $2 million in the fourth quarter of what we anticipate is one-time maintenance expenses due to pandemic-related catch-up and increased year-end operating costs imposed by customers. In spite of all the fully absorbed higher costs we experience, The core rental expense of maintaining our equipment as measured by our direct cost of maintenance parts, lubricants, and fluids for the full fleet rose a competitive 14.9% on a year-over-year per horsepower basis. In addition to the gross margin impacts on our net income, we also retired a number of older compressor units from our rental fleet. A total of 263 compressor packages representing 38,200 horsepower were removed from the fleet at a non-cash charge of $3.1 million. With that, rental fleet size at the end of December 2021 totaled 2,023 compressors, or over 418,000 horsepower, which also reflects an addition of 12 units, or approximately 4,100 horsepower, during the fourth quarter. Over the past 12 months, we have added 65 new fleet units, totaling just over 18,000 horsepower, with the majority of that horsepower being classified in our large horsepower category. As of December 31, 2021, about 45% of our utilized horsepower is made up of compressor units that are in excess of 400 horsepower per unit. Our horsepower utilization is approximately 71% and unit-based utilization was approximately 62% at the end of this quarter. Our capital expense for completed gas compressor rental fleet units in the fourth quarter, which does not include work in progress, was approximately $4.9 million. For the year, we expended $22.8 million on completed rental fleet additions with an additional $1.5 million in capital on vehicles and other PP&E. With the anticipated continuation of activity in the Permian Basin expected in 2022, we anticipate we will spend approximately $20 to $25 million on growth compression CapEx in the coming year. From a balance sheet perspective, we continue to have no debt outstanding at the end of the fourth quarter, with our cash balance at the end of the fourth quarter at $22.9 million. This compares to cash a year ago at $28.9 million and last quarter of $24.4 million. While we fully funded our capital expenditures with cash flows from operations, we utilized $7.9 million of cash on the balance sheet to repurchase over 737,000 shares of our common stock on the open market. In spite of our strong capital spending on committed rental equipment and our stock buyback program, our cash balance in all comparative quarters has continued relatively steady due to our ability to deliver strong operating cash flows. 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 $8.6 million, or 48% of our quarterly revenue. This is a strong cash flow conversion. We also reinvested $3.4 million back into the company through common stock buybacks this quarter. Our total stock buyback program for 2021 totaled $7.9 million, or 5.6% of our outstanding stock as of December 31, 2021. Our average purchase over the course of 2021 is $10.65 per share. In short, 2021 was a year of growth and transition for NGS. We continued to build our large horsepower rental fleet, setting more horsepower in the last half of the year than in any other comparable six-month period. And we also began the process of returning to a normal workflow after nearly two years of pandemic-induced pandemonium. While those transitions should lead to transformational growth for NGS in the future, the costs and investments required in the process had a higher than anticipated impact on margins and profits, especially in the second half of 2021. As we have started the new year, we are focusing on improving efficiency and pricing as ways to boost margins and profits. While we won't shy away from continuing our large horsepower growth, which may result in a higher expense run rate, we will continue to focus on improving sourcing, procurement, and execution to reduce our overall cost profile. Inflation in the oil patch presents a number of challenges, but challenges we will address given our strong financial position and long-time vendor and supplier relationships. We'll also look for ways to use our fabrication expertise and facilities as an advantage to create efficiencies and continue to provide best in class equipment to our customers. We anticipate steady growth in the coming year. This will be primarily driven by activity in the Permian Basin but we are also seeing signs of increased activity in other areas. We have already had commitments for additional higher horsepower units in a couple of different operating areas, and we are currently ordering equipment. We have continued with our practice of ordering committed equipment for the majority of our needs to ensure that we maximize utilization and returns. Natural Gas Services Group remains one of the few oilfield companies with a strong recurring rental stream, no debt, a significant cash position, and the ability to consistently generate meaningful operating cash flow. With the new year well underway, we're steadily beginning to feel we're approaching a more normal operating environment. While many pandemic-related health and safety protocols will remain with us indefinitely, our people are beginning to return to more regular work patterns and more personal customer interactions are leading to new opportunities. We're fortunate that the NGS team remain largely healthy and continue to strive to meet the needs of our customers, regardless of the challenges. I'm grateful for the efforts during the past two years and for their continued efforts as we work to make 2022 another successful year for Natural Gas Services Group. Paul, that's the end of my prepared remarks, so if you would, please open the phone lines for questions.