Natural Gas Services Group, Inc.
Q1 2009 Earnings Call Transcript

Published: 8 May 2009

[Operator:]

This conference is now being recorded. Good morning ladies and gentlemen and welcome to the Natural Gas Services Group first quarter 2009 earnings conference call. Your host for today is Kimberly Huckaba, Investor Relations contact. (Operator Instructions) I will now turn the call over to Kimberly Huckaba. You may begin.

[Kimberly Huckaba:]

Thanks again, [Leo], and good morning listeners. At this time please allow me to read the forward-looking statement. Except for historical information contained herein, the statements in this morning’s conference call are forward-looking and 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, 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 only 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 they 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 that now stated I will turn the call over to Steve Taylor, President and Chairman and CEO of Natural Gas Services Group. Steve?

[Stephen C. Taylor:]

Okay. Thanks Kim. Thanks Leo and good morning to everyone and welcome to Natural Gas Services Group’s first quarter 2009 earnings review. If you saw our earnings release this morning we posted a first quarter that exceeded expectations and that we are particularly proud of in this environment. Compared to last year’s first quarter to the current period, we had net income increase 8%, EBITDA increase 15% and diluted earnings per share were up 7% to $0.31. And this is all on a 6% rise in total revenue. These numbers represent two primary accomplishments. We continued to grow revenue in a very tough market and we grew net income, EBITDA and earnings per share at an even faster rate and continued to hold our costs in check. Now looking at total revenue and comparing the first quarter of this year to the first quarter of last year, revenues were up 6% from $18.9 million to $20 million. Sequentially total revenues declined from the last quarter of 2008 to now, from $22 million down to $20 million. This sequential decline in revenue is due primarily to the impact on our fabricated sales business which we predicted and I’ll talk about further when we review segment comparisons. Looking at total gross margin and comparing the first quarter of this year to the first quarter of 2008, gross margin grew up to $10.6 million or 53% of revenue from $8.9 million or 47% of revenue, which was a 19% increase. This increase in gross margin as a percent of revenue is due to the business mix shift toward rentals as the sales component declines. Sequentially, gross margin was essentially flat as it moved from $10.8 million to $10.6 million. SG&A expense was $1.3 million or 7% of revenue in the first quarter of 2008 and $1.6 million in the first quarter of 2009 or 8% of revenue. In the sequential quarters, SG&A remained pretty well flat in the 7 to 8% range of revenue. Net income after tax in the first quarter of 2008 was $3.5 million. It rose 8% up to $3.8 million for the first quarter of ’09 and both are constant at 19% of revenue. Net income was within $100,000 between sequential quarters, $3.9 million in the fourth quarter of last year and $3.8 million in the first quarter of this year. EBITDA or earnings before interest, taxes, depreciation and amortization in the first quarter of ’09 were $9 million. This is a 15% increase from the first quarter of ’08 when it was $7.8 million. That was also an increase from 41% of revenue last year up to 45% of revenue this year which is a record. Sequentially, EBITDA went from $9.3 million in the fourth quarter of 2008 to $9 million in the first quarter of ’09 but as mentioned grew as a percent of revenue from 43% to 45%. Our fully diluted earnings per share for the first quarter of ’09 were $0.31 per common share. Now looking at segment comparisons and starting with our total sales revenue which consists of approximately 80% customer fab sales on average with the balance being flare sales, part sales, rebuilds and our CiP Compressor sales. Total sales were $9.6 million in the first quarter of 2008 compared to $6.9 million in the first quarter this year. This $2.7 million decrease was due primarily to a $2.8 million decline in our custom fabricated sales. Sequentially, total sales revenues decreased from $9.4 million down to $6.9 million although gross margin grew from 32% to 35% in the sequential quarters. Compressor sales alone were $8.3 million in the first quarter of ’08 versus $5.2 million in the first quarter of ’09 and were $7.1 million in the last quarter of 2008. We expected and predicted that this business which is driven by the availability of capital and gas pricing would contract first and foremost so we’re not too surprised to see these declines. Compressor sales margins were 31% in the first quarter of 2008 compared to 29% in this current quarter but rose from 26% in the fourth quarter of 2008. You can see our guys in Tulsa did a great job controlling their costs in a rapidly declining market and enabled us to grow margins higher. That doesn’t happen much in the fab business in this type of an environment. The compressor sales backlog in our fabricating facility in Tulsa at the end of this quarter, this recent quarter, the first quarter of ’09 was about $8 million. It’s obvious we’re working through the backlog but there is some optimism that this will increase throughout the year. I think the brunt of the impact is in the first part of the year with the potential for some upside later in compressor sales. Our inquiry level is actually higher this quarter than a year ago, so there may be some built up demand, some pent up demand building. And we have as I mentioned I think last quarter call, we have put some new sales people into Houston to identify opportunities for us in this business. Looking at compressor rentals, rental revenue grew 42% in the year-over-year quarters. First quarter of ’08 was $9 million revenue and grew to $12.8 million the first quarter of 2009. Rental gross margin as a percent of revenue in the first quarter of 2009 was 63%. That’s the same as last quarter and up from 62% in the year ago quarter. In rentals as we did in sales we’ve been able to control our costs and maintain or increase our margins. Rental revenue increased sequentially from $12.3 million up to $12.8 million for the current quarter, a 4% gain. This is of course lower than our historical rate of growth but we have grown the last two quarters. We think that’s a real accomplishment in this market. We added 39 new compressor units to our rental fleet in the first quarter. That brings the total fleet to 1,769 units, up from 1,730 units at the year end 2008. We have the first quarter at a rental fleet utilization rate of 82%. Our balance sheet continues to be very strong. Our total short term and long term debt is $15.7 million as of March 31, 2009, and that includes $7 million drawn on our $40 million line of credit. Our total debt to total cap is running about 10% and net debt to total caps is about 8.5%. Capital expenditures in the first quarter of this year were $5.8 million which consisted of $4.8 million of rental fleet equipment and approximately $700,000 for missing retro fits on field units. This is down from $10.3 million in the fourth quarter of last year. We expect this to continue to drop throughout the year. I doubt if we exceed $10 million total capital expenditures this year. That represents an almost 80% reduction of CapEx for this year. As I have stated before, barring any extraordinary expenditure we will be cash flow positive in 2009 and not add to our minimal debt load. Our cash balance on March 31, ’09 was $2.7 million but it is up to over $7 million at the end of April. Now it’s no surprise to anyone listening to this call that the state of our industry we’re in, and of course we’re living in it every day, but as demonstrated by our results this quarter our employees have done a great job getting through a tough period. It’s not over but we have posted two solid quarters since the slowdown started. In comparative year-over-year periods we increased revenue, EBITDA and net income while driving margins higher and minimizing our overhead expenses. Now the Energy Information Administration, or the DOE is projecting an average Henry Hub spot price of $4.24 for 2009. That’s down from a $9.13 average in 2008 and also down from a $8.17 and $5 average price they predicted within the last six months, attesting to the speed of the pricing collapse and the dislocation of the markets. EIA does, however, mention the latest short term energy look of a 50% decline in gas rig count combined with the declining well productivity should lead to some price firming later this year. And we think there’s some other bright spots. Long term potential hasn’t changed for natural gas. This country, no matter how much the government wants us to depend on windmills and solar rays, will need natural gas for a long time in the future and the need is growing by the day. Natural gas is preferred over crude or coal due to its cleaner environmental profile, and there’s some indication that the use of natural gases in motor fuel may be reviving. L&G has reappeared in conversations with the question of how it might affect natural gas markets here in the U.S., whether we will get a flood of it if it doesn’t have anywhere else in the world to go. I’ve read a lot about it lately and the one conclusion to draw is that no one knows what’s going to happen. Natural gas in the U.S., this being an isolated domestic market, competes mainly against itself and with the current oversupply we can see the effects it has on price. It drives it down. Internationally, however, L&G typically competes against crude pricing. This factor alone will tend to keep L&G away from the U.S. shores unless natural gas pricing here rises significantly and if that happens we will welcome L&G as a supply supplement. Looking at the immediate term, I’ve been out to the San Juan Basin and the Barnett Shale recently, talking to our people and dealing with customers. And pricing at the well head is pretty low, around $2.50 per mcf in San Juan and around $3.50 in Barnett. On the surface this doesn’t look like good news and it really isn’t, but operators are still generally pumping gas and staying online, something I wouldn’t have predicted at all last year at price levels like this. There are pricing utilization pressures and they will continue over the near term, but it seems that we are about halfway through this correction. I think Q2 and Q3 will be difficult but feel that the back end of Q3 or the front end of Q4 will be the trough and we will start to see improvement the latter part of this year or the first part of 2010. Lots of things that could affect us one way or the other and the first and foremost being demand recovery which depends on the economy. Now, from our Washington bureau, on the last call I talked about the tax repeal and tax increase that the Obama administration has proposed on the energy industry. And while I don’t usually repeat myself on these topics, and I don’t usually have to there’s so many to choose from, this is such an important one that I wanted to mention it again. The new taxation level being pushed will do nothing but decrease the already minimal amount of energy we produce for ourselves. It will not hurt “big oil” and nearly likely will drive numerous independent operators out. The U.S. is the only country in the world that doesn’t endeavor to fully exploit our own resources. We would rather import foreign sources and then complain about it. These taxes combined with the assault the Obama Energy Department is waging by further restricting further access to resources, resources already vetted and approved, is nothing but industrial class warfare. It’s the bedevilment of an industry that fuels our prosperity and quality of level, but that for some reason doesn’t fit the new administrations agendas. It just doesn’t make any sense. Also I want to make a couple of comments about the proposed cap and trade system for CO2 emissions that Harry Reid at the behest of the Obama administration is pushing. Much as the current calamity is I fear being used as an excuse for an attempt to move the economy towards centralized control, cap and trade emissions regulation under the guise of an environmental initiative is being used as a spear tip for a whole new tax regime and structure. The current administration apparently doesn’t think free markets can efficiently allocate resources as they have for over 200 years. The government is going to assume that role. Cap and trade will let the government set the price of permits sold to allow CO2 emissions. I’m all for a good clean environment but the goals being set for CO2 emissions are scientifically unattainable. The government will have the ability to set the permit prices and to vary them according to their policy agendas, which may or may not have anything to do with the environment. Is there another agenda or am I paranoid? Probably a little of both. But what focused me on this recently was that even though the bill hasn’t even made it to the floor yet, it’s expected this fall, one senator has already proposed exemptions for certain industries. Not because they don’t want to emit CO2 but because they’re in his district and the expense to cash flow will be prohibitive. Ladies and gentlemen, there isn’t hardly any industry that doesn’t emit CO2 in some manner and this misguided effort will raise the cost of everything in this country buys, produces or sells with little corresponding effect on CO2 emission levels. Now, back to the real world. As we go forward are there rough spots ahead? There damn sure are but we’re headed in the right direction and we’ll continue to execute our plan. I think the back end of Q3, Q4 as I mentioned will be the trough and we’ll see some improvement within a quarter after that. I’m pretty optimistic about the market and our position in it. It’s not a fun time, but just as we took advantage of a growing market we’ll do the same thing in a declining one. That’s the end of my prepared remarks. I’ll now turn the call back over to Leo to open the lines for any of you that may have questions.

[Operator:]

(Operator Instructions) Your first question comes from [Steve Fronzy] – Sidoti and Company.

[[Steve Fronzy]:]

In terms of the addition to the rental fleet this year, it looks like you added 39 in the quarter, a little ahead of probably the 100 or so you’re hoping for the year. Any chance you’re expecting now more than 100 this year or is that still a reasonable?

[Stephen C. Taylor:]

No. I mean we think it’s going to be, you know, actually 100 or less because still because the big part of that 39 was in January because we were still winding things down pretty quickly. So January was probably two-thirds of that number. So we’re on the downside already.

[[Steve Fronzy]:]

And then I mean obviously an extremely impressive utilization at the end of the quarter given the decline in rig count, that, I assume, continues to trend down over the next couple of quarters?

[Stephen C. Taylor:]

Well we think so. As I mentioned I think Q2, Q3 are still going to be, you know, I think the trough’s going to be towards the end of Q3 so we’re going to be trending down through that period, so we’re still expecting price pressures and utilization pressure. You know, one of the things about our utilization although 82% is relatively good in this market, we probably drove some of that down ourselves just by some of the units we built in January before we could get them fully shut down. So some of that is even an artificial drop in utilization. So we’re concentrating on as you know we watch that utilization pretty close so, you know, we’ll still see some pressure there.

[[Steve Fronzy]:]

And then just also on pricing, significant pressure, what have you seen so far?

[Stephen C. Taylor:]

Well, you know I guess significant is in the eye of the beholder. We think we’ve done a better job than probably the market in being able to preserve our price. We’re working with our customers on this stuff and it’s only reasonable we do that. And I think we’re in better shape than most just from the point of the quality of our equipment out there and the quality of our service. I think we still are able to maintain some premium pricing and that just translates into probably just a little less of a percentage give back than maybe some others are having to do.

[Operator:]

Your next question comes from Gary Farber - C.L. King & Associates, Inc.

[Gary Farber:]

Just had two questions. One, given the strength of your balance sheet I’m wondering if you could talk about do you think there will be opportunities for acquisitions in this environment. What’s your sense of your competition as far as financial viability? And then just back on this pricing question. You know, one of your competitors reported yesterday their utilization was coming down. It sort of sounded like they might put equipment out there just to keep it out there but pricing might not be robust as they put it out there and I’m wondering what’s your view as to what that might do to the market in the short term?

[Stephen C. Taylor:]

Well I think, you know, from the pricing standpoint, you know, I think you get people that are reasonable and some that are unreasonable. And I think if you get pricing just to grab share, that never works because we’re not going to give up our good customers and nobody else is. I mean you’re going to maintain where you are and especially in areas where you’ve got good concentrations and good density where we do in some of these areas. We can, you know, we can compete very effectively in things like that. And if you look at our, you know, mention our balance sheet and our income statement, I mean we’re still very strong from both perspectives. Of course the balance sheet will always stay strong but you might expect to see some hits in the income statement right now, but we’re still maintaining margins. You know, we’ve still got some growth that we’re showing. So we think we’re in a better shape to take any competitive forays that might happen or anybody might try better than anybody. So, you know, it’s just one of those things. You pay attention, you compete in the markets. We’ve got good customer relationships. They like our equipment. They like our service. And that’s the bottom line. People are still going to pay for what they get. You know, from a standpoint of competitive arena as far as, you know, weaknesses out there, there certainly people starting to feel the strain from a cash standpoint. We know there’s, you know, some relatively, you know, decent size companies have some cash problems and some smaller ones, too. So, you know, how we, much as we have in the past we, seems like two or three times a year we’ve got somebody approaching us or wanting us to, you know, discuss with them some combination. We, as you know, haven’t done anything yet. And I think we’ll still some of that. Maybe it picks up a little bit more or more people want to look at doing something from a, you know, acquisition or something like that. But we’ll take them as they come. It’s all the same sort of thing. It’s that, you know, what’s the price of it? How does it fit into our strategy? You know, is it along the lines that we’ve established we want, you know, from the quality of the fleet and things like that?

[Gary Farber:]

All right then. Just one last one. The correction, you know, the severity of it seems relatively quick. I’m just sort of wondering when there’s an upturn do you need to spend as much on CapEx to drive the growth. Or do you have some backlog as far as equipment that can be put out there that you’ll still need to spend but maybe not at such a rapid rate?

[Stephen C. Taylor:]

Yes. That’s exactly the case. Once this thing turns, I’ll bet we don’t have to spend much capital for a quarter or two because number one, you’ve got more of an aisle of inventory now. They can go back out fairly quickly. And number two, we’ve got more of just a raw goods inventory than, you know, than what we would want. Because the decline came so fast, we still had stuff coming in you couldn’t even get shut off. So we’ve got the ability to, you know, and we didn’t, I mean we haven’t ordered two years forward or anything like that. It’s very manageable. But we’ve got the ability to put stuff back out pretty quick that’s already built and just idle right now. Or if we need to put stuff together pretty quickly with very, very minimal cost associated with it.

[Operator:]

Your next question comes from Michael Drickamer - Morgan, Keegan & Company, Inc.

[Michael Drickamer:]

You were going through some of these numbers rather quick. Let me just make sure I understood you. Did I understand you correct to say that you’d be surprised if CapEx was greater than $10 million?

[Stephen C. Taylor:]

Yes. We’re about halfway there through the end of Q1.

[Michael Drickamer:]

Well that was my next thought. I mean, CapEx for the rest of the year is what slightly more than $1 million a quarter then?

[Stephen C. Taylor:]

Yes. Yes. I mean I just don’t, there’s just really, there’s no growth in the market. Anything we take is share. So we think we can take that with what we’ve got.

[Michael Drickamer:]

Is it going to be that linear or do you have something built in to the fourth quarter for your expected trough to pick up?

[Stephen C. Taylor:]

Well, it probably would be more, well, gosh, my guess might predict more than two weeks out. You know it’s probably maybe a little uptick towards the end. I mean we’re just not doing much right now. But, you know, probably imperceptible from that standpoint but we think as I mentioned we’ll see some lift towards the end of this year, first of next. And we think probably we can handle the vast majority of that with what we’ve got. And so there may be just a little kick up towards the end just with, you know, as always happens, you know, you’ll have stuff sit in the yard that doesn’t fit.

[Michael Drickamer:]

Then the other thing you talked about was how the sales side was negatively impacted to the capital intensive business. Are you starting to see customers now on the rental side of the business that perhaps would have bought the compressors historically?

[Stephen C. Taylor:]

Yes. We’ve seen some come back and just say they don’t want to spend the cash and they want to rent and stuff like that. So it’s not a big, you know, rush towards that. You know, in the overall scheme of things I don’t think it’s going to be very big but, you know, you do see two or three, you know, independents do it. But, you know, some decent size guys starting to look at that, too, so yes, there’s a little movement there.

[Michael Drickamer:]

And then you talked about an $8 million backlog on the sales side but what’s the timing of that backlog? Is that going to be worked out over the next six months or 12 months or?

[Stephen C. Taylor:]

Well it’s stretched out. That’s for the year, so it’s stretched out probably mainly through second and third quarter. And that’s as I mentioned the inquiry level is surprisingly a little higher than what it was this year at the same time. Of course they’re not executing on those inquiries, but it makes me think people are out there getting some ideas, getting some budgetary numbers, seeing what’s going on and you know maybe there’s some demand building up that as we get towards the end of the year that may be released. And then again we’ve put a couple of sales people in Houston within this last quarter that we think will help that also. So we think we can add to that backlog as we go through the year, not just, you know, work off that period.

[Michael Drickamer:]

Well, Steve, this conference call wouldn’t be complete if I didn’t ask you about your sales gross margin. You know it did pick up here in the quarter, came in above where we were expecting, you know. What’s your thoughts there?

[Stephen C. Taylor:]

Well, gee, Mike, you know, I think it ought to be mid-20s but, yes, it’s just those guys do a great, great job of cost control, really watching it and getting, you know, getting equipment through there. I mean we’ve had unfortunately some layoffs on the fab side, too, so we’ve cut some of those costs on that to match the market. So, you know, it’s just they do a good job of watching what they’re doing and we try to adjust to the market.

[Operator:]

There are no more questions at this time.

[Stephen C. Taylor:]

Okay, Leo. Thanks. Well I certainly want to thank everybody for dialing in and thank all of our employees for what they’ve done. These results are theirs. I just get to talk about them and brag about them. But it’s a tough environment, everybody knows that, and we especially want to say how appreciative we are of our employees for just hanging in. Because it’s tough on everybody to get through something like this but it’s not a panic time. We’ll get through it. We know where we’re going and how we’re going to execute and we look forward to getting on through the next couple of quarters and get back on the real track we want to. So thanks for joining me on this call. I look forward to visiting with everybody again next quarter.

[Operator:]

This concludes today’s conference call. Thank you for attending.