Natural Gas Services Group, Inc. (NYSE:NGS) Q4 2022 Earnings Call Transcript

Natural Gas Services Group, Inc. (NYSE:NGS) Q4 2022 Earnings Call Transcript April 3, 2023

Operator: Good morning, and welcome to Natural Gas Services Group Inc.’s Fourth Quarter 2022 Earnings Conference Call. All participants are in a listen-only mode. After the speakers’ presentation, we will conduct a question-and-answer session. As a reminder, this conference call is being recorded. I would now like to turn the call over to Alicia Dada, Investor Relations representative. Thank you. Please go ahead.

Alicia Dada: Thanks, Julia. Hello, everyone, and thank you for joining us to discuss our full year and fourth quarter fiscal 2022 financial results. Today’s call is being webcast on our Investor Relations website at ndsgi.com. Also available on the site is our earnings press release, which was issued Friday, March 31. Before I hand the call over, I’d like to remind everyone that during today’s call, including the Q&A, we may make forward-looking statements regarding expectations of the Company. These forward-looking statements involve known and unknown risks and uncertainties that may cause actual results to differ materially from those expressed or implied on this call. These risks are detailed in our most recent annual report on Form 10-K, and as such, may be amended or supplemented by subsequent quarterly reports filed with the Securities and Exchange Commission.

The statements made during this call are based upon information known to Natural Gas Services Group as of the date and time of this call. NGS assumes no obligation to update the information presented in today’s call. With that, I’d like to turn the call over to Steve Taylor, our Chairman of the Board, Interim CEO and President. Steve?

Steve Taylor: Thanks, Alicia and Julianne, and good morning, everyone. Welcome to our year-end 2022 earnings conference call. Thank you for joining us this morning. Before taking your questions, I’ll highlight our full year results that were detailed in our earnings press release Friday afternoon, discuss the current business environment and provide comments on other aspects of our business. I also note that we filed our annual report on Form 10-K with the U.S. Securities and Exchange Commission on Friday. Before providing the financial highlights for the fourth quarter and full year of 2022, let me provide some context on the current operating environment. Like the broader markets, energy commodities have been increasingly volatile in recent weeks.

This isn’t terribly surprising, given the overall uncertainty in the broader economy. We anticipate that velocity to continue, at least in the near term until the broader financial markets experienced more stability and a clear picture regarding the banking system, Federal Reserve activity and the overall economy emerges. That said, while it’s unlikely that we will see the same oil price acceleration experienced in the past year. We believe the capital discipline of exploration and production companies, the production restraint demonstrated by OPEC Plus members and the lack of near-term production growth is likely to protect the market from the oversupply of crude in the coming months. And if this weekend unexpected OPEC production cut as any indication, we may be witnessing a new chapter in global energy economics unfold on that provides further support for hydrocarbon prices.

On the demand side, while we are cautious on demand growth and in fact, could see modest contraction from Western economies. That slowdown should be mitigated by a steady increase in petroleum demand from China as the economy reopens. In short, while we are less optimistic about price acceleration in the coming months, we are relatively confident that prices will settle in somewhere in the $80 range, which should provide excellent support for current production activity and the growth plans budgeted by our customers. Of course, we will visibly watch for signs of changes in supply and demand fundamentals and look to position the Company to take advantage of opportunities and identify challenges that would impact our operations and capital spending plans.

While natural gas market has less impact on our business plan, it is fair to say we are somewhat confounded by the lack of support for gas prices. That said, a perfect storm of an incredibly mild winter, especially in Europe, what appears to be more moderate in industrial demand in North America and maintenance issues that reduced LNG export capacity from the United States all had an impact on gas prices. While all of those variables are likely to return to more normal levels over time is unlikely that natural gas prices will meaningfully accelerate in the near term. That said, regardless of the actual level of oil and natural gas prices, the dynamics of the production market provides significant opportunities for the compression business and natural gas services group in particular.

As noted in previous quarters, as reservoir pressures decline, unconventional production increases and other production challenges arise, every barrel of oil produced in North America and around the world requires advanced techniques to reach the surface. One of the most important of which is compression. Absent some major economic or geopolitical surprise, which could include continued production straight from OPEC, that would have an impact on global energy demand, we believe commodity prices should remain firm, which should lead to steady growth in production spending. NGS with our past financial discipline is well positioned to take advantage of these opportunities beginning this year and beyond. As we have said on our last call, while we have been and we’ll continue to be focused on operational efficiencies.

Our line of sight to organic growth opportunities on the high horsepower market remains as strong as the industry has seen in a long time. We announced during the quarter that we expanded our credit facility with Texas Capital Bank to provide running room for future growth. At the end of 2022, we had approximately $25 million drawn on that facility. And at the end of the first quarter of this year, our bank debt is roughly $55 million. This leverage has allowed us to grow our fleet for key customers, the vast majority of which is pre-contracted work. While our largest customers are among the best capitalized and strongest companies in the exploration business, we are always seeking new clients as a way to expand and diversify our revenue base.

While our position as a net borrower is a relatively new development for Natural Gas Services Group, we have a long track record of successfully managing our balance sheet and making calculated opportunistic investment decisions. Our borrowings are the result of the opportunities presently in front of us and our assessment of the future potential key customers, including our quest to maximize returns for our shareholders. In the past, we have been able to fund our capital equipment expansions with a combination of balance sheet cash and operating cash flow. But the present activity is so strong and the equipment is so expensive, they were only able to take advantage of the market with supplemental borrowing. I also want to emphasize that these are high-graded opportunities, ones with long-term contracts and market-leading rights.

We are not chasing every job of oil to us. With that said, let’s look at the results for the from the fourth quarter of 2022. Total revenue for the three months ended December 31, 2022, increased to $22.5 million from $22 million for the three months ended September 30, 2022, or a 2% increase. Total revenues increased year-over-year from $18 million for the three months ended December 31, 2021, for a 25% increase. Rental revenue increased 10.4% from $18.6 million in the three months ending September 30, 2022, compared to $20.6 million in the three months ending December 31, 2022. Rental revenue increased to $20.6 million in the fourth quarter of 2022 from $16.5 million in the fourth quarter of 2021 for a 25% gain. Both compared to period increases were primarily the result of the increased deployment of higher horsepower reeling units with the fourth quarter 2022 growth supplemented by rental price increases.

Photo by Zbynek Burival on Unsplash

Rental revenues have strengthened and are now running between 85% to 90% of our total revenues in all comparative periods. As of December 31, 2022, we had 1,221 utilized rental units, representing just over 318,000 horsepower compared to 1,254 rented units representing 298,000 horsepower as of December 31, 2021. We ended the fourth quarter with 65.3% utilization on a per unit basis and 74.8% utilization on a horsepower basis. Notably, all of our higher horsepower equipment is rented, meaning that everything from 400-horsepower and larger is 100% utilized. Utilized horsepower increased by 7% in the fourth quarter compared to the year ago period while revenue per horsepower increased 27.3% when compared to the same period, demonstrating the robust price increases we have been able to implement over the past year.

Our total fleet as of December 31, 2022, consisted of units and just over 425,000 horsepower. Our large horsepower assets comprised approximately 14% of our utilized fleet by unit count but these units provide approximately 45% of our current rental revenue stream. Sales revenues for the sequential quarters declined from $1.8 million in the third quarter of 2022 to $1.3 million in the fourth quarter of 2022. But on a year-over-year quarterly basis, sales revenue increased from $1.1 million to $1.3 million. For the full year comparison, sales revenues increased from $6.9 million to $8.6 million or a 24.5% increase. As noted in our earnings release, adjusted gross rental margin increased sequentially from $8.6 million or 46% of revenue in Q3 2022 and to $11.3 million or 55% of revenue in the fourth quarter of 2022.

This represents a rental gross margin increase of $2.7 million or approximately 30% in the sequential quarters. On a year-over-year basis, our adjusted rental gross margin of $11.3 million in the fourth quarter of 2022, more than doubled when compared to $4.9 million in the same period in 2021. Adjusted rental gross margin as a percent of rental revenues was 55% in the fourth quarter of 2022 and 30% in the same period of 2021. If anyone recalls in the first quarter call of 2022, I stated that we would achieve at least a 50% adjusted gross margin in our rental business by the fourth quarter of 2022. I’m happy to say we exceeded that with all the credit going to our service forces in the field. That is the primary financial metric and they did an excellent job.

Sequentially, we reported an operating loss of $316,000 in the fourth quarter of last year compared to an operating loss of $294,000 in the third quarter of 2022. The slight increase in operating loss from the current period was primarily due to higher SG&A and approximately $280,000 in equipment and inventory retirements. This compares to an operating loss of $8.2 million for the three months ended December 31, 2021. Operating income improvement was primarily due to higher rental revenue, higher rental gross margins, and significantly lower write-downs from rental fleet equipment retirements and obsolete inventory. Our net loss in the fourth quarter of 2022 was $757,000 or $0.06 per diluted share. This compares to a net loss of $80,000 in the third quarter of the year or $0.01 per basic and diluted share.

The higher net loss in the quarter was due to higher SG&A and a higher income tax rate. On a year-over-year quarterly basis, our net loss for the three months ended December 31, 2022, was $757,000 or $0.06 per basic diluted share compared to a net loss of $5.6 million or $0.42 per basic and diluted share for the three months ended December 31, 2021. Improved rental revenue and gross margins were the primary contributors to the lower net loss. For the comparative full years, net income improved dramatically from a loss of $9.2 million in 2021 to 570,000 loss in 2022. For Q4 2022, adjusted EBITDA was essentially flat at $7.8 million when compared to the prior quarter, but increased significantly from $2.3 million for the same period in 2021. I will note that SG&A expenses in the fourth quarter of 2022 were approximately $4.8 million, a $2 million increase from the year ago period and an increase of approximately $700,000 in the third quarter of 2022.

These increases were primarily attributable to severance and retirement expenses as well as other costs related to our executive transition process. Many of these costs were extraordinary and short term in nature, and we expect them to significantly decrease by the end of this year. SG&A is likely to fluctuate over the next several quarters due to trailing transition costs and the overall growth in our business, but we are acutely focused on these expenses anticipate bringing them back into the 13% to 15% of revenue range that we have historically experienced. Our cash balance as of December 31, 2022, was approximately $3.4 million with $25 million outstanding under our revolving credit facility. In 2022, we realized cash flow from operations of $27.8 million and used $65.1 million for capital expenditures.

$57 million of which was expended on our rental fleet. As a side note, for those of you keeping track of the saga of our elusive $11 million tax refund, there has been some progress. We’ve been lobbying the Advocates Office of the IRS and recently had a conversation with the service. There is movement, but there’s a government speed movement. In refunds over $5 million have to go through an audit, which is estimated to take another year to complete. Mind you, this is on top of the almost three years, we’ve already been waiting. In spite of that, we are celebrating the fact that it appears a real person exists with IRS that acknowledges we have a valid claim. As indicated earlier, the compression market remains strong, and we continue to see demand for new compression units, largely in the high horsepower range.

We are likely to continue to deliberately expand our fleet to meet demand as long as such expansion meets our return expectations. While subject to change, based on market conditions and variability and opportunities, we expect our annual capital budget this year to be $95 million. This may fluctuate due to the number of actual contracts we secured, our contract projections and our assessment of the spec builds we need to pursue, but we think this is a realistic figure at this time. Before I take your questions, a couple of closing thoughts. First, as noted in our 10-K file on Friday, our audit noted a weakness in controls related to our accounting for work in progress or WIP and how we categorize certain WIP and inventory versus long-term assets, as well as how and when we expense certain WIP inventory.

This weakness essentially a balance sheet reclassification was a result of a lack of control policy that resulted in the MIS classification of certain WIP inventories. As a result, we’ve made adjusting journal entries to correct errors, and worked with our accounting staff and external auditors and consultants to address this issue, including developing appropriate controls to prevent this issue in the future. We also believe the recent changes in our accounting and finance team and oversight from our new external auditors will mitigate future errors. Overall, we are pleased with the progress made over the past 12 months. While the noise around executive transitions could have been a distraction, NGS was able to remain focused on the business of growing our company and serving our customers, which is reflected in solid growth in our financial and operating metrics.

Because now we’re five years ago, we’d be on a transition to a company focused on large horse by compression. That transition continues and as noted earlier, continues to grow in importance to our story. Already half of our rental revenue now comes from high horsepower compression and large horsepower equipment is a key component of our margin growth. As noted last year or last quarter, we’re now fabricating 2,500 horsepower compression packages, the largest units in our fleet, and continue to gain traction with those units as well as other categories of large horsepower equipment. We currently have 15 contracts for these very large packages. This is significant as we continue to leverage our large horsepower offerings with a broad range of existing and new customers with an eye towards potential opportunities in midstream markets.

We continue to sign rental contracts with both premium rate and term. Continued improvements in service and availability should allow that advantage to continue, and we believe it should extend to the 2,500 horsepower market. Also, in addition to our traditional compression business, we continue to see opportunities to provide compression related to methane reduction initiatives, which have received a boost from the Inflation Reduction Act. While still early in the game, our technology should not only reduce the carbon footprint of our compression equipment it should create operating and tax efficiencies for those engaged in that business. The balance of 2023 could be a pivotal year for this emerging business. On the governance and lease ship front, our Board of Directors continues to engage in the search for new Chief Executive and Chief Financial Officer.

With that said, the team and I will continue to focus on the opportunities ahead of us. We are energized by daily activity and are excited about the future of our company. I’m grateful to J.D. Faircloth, and his willingness to step in as interim CFO and help balance our Finance and Accounting Group. And as always, I’m incredibly grateful and proud of the entire NGS team for their dedication and efforts in making this not only a great energy compression company, be a great place to come to work every day. Thank you and I look forward to your questions.

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Q&A Session

Operator: Our first question comes from Rob Brown from Lake Street Capital. Please go ahead. Your line is open.

Rob Brown: Just wondering, if you could give a little bit more color on the demand environment for high horsepower? I think you said you had 15 contracts in place. How is the new sales activity funnel? And how is the custom environment, I guess.

Steve Taylor: Now, the 15 contracts are just 2,500 horsepower units. So, that’s a brand-new market penetration for us. The — what we classify as larger horsepower, 400-horsepower and up. And the 400-horsepower is very robust. We’re sold out of those and we’re building some more. And more than likely, we expect those to be contracted as they roll off. If you move up into the 1,400 and 1,500 horsepower range equipment and same thing there. We’re totally sold out in that respect, and we’re building more of the 1,500 horsepower units. And again, most of — whether it’s 400 horse or 1,500 horse or 2,500 horse for that matter, the majority of that equipment, 85% to 90% of it is already contracted. So obviously, the market is very robust.

At this point in time, we don’t have anything in the yard. Everything is being built either on pre-contracts or in the 400-horsepower, a little — some spec units being built in there because it’s a pretty popular unit there. But the — so the demand is great right now, and we anticipate it staying that way. Our projections — internal projections see a fair amount of big horsepower needed in the second half of the year and into next year. The OPEC move this weekend would do nothing to hurt that and probably enhance that. So, I would expect that the big horsepower just continues on and telling unless we see some disruptive factor in it. But right now, we see it being pretty positive.

Rob Brown: Okay. Great. And then the CapEx expectations of $95 million is how much of that is from that 2,500 horsepower market?

Steve Taylor: That — let me calculate in my head. That’s probably — that’s 1/3 to 1/2 of it, just those units right there. They’re pretty expensive. So in the 1/3 to 1/2, it’s somewhat of a range, but it kind of depends on how the rest of the build schedule comes out to on our 1,500 horse or a bit towards 400 horse or something like that. But that give you a rough idea, say, 35% to 50% of it is going to be that bigger stuff.

Rob Brown: Okay. And then you talked about pretty nice growth in the rental in the fourth quarter from my price increases. Do you see opportunity for further price increases? Or will that just flow through in ’23 and drive the growth in ’23?

Steve Taylor: We had some additional increases in Q1 of this year, which we’ll report on in the next call. But no, I think we’re at a good point right now. Now any further price increases we see or choose to implement will probably just be as a result of cost of goods going up either the equipment itself or if we have continued inflation and supply chain issues, just inflationary impacts from those items. But from the point of market-driven or induced price increases that we may just choose to do, we feel like we’re okay where we are right now. And again, anything further will be just due to cost of goods or cost of service.

Operator: Our next question comes from Tate Sullivan from Maxim Group. Please go ahead. Your line is open.

Tate Sullivan: Just looking at more change in rented compressors, do you — I mean on net-net, do you still have any smaller horsepower units coming back to from the field? Or should it be given your recent CapEx and $95 million CapEx plan? Should it be a pretty consistent cadence of the increasing the total number of rented compressors in the field?