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

Natural Gas Services Group, Inc. (NYSE:NGS) Q4 2023 Earnings Call Transcript April 2, 2024

Natural Gas Services Group, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. Ladies and gentlemen, and welcome to the Natural Gas Services Group Incorporated Quarter Four Earnings Call. At this time, all participants are in listen-only mode. [Operator Instructions] I would now like to turn the call over to Ms. Anna Delgado. Please begin.

Anna Delgado: Thank you, Luke and good morning, everyone. Before we begin, I would like to remind you that during the course of this conference call, the company will be making forward-looking statements within the meaning of federal securities laws. Investors are cautioned that forward-looking statements are not guarantees of future performance, and those actual results or developments may differ materially from those projected in the forward-looking statements. Finally, the company can give no assurance that such forward-looking statements will prove to be correct. Natural gas services group disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Accordingly, you should not place undue reliance on forward-looking statements. These and other risks are described in yesterday’s press release and in our filings with the SEC, including our annual report on Form 10-K for the year ended December 31, 2023. These documents can be found in the Investors section of our website located at www. ngsgi.com. Should one or more of these risks materialize or should underline assumptions prove incorrect, actual results may vary materially. In addition, our discussion today will reflect certain non-GAAP financial measures, including EBITDA, adjusted EBITDA, and adjusted gross margin, among others. For reconciliations of these non-GAAP financial measures to the most directly comparable measures under GAAP, please see yesterday’s earnings release.

I will now turn the call over to Justin Jacobs, our Chief Executive Officer. Justin?

Justin Jacobs: Thank you, Anna, and good morning, everyone. Welcome to our fourth quarter 2023 earnings conference call. Thank you for joining us this morning. We appreciate your interest in Natural Gas Services Group. I’ll start by introducing the team. Joining me on the call this morning is Brian Tucker, our President and Chief Operating Officer; Jim Hazlett, our Chief Technical Officer; John Bittner, our Interim Chief Financial Officer; and Steve Taylor, the Chairman of our Board of Directors. Steve was our longtime CEO and Interim CEO last year. I asked Steve to start us off with some thoughts on the quarter and the year. After that, John will review the quarter and year in detail, and then I will finish our prepared remarks with thoughts on the current state of the business, our updated guidance, and our growth strategy going forward.

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Q&A Session

We will conclude with a question-and-answer session. Before turning it to Steve, I wanted to take a second to share with all shareholders my appreciation for the first rate approach Steve has taken during his transition. He has been an invaluable resource for me and the team and a welcome presence in the office. As one of our largest shareholders, he is well aligned to continue to drive significant value for all shareholders. And from my perspective, he is, as the saying goes, walking on the walk. Thank you, Steve, and the floor is yours.

Steve Taylor: Thanks, Justin. I appreciate the kind words and want to assure everyone listening that my feeling is mutual. We have a great management team in place and it’s been my pleasure to work with them. I won’t take long because I think the results speak for themselves. 2023 was a record year for revenue and EBITDA among other items. As we look at this year and particularly this quarter we’re happy with almost every aspect of our performance. But we talked about our successful bank funding throughout the year, our ability to obtain pre-contracted work of long duration at excellent rates, or the operational and environmental technology we’re increasingly incorporating into our equipment, there are many areas to be happy with.

We were especially proud of those items that we have accomplished that we can continue to build on in the future. Among them are the continued successful execution of our high horsepower strategy that has well established us in the 1,500 horsepower market and has moved us into the 2,500 horsepower realm. Our ability to secure additional blue chip customers that will contribute to our growth in the future and our safety performance. That resulted in zero workplace incidents among our employees in 2023. I see these as legacy initiatives that we can continue to build on into the future. Whether you look at the recent fourth quarter or the full-year, the company exhibited exceptional growth and results in 2023. I’m not going to recite road numbers, John will go through those.

But I will note that any time you have a year that exhibits 40% to 50% year-over-year growth in rental revenue, rental adjusted gross margin, and total EBITDA, it’s a hell of a year. I’ll distill all this into the company’s ability to identify opportunities and execute on them. We have many opportunities ahead and our management team, led by Justin Jacobs, the CEO, is well positioned and possess the ability to continue the company’s growth. As chairman and as a significant shareholder, I have great confidence in our employees and our management team to continue our success. I’ll leave you with one final comment, which is the title of the song from 1986, The Future’s So Bright, I Gotta Wear Shades. Now, I’ll turn it over to John Bittner to review the quarter and year in detail.

John?

John Bittner: Thank you, Steve, and good morning, everyone. To echo your comments, we had a very successful fourth quarter to finish a strong year. So let me jump first into review of the fourth quarter first and then I will get to the full-year 2023 results. Total revenue for the three months ended December 31, 2023 increased to $36.2 million which was up $13.7 million or 61% from $22.5 million in Q4 2022. Our revenue was up 15.5% from $31.4 million for the three months ended September 30, 2023. Rental revenue for Q4 2023 was up — was $31.6 million, up from $20.6 million in Q4 2022 for a 54% increase year-over-year, and up $3.9 million from $27.7 million in Q3 2023, a 14% increase. Our sales revenue for Q4 2023 was $2.9 million, up $1.6 million, or 125% from $1.3 million in Q4 2022, and up $1.5 million from Q3 2023 for a 107% increase.

After market services, our AMS revenue was $1.7 million for Q4 2023, which was up $1 million or 153% for the same quarter in 2022 and down by approximately $600,000 sequentially, a 26% decrease. Our adjusted total gross margin of $20.3 million in the fourth quarter of 2023 increased approximately 89%, when compared to $10.7 million in the same period in 2022. Sequentially, adjusted total gross margin dollars increased 39% from $14.6 million last quarter. Adjusted gross margin as a percent of sales for Q4 2023 was 55.9% versus 47.6% for Q4 2022 and 46.4% in Q3 2023. This material increase in our margin percent was driven primarily by rental adjusted gross margins. Our rental adjusted gross margin dollars increased year-over-year to $19.2 million in Q4 2023 from $11.3 million in Q4 2022, representing a 70% increase.

Sequentially, rental adjusted gross margin dollars increased from $14.2 million, or a 35% increase. Our rental adjusted gross margin as a percent of sales for Q4 2023 was 60.7% versus 54.8% for Q4 2022 and 51.4% in Q3 2023. Our rental adjusted gross margin was higher than we expected in Q4, primarily due to lower-than-expected labor, parts, and oil expense. Our expectation is that rental adjusted gross margins going forward will be somewhere between what we experienced in Q3 and Q4 as we indicated our expectation for Q4 on the third quarter earnings call. Adjusted gross margin dollars for our sales revenue increased year-over-year by $1.6 million to $2.9 million in Q4, an increase of 125% and increased by 107% sequentially. Adjusted gross margin as a percent of revenue for sales was $21.2 in Q4 2023 versus a negative 65% in Q4 2022 and a negative 7% in Q3 2023.

Our AMS adjusted gross margin for Q4 2023 of $440,000 represented $152,000 increase from the prior year or 53% and an increase of $35,000 or 9% from Q3 2023. AMS adjusted gross margin as a percent of revenue was 26.3% in Q4 2023 versus 45% in Q4 2022 and 18% in Q3 2023. As mentioned on last quarter’s call, we’ve seen a significant increase in AMS revenue from historical levels beginning in Q2 2023. This increase is primarily due to pass-through services that we provide to or arrange for our customers when installing our large horsepower units. These revenues will fluctuate with the volume of equipment set in each quarter and they carry low pass-through margins, hence the decline in gross margin percentage from the prior year period. The volume of new unit sets saw the highest levels activity in Qs 2 and Q3 of 2023 decrease somewhat in Q4 2023.

Our fourth quarter 2023, adjusted EBITDA was $16.3 million, compared to $7.8 million in Q4 2022 or 110% increase year-over-year, and a 38% sequential increase from $11.8 million in Q3. Our Q4 2023 adjusted EBITDA benefited from our unexpected high rental adjusted gross margin and positive contribution from our sales adjusted gross margin. Pretax operating earnings were $4.4 million for Q4 2023, which improved from an operating loss of approximately $300,000 in Q4 2022. Our Q4 2023 operating income was down approximately $500,000 sequentially from Q3. However, it’s important to note, we did take onetime charges of approximately $4 million to increase our inventory reserve as a result of the cessation of fabrication operations at our Midland facility, and additionally, a charge of approximately $500,000 for the retirement of idle units, both of which as disclosed in our 10-K filed yesterday.

Without these charges, our pro forma operating income would have been $8.9 million for Q4 or a sequential increase of $4 million from $4.9 million in Q3 2023. Net income in Q4 2023 was $1.7 million, compared to a net loss of approximately $800,000 in Q4 2022, but down from net income of $2.2 million in Q3. Again, the Q4 net income results include the impact of the onetime items discussed above. Earnings per share for Q4 2023 were $0.14 and $0.13 on a basic and fully diluted basis, respectively, compared to a loss of $0.05 per share for Q4 2022 and earnings of $0.18 per share in Q3 2023. On a full-year basis, the total revenue for the company increased by 43% to $121.2 million in 2023 from $84.8 million in 2022. Our rental revenue was also up 43% to $106.1 million in 2023 from $74.5 million in 2022.

Our sales revenue was up approximately $353,000 or 4% to $8.9 million in 2023 from $8.6 million in 2022. Our AMS revenue was up 240% to $6.1 million in 2023 from $1.8 million in 2022. Our adjusted gross margin dollars increased by 53% year-over-year to $58.7 million in 2023 from $38.5 million. Our adjusted gross margin for rental was $57.3 million, which was up $20.6 million or 56% from 2022. Our adjusted rental gross margin as a percent of sales for 2023 was 54%, compared to 49.3% in 2022. Adjusted gross margin dollars for sales was zero in 2023, compared to a positive $918,000 in 2022, which was approximately 10.7% of sales. Adjusted gross margin for our AMS business was $1.4 million for 2023, compared to $835,000 in 2022. Adjusted gross margin as a percent of revenue for AMS was 23.5% for the full-year 2023, compared to 46.6% of revenue in 2022.

Again, the decline in gross margin percentage was driven primarily by the increase in loan pass-through billings — low-margin pass-through billings associated with the new unit sets in 2023. Our adjusted EBITDA for 2023 was $45.8 million, as compared to $29.2 million in 2022 or a 57% increase in 2023. Our operating income for 2023 was $10.5 million as compared to approximately $400,000 for 2022. Our SG&A expense was $2.8 million higher in 2023, as compared to 2022 at $16.5 million in ‘23 versus $13.6 million in 2022. However, our second-half ‘23 run rate was less than our first-half ’23 due to some non-recurring items experienced in the first-half of the year. Also deducting from our operating income in 2023, we did have a non-cash non-recurring charge of $779,000 for an asset impairment in the second quarter and the one-time charges of $4 million for the inventory reserve, the $500,000 or retirement of idle units discussed above, both of which were taken in Q4.

Our net income for 2023 was $4.7 million, compared to a net loss of approximately $600,000 for the full-year 2022. Our basic EPS for 2023 was $0.39 and $0.38 on a fully diluted basis, compared to a net loss of $0.05 per share in 2022 for both measures. As of December 31, we had 1,247 utilized rental units representing just over 420,000 horsepower, compared to 1,221 rented units, representing just over 318,000 horsepower as of December 31, 2022. We have added approximately 95,000 net horsepower to our fleet over the course of the last year, representing approximately a 22% increase in total fleet horsepower. Our total fleet size just passed over 500,000 horsepower in September, and we ended the year a total of 520,365 horsepower. This is up from approximately 425,000 horsepower fleet size at the end of last year.

During the same period, our rented horsepower grew by over 102,000 horsepower. We ended the fourth quarter with 66.5% on a per unit — utilization on a per unit basis and 80.8% utilization on a horsepower basis. Our revenue per horsepower increased 17% over the year, demonstrating the impact of the growth in high horsepower units and also the price increases we’ve been able to implement over the past year. Our total fleet as of December 31, 2023, consisted of 1,876 units and roughly 520,000 horsepower or 277 horsepower per unit. Our average horsepower per unit has grown by 22% over the past year and notably, approximately 98% of our high horsepower fleet is utilized in drawing rent currently. Turning to the balance sheet. We ended the year with $2.7 million in cash and $164 million outstanding on our amended and restated revolving credit facility.

In looking at our 2 financial covenants contained in our credit agreement, our leverage ratio at the end of Q4 was 2.53 times, which was down from 2.71 times at the end of Q3. Our fixed charge coverage ratio for Q4 was 3.88 times, up from 2.78 times in Q3. So we were comfortably in compliance with both our financial covenants as of December 31, 2023. Our accounts receivable balance as of December 31, 2023, was in excess of $39 million, which is elevated from normal and expected levels due primarily to a significant increase in rental activity in certain process-related billing delays, which we expect to address during 2024. The net book value of our rental fleet at year-end was approximately $374 million. We generated cash flow from operations of $18 million compared to $27.8 million for 2022.

The decrease is primarily related to the slower collections in our accounts receivable as discussed in the paragraph above. We had capital expenditures of approximately $154 million during 2023. And we increased the balance on our amended and restated credit facility by $139 million during 2023. With that, I will turn it back over to Justin for a discussion of the current operating environment. Justin?

Justin Jacobs: Thank you, John. Overall, we continue to see solid demand for both our rental services and new equipment with generally attractive pricing. We see a favorable environment for potential growth over the near to medium term and believe we are well positioned to expand our market share, while continuing to perform at high levels for our customers. Approximately 75% of our active fleet is located in oil and liquids-oriented basins, where activity is primarily driven by crude oil prices. As such, I’ll turn first oil. On a macro level, oil prices appear to be relatively steady, which should continue to drive activity. We have reasonable confidence in the oil markets for the near term. Activity and forecast generally shows stable to increasing production levels for the near to medium term.

Natural gas markets are a different story. Pricing is weak, and gas-oriented rigs are at a relatively low level. The current moratorium on future LNG facilities has likely negatively impacted sentiment about gas production, at least temporarily. Overall, I would describe the natural gas production market is unsteady. From the company perspective, we do not currently see natural gas production as a growth story, but our people are doing a good job maintaining our presence in the gas-oriented areas, and we continue to profitably rent equipment in these bases. While the overall environment can be described as favorable, we will remain in the constant state of awareness that commodity markets can change to the negative in a hurry. As such, we will consistently plan our growth with an appropriate margin of safety to withstand any potential downturn.

I’ll turn to our 2024 outlook with an update to guidance provided on our third quarter earnings call. For a written summary of our outlook, I would point you to our earnings release filed after the market closed yesterday. And I would also remind you of the disclaimer provided at the beginning of this call, which addresses forward-looking guidance. Our current outlook for 2024 adjusted EBITDA is $58 million to $65 million. This is a material increase from the guidance provided on our third quarter call. As noted in the earnings release, we believe the low end of the range represents our current view of the annualized amount of fourth quarter 2023 adjusted EBITDA that is run rate or recurring. As it relates to the fourth quarter of 2023, there are 2 items to which I would draw your attention.

First, we had sales adjusted gross margin of $0.6 million in the fourth quarter. But for the first three quarters of the year, we had negative $0.6 million. We believe the first three quarters of the year are a much better forward indicator than the fourth quarter. Second, as John noted earlier in the call, the fourth quarter 2023 rental adjusted gross margin of 61% exceed our expectations. I would describe margins at that level as everything went right. Taking both of these points into account leads us to believe the low end of the range is a bit of approximation of the run rate adjusted EBITDA of the fourth quarter of 2023. I would further note that we believe there are some areas of investment required in 2024. While we have not yet quantified these investments, they are focused on improving the scalability and efficiency of our operations, both in the field and the corporate offices to drive material future growth.

Along those lines, I’m pleased to announce that our new website went live yesterday. Although a relatively small investment, it is indicative of our intent to make sure all aspects of our business are in line with the technologically innovative equipment we provide to our customers. I would like to thank our team who made this happen. I’ll move next to new unit capital expenditures. For 2024, our new unit capital expenditures expected range is $40 million to $50 million. Of that, approximately $15 million is capital to build new units from the 2023 plan that will be completed and installed in 2024. The balance is 2024 capital planned expenditures that are currently expected to be completed and installed in late 2024 and/or early 2025. In terms of return on invested capital, we are targeting at least 20%.

This applies to any growth capital expenditures, which I would define as new units, unit upgrades and unit conversions. This target is an average rate across our growth capital expenditures. I would also like to discuss our forward growth strategy. While each of these items will help us meet or hopefully exceed our 2024 outlook, they also reflect our long-term intention to grow our revenue and cash flow. There are four parts to our growth strategy: number one, optimize the existing utilized fleet; number two, improve our asset utilization; number three, expand the rental fleet; and number four, execute accretive mergers and acquisitions. Let me describe each of these points in a little detail. First, optimize the existing utilized fleet. We believe there are opportunities to modestly improve the profitability of our existing utilized rental fleet through targeted price increases particularly in geographic areas that have experienced higher rates of cost inflation, along with operational efficiencies by using improved data collection and analysis to optimize our costs in labor, parts and maintenance.

Second, improve our asset utilization. We believe we can improve the overall cash flow of the business by increasing utilization of the fleet, as well as creating investable cash for non-cash assets. We have a significant number of currently unutilized units. Unutilized fleet on the books as of year-end 2023 was more than 600 unutilized units consisting mostly of medium and small horsepower units. We will review these unutilized units to determine where investment can improve the marketability and cash flow potential of the units. We also have a significant amount of capital tied up in non-cash assets. Notable examples of this include the income tax receivable and the higher accounts receivable, which John discussed earlier. We believe these non-cash assets can be monetized and invested back in the fleet at or above our target levels of return on invested capital.

Third, expand the rental fleet. We intend to prudently increase the size of our rental fleet, mainly through precontracted agreements with our customers. We believe our future growth in this part of our strategy will be primarily driven through our placement of larger horsepower centralized station natural gas compressors for unconventional oil production with select increases in medium horsepower units to meet customer demand beyond our existing fleet. Fourth, identify and execute accretive mergers and acquisitions. We believe there may be opportunities in mergers with or acquisitions of rental compression companies or related businesses providing similar services. While there is no certainty of the probability of any particular deal, we will continue to evaluate potential acquisitions, joint ventures and other opportunities that could enhance value for our shareholders.

At this point, we will not provide overall growth goals for the medium to long term nor will we provide a breakout for each of the components of the growth strategy in terms of contribution. However, it is the framework for how we intend to drive material growth over the next three to five years, and we’ll look to provide further detail in the future. I remain optimistic as to our growth potential and look forward to delivering against that potential to drive value for our shareholders. This concludes our prepared remarks. So I will ask the operator to queue up for the question-and-answer portion of our call.

Operator: Thank you so much, sir. Ladies and gentlemen, at this time we will conduct the question-and-answer session. [Operator Instructions] We are now ready to begin. We do have some questions in the queue. Mr. [Indiscernible], please go ahead.

Unidentified Analyst: Thank you. Good morning. Maybe you could just talk a little bit about what takes you to the high end of your guidance of the 65?

Justin Jacobs: I think it’s — as we look at the — going through the growth strategy, those items really towards the — on the first point, which is optimization of the fleet and seeing what we’re able to do in terms of targeted price increases, some potential improvements in operational efficiencies. And then as we look to the third point, expanding the fleet, it’s really the timing of when some of the units, which were in the ’23 plan and that has spilled over into 2024, the timing of when those are installed.

Unidentified Analyst: Understood. And then in terms of your CapEx, in terms of sort of the new units, can you talk about how much horsepower you’re planning on adding, I guess, between the ’23 carryover and into ’24?

Justin Jacobs: I would give those numbers really just in aggregate, which is if you look at the amount of capital that we spent in 2023 and the horsepower that was added, the ratio as you look at that for 2024 will be roughly the same.

Unidentified Analyst: Got it. And then you talked about gross margin and sort of guided to sort of — between 3Q and 4Q if I got that correct. Everything went right in Q4 understood. But can you talk about which specific parts you’re seeing maybe go higher? And therefore, reducing your gross margin?

Justin Jacobs: It was really as we look at the performance in the fourth quarter, as we said, it surpassed our expectations, and there’s really no particular line item that stood out. It was really across the board with the major line items we highlighted, which are labor, parts, consumer expenses largely oil. And so as we looked at those and looked at the performance of the machinery and just the timing, we would say that really, it’s kind of across the board, our expectation is those will come down. So there’s no particular line item that we would point to. It was really a — everything went exceptionally well.