Alicia Dada - Stephen C. Taylor - Executive Chairman, Chief Executive Officer and President.

Jason A. Wangler - Wunderlich Securities Inc., Research Division Joseph D. Gibney - Capital One Securities, Inc., Research Division Robert D. Brown - Lake Street Capital Markets, LLC, Research Division Craig Hoagland - Anderson Hoagland & Co. Peter Van Roden Veny Aleksandrov - FIG Partners, LLC, Research Division.

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group Second Quarter Earnings Call. [Operator Instructions] Your call leaders for today's call are Alicia Dada, IR Coordinator; and Steve Taylor, Chairman, President and CEO. I would now like to turn the call over to Ms. Dada. You may begin..

Thank you, Ross, and good morning listeners. Please allow me to take a moment to read the following forward-looking statement prior to commencing our earnings call.

Except for the historical information contained herein, the statements in this morning's conference call are forward-looking and are made pursuant to the Safe Harbor provisions as outlined in the Private Securities Litigation Reform Act of 1995.

Forward-looking statements, as you may know, involve known and unknown risks and uncertainties, which may cause Natural Gas Services Group's actual results in future periods to differ materially from forecasted results.

Those risks include, among other things, the loss of market share through competition or otherwise; the introduction of competing technologies by other companies; and new governmental safety, health or environmental regulations, which could require Natural Gas Services Group to make significant capital expenditures.

The forward-looking statements included in this conference call are made 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 filed with the Securities and Exchange Commission.

Having all of that stated, I will turn the call over to Steve Taylor, who is President, Chairman and CEO of Natural Gas Services Group.

Steve?.

Okay. Thank you, Alicia, and Ross, and good morning, and welcome to Natural Gas Services Group's second quarter 2014 earnings review. Our 16% year-over-year rental revenue growth continued at a strong pace for gross margins in this segment and the company as a whole strengthening again this quarter.

Shipments of gas compressors and liquids and oil shale-oriented basins continued at a good rate, and our plant fabrication expense is on track to open up in the fourth quarter this year.

Compressor sales volumes were off a bit this quarter due to some delayed orders, but our backlog is intact and we anticipate this equipment will ship to the balance of the year. We are pleased with our performance this quarter and anticipate continued progress. I'll detail these comments as we go through the narrative, so let's move on to the numbers.

In the year-over-year quarters, our second quarter 2014 total revenues increased 8% or $1.7 million to $22 million from $20.3 million in the second quarter 2013. Rental revenues led that increase with a 16% annual growth rate.

The sequential quarters of the first quarter 2014 compared to the second quarter of this year, total revenues were off slightly $400,000 to $22 million, primarily due to typically fluctuating compressor sales volumes.

Comparing this current quarter to the second quarter of last year, total gross margin was up 6% from $12.3 million to $13 million or 59% of revenue. Sequentially, total gross margin increased 8% to $13 million and moved up from 54% to 59% of revenue.

Gross margins in all 3 of our product lines, rentals, sales and service and maintenance, increased this quarter to 60%, 43% and 60%, respectively. Those continue to be industry-high margins across the board. Our SG&A was 12% of revenue this quarter, which is the same rate as last year -- the last quarter.

We anticipate this to trend down slightly over the balance of the year. However, we have added engineering resources and plan on broadening our sales efforts, so a 10% and 11% average rate will probably be what we see going forward.

Compared to the year-over-year quarters for operating income reflect a decrease from $5.8 million in the second quarter of last year to $5.1 million this current quarter. This is driven by the higher SG&A rate and an 18% or $800,000 higher depreciation expense resulting from our rental fleet growth.

Sequentially, operating income increased 17% to $5.1 million, primarily driven by higher margins across all our product lines. In the comparative year-over-year second quarters, net income decreased from $3.8 million last year to $3.4 million this year for the same reasons I just mentioned.

We increased 19% to $3.4 million between the sequential quarters of this first quarter of 2014 to the second quarter of this year. Our net income to revenue ratio was 15% this quarter. EBITDA increased in both year-over-year and sequential quarters.

On a year-over-year basis, EBITDA increased from $10.2 million in the second quarter of last year to $10.4 million in this current second quarter. While sequentially EBITDA climbed 10% and is running at 47% of revenue. On a fully diluted basis, earnings per share this quarter's $0.27 per common share.

Now breaking down the product lines and looking at sales revenues.

In the year-over-year quarters, total sales revenues, which includes compressors, flares and aftermarket activities, fell from $3.3 million in the second quarter of last year to $2.3 million in the second quarter of this year, with the decrease primarily attributable to a lower level of flare sales than last year.

The sequential quarters total sales revenues were down the same amount about $1 million, but this is primarily due to the deferral of some compressor builds in subsequent quarters. Reviewing compressor sales alone, in the current quarter there were about $500,000 compared to $700,000 in the second quarter of 2013 and $2.2 million last quarter.

We anticipate that our sales level this quarter would have matched last quarter's, as I just mentioned some of the booked orders were delayed.

In the first quarter, we received a good longer-term contract to build equipment for a large customer, and although the total dollar amount is steady, the rate of production has been stretched out to more closely matched their fuel production schedule.

Our compressor sales backlog is, however, inching up and stretching out and was $10 million to $11 million at the end of the second quarter of 2014. We estimate that this will be built out over the next 2 to 3 quarters.

Rental revenue had a year-over-year increase of $2.7 million or 16% from $16.7 million in the second quarter of last year to $19.5 million in the current quarter. Gross margins were 60% of revenue this quarter compared to 63% in last year's comparative quarter.

Sequentially, rental revenues grew almost 4% from $18.8 million to $19.5 million, and we had a good move in gross margins with an increase from 58% in the first quarter to 60% this quarter.

If you recall, our rental growth rate between the fourth quarter 2013 and the first quarter this year was a bit depressed due to a higher than normal rate of rental returns. We were back on our typical growth rate this quarter. Our turn is still higher than normal, but we're keeping up with it.

We continue to set newbuild units into the oil and liquid shales with a new contract rate in the first 6 months of this year running about 20% higher than the comparable period last year. Fleet size at the end of June was 2,732 compressors. We ended the second quarter with rental fleet, unit and horsepower utilization in the 78% to 79% range.

This was a net addition of 176 compressors year-to-date on a capital spend of $15 million this quarter for rental compression fleet expansion. Our active rental fleet is now about 45% deployed in the oil shales and liquids-oriented plays. Going to the balance sheet.

Our total short-term and long-term debt was less than $0.5 million as of June 30, 2014, and cash in the bank was about $14.5 million. Our cash flow from operations for the first 6 months of the year was $18.2 million.

From macro prospective, the price of gas held a little bit more promise last quarter than this, but that has waned and looks like another flat year for that commodity. But we have not seen growth there for a long time, so it's not a detriment to our forward plans.

Our customers' activity levels appear to be staying strong in liquids-oriented plays and the price of crude, which is driving most of that activity, looks to stay high through the year. We continue to add equipment to existing areas and think some of our new areas hold good potential.

Overall, trends look to be positive and we are confident that no matter the environment, NGS will continue to execute as required. That's the end of my prepared remarks. And I'll turn the call back to Ross for questions anybody might have..

[Operator Instructions] Our first question comes from Jason Wangler from Wunderlich Securities..

Just, you kind of mentioned that there are just want to maybe dive in a little bit more on the churn and just what you're seeing from the gas. I guess you're just kind of saying it's more normalized. Obviously, it's -- last couple of months, we've kind of just seen the commodity trend down.

Do you think we're kind of maybe flat back to your baseline of gas work? And at this point, you're just -- obviously, just working on the oil and liquid side and whatever happens there, we'll see if it improves, but otherwise you're kind of back to the steady-state that you've been here for a while now?.

Yes, I think so. It's grown a little higher than what had historically been, but I think we're getting a lot of movement on the gas side. And we continue -- just like first quarter, we continue to see the gas area as being in the weak part of the business, obviously. As I mentioned, the oil and liquids plays are still very active.

We're running ahead of even last year on that, and about the same pace as 2012. So that's still busy.

We've just got to kind of what should be, I think, we're -- well, this is August now, yes, you would typically think any big of the weakness on gas would have already been happening and now we start going into a little of the colder weather in the fall, in the winter and things like that, that will make it, if not strengthening, at least some stability in that piece of it.

So -- but we're back on the same growth -- quarterly growth rate we've been used to. So we think generally, it's a positive trend..

Sure, that's great. And then just do you have any -- I know, last time we chatted, at least the Quad O stuff you maybe kind of see once in a while something kind of trickle out.

I mean, are you seeing much more there, or maybe just your thoughts on the regulation and where that's going?.

Well, I mean, we're still -- we see a little movement on that thing. And of course, as we said on the last couple of calls that people are worried in these environmental regulations come in to control methane emissions of locations. Not the step change we thought it might be in the market, but we are seeing some movement there.

Typically, much smaller equipment, the 20-, 30-horsepower stuff, stuff we really don't deal in. It's more of a mom-and-pop sort of thing. But we are seeing some of our stuff move out a little bit. It's not just as much as we thought and as quick as we thought. But still -- it's still going to be a good incremental market.

If you remember, part of the whirlwind effect this April, the next part goes in effect next April. So yes, there's probably nothing but growth going to be in that thing. Thing still remains to be seen just how fast and at what rate it grows..

Great. And then -- sorry, just last one if I could. As far as the expansion, you said it's kind of on track.

Do you pretty much think that as you get into '15 is when we'll really see the effect you've been able to put out a lot more compressors with the expansion?.

Yes, we're running pretty good right now. The expansion is going to do 2 things. It's going to increase our total throughput at the Midland facility, and that's where the expansion's going. What we've done in the past is have shifted between Midland and Tulsa. Midland's always been primarily rental. Tulsa's been primarily sales in the past.

We've moved more rentals up to Tulsa in the past couple of years to help drive that rental piece. But we'd never wanted to get to the point where Tulsa was all rental. We still want to maintain some of the sales stuff.

So what we will see in the third and fourth quarters of this year as the facility comes on in Midland, Tulsa's got -- again, this backlog is primarily a third and fourth quarter-driven event. So we're going to see Tulsa really come down in rental throughput, Midland start to pick up.

So we may not see a whole lot at the end of this year as far as difference in capacity, but next year it will be on full speed. And it will kind of depend on just how our sales backlogs and volume keep going next year as to the ultimate capacity we see out of it. But we're still looking in that -- we did 277 units last year.

We're still looking in that 300, 325 this year and then 325, 350 next year..

Our next question comes from Joe Gibney from Capital One..

So a quick question.

I apologize if I missed this in your remarks, but the gross margin percentage on your compressor sales in the quarter, and maybe what the dial-in going forward as you've had higher sales gross margin in the quarter, and just what the average mix and the low throughput, I was curious what it was in the quarter?.

Yes, total sales was 43%. And yes, that includes flares and everything else. But actually our compressor sales were running in the 25% to 30% range. So we're getting some really good margins on the compressors sales. Now, obviously, the volume was down a little this time, so wouldn't hold across a whole lot of business.

But the -- our sales margins were running pretty good Q1 also. Compressor sales margins, I want to be sure to differentiate that. So we're doing pretty good on that piece of business.

Now part of that is, about half of our business now is international and you typically get higher margins on that business, but we're hoping we can maintain that -- this mid- to high-20s going forward..

Okay.

And just your outlook on the flares side, can you just sort of trend down a little bit here, but just for flatlined at current levels, would you expect this to sort of step down a little bit as we get into '15?.

Yes, we've always said that the flare business is one of those opening and closing windows. It's been opening for about 3 years and now it's starting to close. And so we think we saw the peak last year. Still a good decent business, delivers high margins for us, not a whole lot of revenue. But yes, we see it coming off.

Of course if anybody pays any attention to the Bakken, you see there's a lot of pressure up there, you've got flares down, we've got flares out here in the Permian. Nobody likes flares essentially. We don't mind them that much, but -- since we sell them. But yes, there's a lot of pressure from local regulators and things like that to get them down.

So we think that will continue to trend down. I think we'll hit a probably level, that's a bit in terms of what it is in '15, and then there's always going to be the ongoing requirement for flares and I think it may even be -- if you go back to, say, '09 or '10, before it really started ramping up, there's a given level there.

I think we'll probably settle out at above that level going forward just because with all of these -- the Quad O and regulations and things like that, it's not quite as easy to be able to vent gas as you could before. So again, be a lot of standby flares out going forward.

So long answer to a short question, but it's coming up and we don't think it'll settle back -- we think it'll settle at a higher rate than what it was historically before..

Okay, helpful.

And just last one for me, just on the G&A boost in terms of the incremental personnel that you're adding I think you referenced on the more engineering resources and sales, does that actually give a little more color on some of the boost in personnel as you guys ramp up some of your capacity in looking forward?.

Yes, we've brought up engineering more to a full speed sort of thing from the -- starting from -- the sales backlog has grown, so we have a little more umph there from that standpoint and sort of what some of the additional production going on. Yes, there's some other things we're kind of looking at in the market.

We do want to increase our sales presence. That's probably going to be the bigger thing. We look at towards the end of this year and into the first of the year. We've got good growing areas.

They're actually getting bigger where they can support some more sales staff to keep them growing and there's a couple of 3 new areas we really want to start pushing a little harder. So it's going to be in conjunction with our capacity expansion, keep the markets we're growing and then try to move them a couple more..

Our next question comes from Rob Brown from Lake Street Capital..

Steve, on your equipment revenue, I think you gave some pretty good thoughts there about how that ramps up towards the back of the year.

But do you still think the year will come in, in that sort of $15 million range, or should we think about that as a little lower for the sales revenue?.

Yes, we've said it'll be in the $10 million to $15 million and I'm probably going to stick with that a little just because we're constantly seeing the stuff moving around. This quarter, it moved around again and last quarter it moved around. So we -- and probably midpoint would be a good number, if you just want to put a pin in it.

We think it'll -- a lot of backlog will be built in the third and fourth quarters, some may slip over into the first quarter next year.

One of the things we're going to do now is in the orders we start getting, and of course, those are booked orders, but in new orders also, our team slipped into next year anyway just because of raw goods deliveries, engines, compressors, coolers, things like that. So I'm hesitant to lean you towards the high side or the low side.

I'd say probably the middle somewhere is probably where we'll end up on a full year basis..

Okay, good.

And on your capacity expansion, does that give you -- I guess does that give you more rental growth or maybe just remind us again on the units that'll open up, and how you're shifting towards versus rental versus sales?.

Yes, that's strictly a -- well, not strictly, but it's -- their expansion's intended to increase our rental throughput. Now, we can build some sold equipment there, too, but typically we do that stuff up in Tulsa. We'll do some smaller stuff sometime. It kind of depends on the floor space commitment for this in Tulsa or Midland as to what we can do.

But yes, it's intended for rental expansion. So again, we're -- this year, we think that'll be in that 300 unit range, which is about 10% -- 10% to 15% higher than last year. And then once we get to -- that just the fourth quarter really coming off in the quarter. Then as we go into next year, we'll be more up in the 325, 350 range..

Okay, and last question.

Could you give us an update on your liquids separation project? Is that product -- is that -- sort of where you're at on that and what's with the next milestone there?.

Yes, we're still looking at that from a point what -- from a little wellhead to sort of separation skid. So we're still in the midst of mild [ph] design. We're looking at probably some other -- that process, a couple of other adjunct processes and ancillary items there.

So we're still on track to be looking at trying by the end of this year or end of next year to see if this is something that may be attractive from an operator, may fit into our bailiwick and things like that. So it's pretty much on track, just kind of grinding out the designs and marking data and research and things like that right now..

Our next question comes from Craig Hoagland from Hoagland Anderson -- Anderson Hoagland..

I think you mentioned the statistic -- I just want to go back to which was new contract rates were up, if I got it right, 20% in the first half..

Right, compared to last year..

And does that refer to the rate of bookings for rental equipment or what exactly does that refer to?.

What it is, is number of units set. So equipment actually set and earning revenue is running at a higher rate this year than what it was compared to period last year..

Okay, so 20% more units generating revenue?.

Well, that's been said. Now what you have the do, from the rental side, you have the equipment that's set and you also have the equipment that's terminated. So you get that churn on that, and that's what I was referencing before. So you won't necessarily -- it's not necessary equate to the growth rate.

What it really points to is just the activity -- primarily, the activity in the oil shales is continuing at a higher rate..

Yes, and that was a reference to the liquids part of the business?.

Right. Yes, because that's primarily -- that's what -- from a capital standpoint, that's 99% of what we're building, so that's the driver right now..

Our next question comes from Peter Van Roden from Spitfire Capital..

Just a couple quick ones. Can you walk us back through the number of units you added? You went through that pretty quick. I just wanted to make sure that I have it right..

Yes, let's see. I think it was 176 year-to-date. And it splits about half and half by quarter..

Yes, okay. And then on the SG&A front, you mentioned you're adding some salespeople and you're looking at some new areas.

Are those gas or liquids areas?.

Well, where we have salespeople located, they actually have both areas, but we're adding them from the liquids standpoint. But they'll be able to capitalize if we're getting movement in gas. But we had sales guys located in the strategic areas around the country in these basins.

So -- for example, the Dallas/Fort Worth area, you've got oil and gas out there, same way in the Rockies areas, stuff like that. So they'll be able to call or chase business in either one of them, but our primarily direction is for the liquids plays..

Okay. And the final one for me is some of your competitors, I guess, in the last month have announced some decent-sized acquisitions.

Do you have any thoughts on this?.

Well, I know most of those guys, I wish them well. Some of them look a little expensive. And I think that the market seems to think so, too. But I don't know -- we'll watch and see how it all plays out. It's not any new players, it's just combinations. So we're all familiar with what -- how they operate and what they do.

I think it has confirmed that we continue to be the most profitable company in the industry, at least on EBITDA to revenue ratio. So we're able to see some number we haven't seen before. So I don't think it changes the competitive dynamics a whole lot, but remains to be seen and see how that all works out..

Do you think it helps you or hurts you from the pricing perspective?.

Typically, consolidation would help. Now -- again, that remains to be seen, too. We still continue to be the highest priced guys around, and you would hope that some of this would help from that standpoint. But yes, we'll have to kind of see what happens. The dynamics change in things like this, so it's kind of hard to tell right now..

Our next question comes from Veny Aleksandrov from FIG Partners..

A very short question on the utilization. You said 78%, 79% in the quarter.

Having in mind that a small compressors and the dry gas are not doing so great as the rest of the fleet, how much space for improvement do you have on the 79%?.

Yes, most of the overhang is the dry gas stuff and that's what we have for a while on that. So I think we'll see continued improvement in that. Yes, we're getting to a situation, we're adding so much equipment each year. We're growing the fleet 10% to 12% a year, which is the fastest growth rate in the industry.

So you kind of get some quarterly variations on that utilization. You may have a point or 2 swing in some of that stuff, because we're adding it so quickly, we're putting that stuff out, but yes, you may have a little 10 or 20 units sitting around over the quarter makes a difference in a point on the utilization.

So I'm not too concerned about little variations on the quarter on it. But I think we will continue to see some improvement over time on that. If you look at our utilization chart over time, you kind of -- you have little spurts of growth in it, then you kind of flatten out a bit.

I think as things consolidate and equipment going out, then you have little spurts and flattens a little bit. So I think we're kind of in that pace right now where it's kind of flatten in that 79% range or so. But I anticipate it'd continue to next year..

[Operator Instructions] And at this time, there appears to be no further questions..

Okay, Ross, appreciate it. Alicia, thank you, and thank you, everyone, for joining on this call. I appreciate your time this morning, and look forward to visiting with you again next quarter. Thanks..

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