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

Joseph D. Gibney - Capital One Securities, Inc., Research Division Robert D. Brown - Lake Street Capital Markets, LLC, Research Division Jason A. Wangler - Wunderlich Securities Inc., Research Division.

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

Thank you, Erika, 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 the 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 cause -- 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 that stated, I will turn the call over to Steve Taylor, who is President, Chairman and CEO of Natural Gas Services Group.

Steve?.

Thank you, Alicia and Erika, and good morning and welcome to Natural Gas Services Group's First Quarter 2015 Earnings Review. I'll start off by saying I'm pleased with our performance in this first quarter, especially the growth we achieved over the year-ago period, where we saw improvement in all segments of our business.

On a sequential quarterly basis, rental revenue held up, but as we anticipated, quarterly compressor sales slowed down. Our rental gross margins continued strong this quarter, and our EBITDA and net income metrics, with respect to revenue, grew.

Cash flow from operations was exceptionally strong this quarter, and we anticipate appreciable growth in free cash generation throughout the year. Looking forward, 2015 will be a more challenging year. And while we expect pricing and utilization pressures, we're focused on our cost and maintaining our service response to our customers.

I'll comment in more detail as I review the financials. Starting with total revenue and looking at the year-over-year comparative quarters. Our total revenues increased 11% or $2.4 million from $22.3 million in the first quarter of 2014 to $24.7 million in the first quarter of 2015.

We had strong gains across all product lines this quarter compared to the same quarter last year, with rental revenues up 10%, sales revenues up by 17% and service and maintenance increasing 16%.

For the sequential quarters of the fourth quarter of 2014 compared to the first quarter of this year, total revenues were down almost 9% or $2.4 million from $27.1 million to $24.7 million. Rental revenues were up marginally, but compressor sales are the major driver to this quarter's change in revenue with a $2.6 million decline.

Moving to our total gross margin and comparing the first quarter of last year to this current quarter. Total gross margin was up 18% from $12 million to $14.2 million and increased from 54% to 57% of revenue. Sequentially, total gross margin was off 5% from $14.9 million to $14.2 million, driven by the aforementioned decline in sales revenues.

Gross margins were, however, 57% this quarter compared to last quarter's gross margin of 55% of revenue. Our sales, general and administrative expenses continue to be the lowest in the industry and were at 10% of revenue this current quarter. This compares to 12% in last year's comparative quarter and 9% last quarter.

Operating income increased by 33% in the comparative year-over-year quarters by almost $1.5 million, up to $5.8 million, but decreased 13.6% in the sequential quarter comparisons. Again, this decrease was due to lower compressor sales in the first quarter this year as compared to the fourth quarter 2014.

Operating income is running at 23% of revenue for the quarter, up from 20% for the same quarter last year and 25% last quarter. In the comparative year-over-year first quarters, net income increased 29% to $3.7 million this year, up from $2.9 million in the same quarter of 2014.

As a percent of revenue, net income rose from 13% in the first quarter of 2014 to 15% in the first quarter of this year. The sequential quarters of Q4 2014 and Q1 2015 saw net income dip $300,000 from $4 million to $3.7 million, but holding at 15% of revenue for both quarters.

Again, the decrease is due to fewer compressor sales in the first quarter this year. Looking at EBITDA on a year-over-year basis, EBITDA increased 23% from $9.4 million in the first quarter of last year to $11.6 million in this current first quarter 2015.

Sequentially, EBITDA was down $770,000, while still running at 47% of revenue, which is up from 42% in the year-ago quarter and 46% in the fourth quarter 2014. On a fully diluted basis, earnings per share this quarter was $0.29 per common share, an increase from $0.23 in the year-ago quarter, but down $0.03 per common share from the previous quarter.

Total sales revenues, which includes compressors, flares and aftermarket activities, grew almost $600,000 in the year-over-year quarters from $3.3 million in the first quarter of 2014 to $3.9 million in the first quarter of 2015.

The increase was primarily attributable to higher flare and compressor sales than last year, but aftermarket sales also grew. For the sequential quarters, as mentioned, total sales revenues decreased $2.5 million from $6.4 million to $3.9 million.

Reviewing compressor sales alone, in the current quarter, there were $2.5 million compared to $2.2 million in the first quarter of last year and $5 million last quarter.

As I noted in the last quarter's call, our compressor sales backlog always suffers in a downturn, but it has held up fairly well the last couple of quarters, with the current backlog at approximately $3.5 million as of March 31, 2015. This compares to last quarter's backlog of roughly $4 million.

Rental revenue had year-over-year quarterly growth of $1.8 million or 10% from $18.8 million in the first quarter of 2014 to $20.6 million this current quarter. Rental gross margins exhibited a healthy increase from 58% in last year's comparative quarter to 62% this quarter.

This margin expansion, combined with our high rental revenues, contributed to 19% higher rental gross margin dollars in this current quarter. Our field personnel have done an excellent job controlling their direct expenses, while maintaining our service response to our customers. I want to recognize that.

Sequentially, rental revenues held steady at $20.6 million, with gross margins of 62% for each quarter. Our rental margins have averaged 61% in the last 4 quarters, with this being the high watermark over the past couple of years. This demonstrates that we have our operating expenses under control.

We do anticipate pressure on margins, so our cost control average will continue, but we think we are well positioned. Fleet size at the end of March was 2,918 compressors, and we had a net addition of 39 compressor units this quarter.

Last call, I estimated that capital expenditures would be $10 million to $15 million for the first 6 months of this year, and that's all we thought we could forecast at that time. We spent approximately $6.9 million on fleet compression in the first quarter and the indicators are still muddled enough that we will stay with that prediction.

But I will say that, unless we see solid opportunities, I don't anticipate that second half spending would even approach this reduced level. Our active fleet utilization dropped 200 to 300 basis points since last quarter to 73%, with our active and contracted compression utilization at the 74% level. Utilization is an indicator we watch.

In a strong market it will usually correlate to growth. However, in a declining market like we are in, it tends to have a more elastic relationship to what is going on. This is primarily due to the impact of pricing that begins to have a larger impact. For example, utilization can be driven by lower or higher rental prices.

Lower prices, obviously, being able to facilitate higher utilization, albeit at the expense of profitability. As we have noted in the past and continue to practice, NGS will tend to sacrifice some utilization in order to support our chosen pricing.

So while we watch it, the significance of utilization now has to be considered in conjunction with market pricing and profitability. I think utilization will remain under pressure through the year, and March was the most severe month we've seen. So I don't know if that signals a trough or the start of a rougher period.

But since we cannot predict what will happen, our strategy is to position ourselves for the worst, but be ready to respond as required. Speaking of which, in counteracting our utilization pressure, average rental rates across our active fleet increased 5% in the year-over-year first quarter periods and 2% sequentially.

Average rental rates for newly set units this quarter were almost 12% higher than the first quarter 2014 and were up 3% sequentially. We are seeing pricing pressures from customers and competitors, and we do expect to see some softening in these averages over the year. But today, we haven't had a lot of customers approach us for discounts.

Where we have had to negotiate lower rates, though, I am pleased with our results. Our approach to these market downturns has been to address pricing aggressively, not from the point of cutting them indiscriminately but to hold them as tight as we can to preserve our margins and premium status.

This doesn't mean that we won't be competitive where we choose, but we do employ yield management practices in an attempt to maintain pricing where we think we can differentiate ourselves with our equipment and our service.

Although pricing will probably stop climbing, our past gains have given us an enviable pricing position as we head into the rest of the year. As noted, we have pulled back on our fabrication dramatically and don't anticipate adding any further compression, unless it is fully utilized and precontracted.

The only exception to this will be a minor build-out of our new vapor recovery units and our larger horsepower reciprocating compressors to ensure reasonable deliveries for this equipment. Speaking to this, we have our first 2 400-horsepower units being delivered to the field in the second quarter.

If you recall, we previously announced our intention to move into the 350- to 500-horsepower segment and initially thought our first units would be ready by the end of this year. However, in the meantime, we have had an opportunity to place 2 of these units with a good customer, and they have contracted more. So we are ahead of schedule.

We fully expect a successful debut, and are already gearing up for manufacturing capacity and capability to roll these units out as the market demands them.

In addition to these product developments, we have also entered into a formal research and development effort within another industry group that we think, if successful, may challenge the traditional view of rental fleet compression and potentially offer some disruptive technology to a tradition-bound industry.

I'll caution that since this venture is just entering an exploratory phase, and since there are some competitive aspects to it, I will not provide regular updates. And I will comment as we have something to announce.

There are, of course, no guarantees that we can achieve what we are attempting, whether it's due to technology challenges or market acceptance. But as you can see, we're pursuing various opportunities that we think will add value to the company. Now going to balance sheet.

Our total short-term and long-term bank debt is approximately $400,000, and cash in the bank was approximately $8.6 million, both as of March 31, 2015.

Additionally, due to a significant tax refund in April, our cash balance has doubled to approximately $12 million at the end of the last month compared to about $6 million in cash we had on December 31, 2014. Our cash flow from operations was $11.6 million for the quarter.

This is the highest it's been over the past year and was aided by a reduction in inventory and work in progress. Our free cash flow this quarter is the highest quarterly average amount generated since 2009. Now about the market.

Let me quickly dismiss any false hope you may have about my ability to predict the price of oil or gas, higher or lower, in any time frames.

I certainly have my opinions, but my reluctance to predict was reinforced yesterday when I read a special section of The Wall Street Journal in which 2 "experts" had totally divergent ideas about what will happen and when.

So I choose to practice the action recommended by Mark Twain, "It is better to remain silent and be thought a fool than to speak and remove all doubt." There do seem to be some positive indicators coming out, the most encouraging being a drop in production in some major shale oil basins.

I do think the market will remain difficult throughout the year. Our business tends to be impacted on delayed basis relative to drilling-oriented services, but we will also recover later. Because once operators decide to resume activity, there will be a delay getting production back on.

We are well prepared for the coming year and the competitive forces going forward. And we look forward to planning out for the rest of the year. That's the end of my prepared remarks. And I'll turn the call back to Erika for questions anyone might have..

[Operator Instructions] Our first question comes from Joe Gibney from Capital One..

Just a quick question on cost. I'm just trying to strike a balance between differentiating by maintaining service quality and what you can do to control direct expense.

So what do you nibble out on the fringes as to try to do that? Specifically, just trying to do -- get a better understanding of kind of how you control cost or whittle it down a little bit at this point..

Well, the standard things -- you certainly -- start coming back on, field expenses first from the point of what's the overtime running, how can we cut that down or can we be more efficient there. Certainly, we are trying to share the fun with our suppliers and going back to them and seeing whether they can help us to reduce some of our costs.

We've had some natural reductions with oil coming off. Obviously, our lubricating and oils are also down somewhat. So some of that you get just as a function of the slowing market and lower commodity price. We look at all different things. We -- as in the past, we'll cut the small and large because a lot of smalls add up to large stuff.

And I won't go into all the details because some of them, we think, are not proprietary, but we think are unique in how we're approaching things. But the main thing we do, we get our costs down. And I think you can see from the last downturn, and certainly starting into this one, that our margins are holding up well.

But we -- the thing we won't do is sacrifice the service response to the customers. So we know going through a downturn like this, that's a very tempting target and something easy to do, maybe you load up your field guys a little more.

Now certainly, we'll be much -- we'll be as efficient as we can in that respect, but we're not going to overload people from the point that starts impacting downtime, that starts to impact some of the customer's ability to produce what he can produce, et cetera.

So we look at anything and everything and along with suppliers and certainly our work with the customers would go through [ph], but we intend to maintain the service response at the same time..

Okay, helpful. And then just in terms of your short horsepower mix. What's going on in the market? And how -- so you referenced, obviously, this move into the 300-plus-horse tranche and getting some traction there.

In terms of stop activity, customer pushback on pricing, is it -- it almost sounded from your comments that there's sort of a barbell, where the higher-end equipment that you're putting out is still executing well and there's still demand on the VRU side, it sounds like, maybe you could update us on that.

But is there more pressure in sort of the -- more your standardized sub-200-horse kind of units right now? Or is it sort of generally across the board, but you still -- you have some traction on the higher horse side? Just curious how that's kind of parsing out as the market unfolds a little bit here..

Yes, it's a -- it's across the board, pretty well. We're not seeing -- now this is more oil-oriented, which you would figure with oil coming off. Gas, as we all know, has been flat for 4, 5 years now. So we're not seeing a whole lot of impact there. In fact, it will be interesting to see how it goes through the year as to what gas may do.

Because there's -- although you get the oil coming off, there may be some glimmers of hope on some gas pricing going through because, obviously, you're reducing the associated gas in the market also. So it's across the board. It is more impacted on the oil side, though.

And I think, naturally, what we would expect is most of the oil growth has been driven by these 200-horse -- 200- to 250-horse units that we've put out primarily on gas lifts. So that is where we're seeing most of the impact because that's where all the growth has been in the last 4 or 5 years. So it's not unusual we're seeing it there, I don't think.

You're getting -- you're just getting a lot of movement in the market. Customers, as will happen in these periods, pendulum tends to swing pretty hard back and forth, just like it was -- price went a little too high last year and now I think we're probably going to swing a little too low going this year.

But we're seeing various reasons why wells -- some wells are getting shut in, some wells are getting delayed. The growth profile going forward has certainly slowed down. The name of the game right now is maintaining what you have out there or at least mitigating or trying to minimize utilization pressures.

So summarize that answer, pretty well across the board, certainly focused on oil more so. And the gas lift units are seeing some impact..

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

On your utilization rates, you talked about -- I think March was sort of a weakening and a low point.

Does that mean things have improved since March? Or what's the kind of trend there? And how do you see it playing out for the rest of the year?.

Well, you don't know a low point until you get a few months down the road, right? So -- I think that's what I said in March. I'm not -- is that a trough? Or is that just the beginning of a tougher trend? It's too soon to tell. I -- we don't know. We just noticed that January, February seemed to be fairly flat, and then March really took a drop.

Now we've had more strengthening in oil price since then. And so again, I'm not predicting. I'll let you call it how you think that might go. But certainly, that wouldn't be a negative going forward. So I expect continued pressure on utilization from a couple of perspectives. Number one, just the market. That's just how the market's going to go.

And again, operators are not just cutting but slashing, in some respects, their expenses. And compression is one of those. And then secondly, from the point that we will tend to try to maintain our pricing much more than what I've said the general industry does in that perspective. And that's going to have some impact on utilization.

Now again, we try to balance that. We're not going to just stick our head in the sand and draw a line and say, "No, we're not going to go past this or that." But we do look at every job individually, price according to where we think we have strengths or weaknesses and go from there.

So it's -- again to summarize that, I guess, I do expect further pressure on utilization. Whether it accelerates or mitigates, it's hard to tell right now..

Okay, great. And then you're generating a nice cash.

What's sort of your thoughts on the uses of cash through the downturn here?.

Well, right now, we're going to hold them very close to our chest and not let it go. But much like the last time -- being in a cyclical industry, as we are. And these cycles tend to be -- maybe it's just me, or they tend to be getting more frequent. About every 5 years, we seem to go through one just to shake us up.

But we -- when you come out of these things, you always need to be able to react to the market. Put equipment in the customers' hands, grow as required. And that takes cash, with capital equipment like this. So right now, I mean, we've built it up certainly pretty quickly here the last couple of quarters. It'll continue to build.

We're just going to put it in the bank right now, preserve it as we go through this downturn. Certainly, we're in excellent shape from a -- essentially, a no-debt standpoint, not really needing cash from the point of having to survive or exist, but knowing that you need it coming out of these downturns.

And I -- I think this oil -- when you have an oil downturn, the most recent ones -- now you can go back and find a contradiction to this in some other places, but they've tended to be pretty well down and pretty well up. Unlike gas, were pretty well down and just stays down. We don't really get a -- we don't get a V or a U or anything.

We get a kind of an L, I guess. I mean, I'm -- I think we're going to start to come out of this one. I think this year is a rough year. But I think -- '16, we start seeing a little bit better pricing, a little more activity and things like. So I don't think we're into this thing where we're going to be conserving cash for 2 to 3 years.

I think we've got a year that we can build it up, and then we're ready to address the market as we need that cash..

Our next question comes from Jason Wangler from Wunderlich..

Just maybe turning over to the sales side. Looked a little stronger, I think, than maybe, at least, I had expected. Are you seeing anything different there? Where there a couple of one-offs? And then obviously, the backlog in pretty good shape, too.

Just how you maybe see that playing out throughout the year?.

The sales thing is really hard to predict, as I say every quarter, and everybody's probably tired of me saying that. But it really is hard to say, especially in a market like this. It's almost impossible to say how thing are going to go. You get a backlog, that really only stretches 1 or 2 quarters, doesn't give you much visibility.

So I am happy with where the backlog is from the point of -- in the past, I think the past 2 or 3 years, we've always said that we were aiming for our sales revenues to be $10 million to $15 million. And those were in growing years.

But we were managing to that level from the point of not wanting to have that sales getting too large because of, just, we're concentrating on the rental side of it. Now again, we will let it go if -- we're not going to turn away a job just because it messes up the percentages of revenue. But -- but generally, that's where we've been holding.

So -- so far, the backlog is running about that rate as in a good year. Now I do expect it to come off. And we're starting to see some indications that, that backlog will start to fall a bit. But again, we've got a fair amount of proposals out that we try to evaluate and risk as far as what we think the revenue potential of that may be.

And then we've taken a little harder look at the risking part and reduce the number that we think may happen. But there's still a fair amount of potential backlog out there. Let me say that. But I'll also hasten to say, don't anyone think that this -- the sales is going to be going up or anything like that.

I fully expect sales backlog to reduce through the next couple of quarters at a minimum and come on down. But we're happy it's held up so far the last couple of quarters, a little better than what I expected..

Okay, great. And on the rental side, obviously, kind of slowing the pace there. But just curious, you talked about March being a tougher month.

Can you maybe just comment on where you're seeing the weakness, whether it's in price, whether it's in utilization, just where you're seeing those tougher areas, given the changing dynamic?.

It's mainly utilization. As I mentioned, our pricing still are holding up fairly well. And even if where we've had to negotiate some discounts here in the last couple of months, it's been a lower level of deals we've had to negotiate than I would have expected. And we're very happy with what we've been able to negotiate.

We've been able to exchange some discounts for some additional work and/or added terms or things like this. So most of the pressure we're seeing is from utilization, primarily just -- and some of this is -- I mean, there is -- we look at these jobs and see when we're getting them back and what can we do to mitigate that.

And some of this stuff is just -- as I mentioned, customers have just really slashed a lot of expenses and try to really pull down some stuff.

So at $100 oil, where you might have had maybe a little more equipment out there than you really needed, but you didn't want anything down, you wanted standby capacity because of $100 oil, you don't need that now, $50, $60 oil. So some of that stuff comes off. Some of the shales are getting to be 4 to 5 years old.

So you're seeing some natural decline, and we would've seen this even at $100 oil. You're seeing some natural decline in some of these wells. Not only the oil is declining, but the gases associated with that wells are declining.

So gas lift tends not to be the preferred method of producing that well, after 4 or 5 years, start getting more into the depletion piece of it. So there's all kinds of things going on, but it's mainly utilization pressure right now that's flattened it out..

And one more, if I could, just on that.

Geographically, are you seeing certain areas that are more affected than others? Or is it pretty much just kind of, like you said, it seems everything's kind of getting cut right now and you're just kind of seeing it from different areas at different times?.

Yes, we're -- probably about half of the areas are being impacted and half aren't. I think I read yesterday or the day before, I think that the -- out of the 5 major oil shale basins we've had, Niobrara, Bakken and the Eagle Ford already start to roll over on production. At least, I think, as in April.

Yes, we'll see what the months going forward do, but you would expect that to continue coming off -- production coming off, which is obviously something we want. You don't necessarily like it from a business standpoint, but it's part of that phase we're going to go through to get pricing back up and it's start activity back.

And the 2 areas that have -- actually have increased production have been the Permian and the Utica. And we're seeing the same thing. We're still having good luck in the Permian and the Utica, and we're seeing pressures in these other areas. So it's pretty well along with what the industry is reporting from a production standpoint..

[Operator Instructions] At this time, I have no further questions..

Okay. Well, I appreciate everybody joining us. And Erika, I appreciate your efforts. So I appreciate your time. We'll -- we're looking forward to visit you again next quarter, then. Thank you..

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