Good morning ladies and gentlemen, and welcome to the Natural Gas Services Group Third 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 turn the call over to Ms. Alicia Dada. You may begin..

Thank you, Ross and good morning, everyone. Please allow me 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 risk 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 cash and 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 to Mr.

Stephen Taylor, who is President, Chairman and CEO of Natural Gas Services Group.

Steve?.

Thank you, Alicia and Ross, and good morning everyone. And welcome to NGSG's third quarter 2019 earnings review. This morning, we report our third quarter 2019 results. If you had time to review them, you'll see that we had growth in all revenue streams and improvement in all our sales and rental margins.

Rental revenues grew 20% compared to the same period last year and 6% compared sequentially. Both led by robust performance in our large horsepower class. Our compressor sales continue to be strong, with the gross margin percentage this quarter being the highest since the first quarter of 2018.

Cash flow from operations for the quarter was $14.2 million, or 68% of revenue. Now balance sheet cash level remained solid at $19.5 million.As we continue through the call, I'll further discuss in detail these financial results as well as include operating and market comments.

From a non-operating perspective, we do have various non-cash non-recurring items in the quarter which we will review shortly. And a special note, we announced the retirement of Larry Lawrence, our Vice President and Chief Financial Officer last night.

I'll comment on this at the conclusion of these remarks.Looking at total revenue, NGS reported total revenue of $20.9 million for the third quarter 2019, a 27% increase compared to the same quarter of 2018.

We expect an increase in all revenue streams for the 49% increase in sales revenues, 20% in rentals and 32% in service and maintenance when compared to the same quarter 2018. Sequentially, total revenue increased by 5%. Rental revenues increased 6% sequentially, or sales revenues increased slightly from an already robust level last quarter.

In the comparative 9-month year-to-date period our total revenues increased approximately $9.4 million or 19%.

Total adjusted gross margin for the 3 months ended September 30, 2019, increased to $10 million from $7.8 million or 27% for the same period ended September 30, 2018.Adjusted gross margin which does not include depreciation or the various non-cash non-recurring items as a percentage of revenue for the 3 months ended September 3, 2019, was 48% consistent with the same period in 2018.

Sequentially adjusted gross margin for the third quarter 2019 increased from $9 million to $10 million, or 12% from the prior quarter. Adjusted gross margin as a percentage of revenue increased to 48% in this quarter, compared to 45% in the prior quarter.

In the third quarter, we recorded a number of non-recurring charges that had a non-cash impact on the third quarter income statements.

The first and largest of these was an impairment of the goodwill we've carried on our balance sheet since 2005.The qualitative and quantitative evaluation of our market value compared to book equity value indicated our goodwill was fully impaired, which resulted in a total charge of approximately $10 million.

We also undertook a comprehensive review of a parts inventory for any excess related to slow-moving items and retired and obsolete parts. As of September 30, 2019, we have recorded a $3.4 million inventory allowance related to these items. This is approximately 12% of our total inventory.

Additionally, we decided to retire 327 compression units representing 39,800 horsepower approximately from our rental fleet that were close to or at the end of their economic lives.

The majority of this equipment our compressor packages designed for low pressure, low volume dry gas fields, like the Barnett Shale or San Juan basin coal beds that have limited applicability in this era of extremely low natural gas prices.

We record a $1.5 million loss related to this retirement, which represents less than 1% of the netbook value of our total fleet assets.From a reporting perspective in accounting for these various non-cash non-recurring charges in the third quarter, we experienced an operating income loss of $13.6 million and a net income loss of $12.2 million.

The loss on earnings per share basis was $0.93. Moving forward to the remainder of the financial discussion today, I'll discuss the adjusted operational results, which do not include the aforementioned impact of the various non-cash non-recurring charges.

The reported results, which do include these effects are presented in the earnings release and the 10-Q.Selling, general and administrative expenses were $2.8 million, a year-over-year increase of approximately $440,000 and $110,000 sequentially.

Our adjusted SG&A expenses have continued to run at our typical 13% to 14% of total revenue for all periods. Adjusted operating income for the third quarter 2019 was $1.3 million, a $1.4 million increase from third quarter of 2018 and almost $750,000 increase sequentially.

Adjusted net income was $1.3 million for the quarter which more than doubled second quarter's net income and compares to the year ago quarter of $236,000.Adjusted earnings per diluted share was $0.10 for the third quarter which compares to $0.04 last quarter and $0.02 a year ago. Earnings per share for the year-to-date 9 months of 2019 is $0.17.

Adjusted earnings before interest, taxes, depreciation and amortization or adjusted ABITDA for the 3 months ended September 3, 2019, was $7.3 million, a 29% increase from $5.7 million for the same period 2018. EBITDA increased over $840,000 or 13% sequentially.

Adjusted EBITDA for the 9 months into September 30, 2019, was $19.8 million compared to $17.1 million or 16% growth for the same period ended in 2018.

Adjusted EBITDA margins continued to be robust, and have ranged between 32% to 35% of revenue in all comparative periods.Moving to sales revenue and total sales, which includes compressors, flares and product sales.

On a year-over-year basis, NGS total sales revenue increased 49%, primarily due to an increase in compressor sales of $1.8 million or 63%. Sequential sales revenues increased slightly to $5.8 million, making sales revenue to this quarter the highest since the second quarter 2018.

Third quarter 2019 total sales gross margin was 25% of revenue compared to 24% in the second quarter of 2019 with gross margin dollars up 7% sequentially. Gross margins were above the 22% level we saw a year ago. The gross margin dollars increased 22%.

This quarter's gross margin is the highest percentage for the sales segment we've seen since third quarter of 2018.Third quarter 2019 compressor only sales increased from $2.9 million dollars in the third quarter 2018 to $4.7 million this quarter, an increase of almost 63%.

Compressor only sales of $4.7 million compared to $4.8 million in the prior quarter. Year-to-date compressor only sales were up $2.7 million or 29% to $12.2 million for the 9 months ended September 30, 2019.

compressor only sales margin was 22% for the 3 months ended September 30, 2019, compared to 19% of the same period a year ago, and increase 1% sequentially. Gross Margin dollars for compressor sales increased 92% and 4% in the year-over-year and sequential periods respectively.

Ourselves backlog as of September 30, 2019, was approximately $5 million compared to approximately $7.4 million in the second quarter of 2019.We witnessed a very good quarter in our sales business. Compressor sales and total sales revenues were up substantially in the year-over-year period as the gross margin is also expanding.

We continued with our rental business with rental revenue of $14.4 million for the third quarter 2019 and $41.4 million year-to-date. Rental revenue increased 20% for the year-over-year period and 18% year-to-date. Sequentially, rental revenues increased over 6%, showing acceleration in our rental growth this quarter.

Compared to the second quarter 2019, our average rental rates on a per unit basis increased 4% and we're down 1% on average per horsepower basis.

The slight decrease in per horsepower rates is not unusual because larger horsepower equipment costs less per horsepower, which translates into lower per horsepower rental rates.Rental rates increased by an average of 12% per year in the year-over-year quarters mainly due to our continued penetration into the large horsepower markets, which carry higher rental rates.

Rental gross margin this quarter was 56%, an increase from second quarter 2019 rental gross margin of 53% and last year's quarter of 55%. Our quarterly rental gross margins had been somewhat variable due to the high network expanse we experienced when we set commission and start-up large horsepower units.

With our margin recovery, we may have hit the necessary critical mass in installed high horsepower that will enable us to better cover these expenses with the rental revenue being generated.Fleet size at the end of September 2019 totaled 2,277 compressors.

Are almost 406,800 horsepower in addition of 38 units are a little less than 34,000 horsepower during the third quarter. As of September 30, 2019, 29% of our utilized horsepower is classified as large. Over the past 12 months, we've added 16 new fleet units totaling 56000 horsepower, with 95% of those units classified in our large horsepower category.

Factoring for the equipment retirement previously mentioned our horsepower utilization was 66% and unit base utilization was 62% as of September 30, 2019.As we have noted our large horsepower class continued to exhibit vigorous growth.

Our medium horsepower range has made incremental gains throughout the year but we still experienced a hard churn in this class than usual. There are however marked opportunities for the placement of additional equipment before the end of the year that we'll have to be successful with.

Overall and in sum total, we had 24% more horsepower generating revenue compared to last year's quarter, and 9% more revenue during horsepower sequentially.NGS received additional orders in the third quarter for our large horsepower units and for specialized high-pressure compressors.

We're also building 3 additional high horsepower units in anticipation of future demand. Additionally, we accelerated the fabrication of some anticipated 2020 capital expenditures lead to the large horsepower rental units in 2019 due to customer timing demands.

As has been the case for the past 2 years, more than 9% of these orders are committed and under contract at premium rental rates, with many of them having longer rental terms than what is generally captured in the market.With these additional orders and fabrication and accelerate deliveries all of which will result in future cash flows, we have increased our 2019 capital expenditure budget for the rental additions to $60 million to $65 million from the previously discussed range of $40 million to $45 million.

Through the first 9 months of this year, we have spent $47.5 million on rental fleet equipment. As far as a 2020 projection of capital spending, our customers are still evaluating their needs so we don't have a definitive outlet, except that we do expect our 2020 CapEx spending to be lower than the past 2 years potentially up to 50% lower.

If that's correct NGS will be getting generated pads of free cash flow in the second half of 2020.We understand concerns over expanding our capital expenditure budget.

With that said, it is important to emphasize that the vast majority of the cash at NGS is dedicated to capital expenditures is for firm orders which result in premium price, long term rental contracts with premier customers. Those contracts provide good line of sight for future earnings and cash flow.

Moreover, as we're discussing in the past, our financial discipline has provided us with the flexibility to act on these opportunities, where many of our also brethren are not as fortunate. Our operating model over the years has been to build caster in terms of lower activity in anticipation of opportunities when the industry gets busy.

Although we cannot presently tie our free cash flow generation because we are investing cash into high return assets. If you look at our cash flow from operations yield, calculated over the last 12 months it is almost 14%.

This is a good proxy as our ability to generate cash, whether it's been on cash flow generating equipment, or used to rebuild our cash balance.On August 12, 2019, NGS announced that our board had approved an authorization to invest up to $2 million directly into the company through a stock buyback. The authorization expires on September 30, 2020.

This authorization allowed us to allocate capital in what we think is a desirable investment, NGS itself. But it's also an indication to the market that we think the company is significantly undervalued.

As at September 30, 2019, the company had repurchased almost 30,000 shares at the cost of almost $490,000.Moving to the balance sheet; our total bank debt remains minimal at $417,000. As of September 30, 2019, our cash balance remains strong at $19.5 million.

We generated positive net cash flow from operating activities in this quarter $14.2 million, which represents 68% of our quarterly revenues.Last night we announced the retirement of one of our officers, our VP and Chief Financial Officer Larry Lawrence effective November 15.

Larry has been with NGS for nearly a decade and has overseen significant growth in the business. Not only has he been of unique service to the company over this period, but also to me personally as I successfully navigated the ins and outs of the industry these past years. Successfully, I might add.

Larry has been an integral part of our team and while we wish him well in his retirement, he will be missed. He's become a trusted member of the NGS leadership team as well as a friend. Due to Larry's retirement and recognition of his significant contributions to the success of NGS, the Board of Directors has unanimously authorized acceleration of Mr.

Lawrence's invested shares in the company.

This will result in a one-time non-cash expands for approximately $270,000 which will be recorded in the fourth quarter this year.With Larry's retirement, we also announced the appointment of Jim Lawrence to the position of vice president and Chief Financial Officer, as well as our principal accounting officer for reporting purposes.

Jim has over 20 years of financial and accounting experience with public and private energy companies and has worked in and around midland for close to a decade. We're pleased to welcome Jim to NGS in this important role and we look forward to his contributions and leadership.

Complete details on Jim and his appointment can be found in our press release NAK filling last evening.In closing, this quarter clearly demonstrates that NGS is well-positioned as we proceed into 2020. Capital discipline seems to be the Latest mantra in the oil field has been our tune for years.

We have never had an annual earnings per share loss in over 15 years, no matter the state of the industry.

And our apparently controlling position of current very little debt has served us well, not only from a financial and risk perspective but just as importantly, we're prepared to take advantage of those opportunities that return positive earnings to our shareholders.

Our ability to allocate capital cautiously and judiciously pays extra dividends in markets that are unpredictable.I don't want to end this call without recognizing those at [indiscernible] quarters like this.

Our engineers and fabricators have built equipment of exceptional quality, our field technical force that delivers exceptional service to our customers, our financial accounting groups that keep track of it all and our ancillary departments and services that provide the daily support for our frontline personnel to do their job.

None of this is obviously possible without the dedicated work of our employees. Ross, that's the end of my prepared remarks. So please open the phone lines for questions..

[Operator Instructions] Our first question comes from Rob Brown from Lake Street Capital. Please go ahead, Rob..

Morning, Steve. Maybe just go a little bit further into the high horsepower business. It's been doing well over the last few months and you're seeing revenue growth there but also order growth for the rental equipment. Maybe you have some color on the market environment.

Are you seeing a market environment improvement? Is it share gains and what's really driving the growth?.

Well, of course, the primary part of it is a couple of big contracts we got a little over a year ago. We've been building those out. And also, installing those so that's been the primary source of the revenue growth and course the CapEx growth too. Just pushing that equipment.

So that's it but we're also we started placing some equipment with some other customers. We've been pretty well tied up on those major orders from a fabrication standpoint up to this point. We're starting to see some light at the end of the tunnel. So that relates to the speculative units that I mentioned.

Only 3 of them so nobody needs to panic, but we do need to have that stuff in the queue to be able to rent it. So we've seen a couple of other customers start to come into the fold on that. Generally the markets -- obviously that's all penetration because we weren't in this business probably 3 years ago so we're making market share gains on that.

We're making penetration. The industry is expecting somewhat of slowing in 2020. There's probably already a little bit of it. Some of the certainly the upstream or more the drilling orient guys have seen it are saying providers, pumping companies, drillers, things like that.

As you've heard before, in the past, we typically don't see slowdowns till after the drilling piece out with us be on more of the production side. But we're uniquely positioned, I think, very well-positioned from the point that we were still building equipment that's been contracted. That's going at a good range.

So we still see another quarter or 2 of growth and just completing the contracts we've got, and then we'll have another quarter to add to that of increasing revenues from that equipment being installed. We're a little anomalous to what the market looks like right now.

But if it does slow to more of a -- or less activity and what we've seen and what we're continuing to build out, as I mentioned, the only bad thing will happen to us, we'll start generating a bunch of free cash. So I think we're in good shape. I do think the mark -- obviously, the overall market is slowing.

I think that will impact production side somewhat but the good thing about the production side is when the drilling side slows down, that's the only thing bringing money as production. So we tend to be hit less and certainly the big horsepower is on long term contracts.

So the contracts are a sense of link that will carry us through any anticipated slowdown that we may even see into next year. Somewhat irrespective of the market worse we're a bit insulated from things right now just based on our contractual obligations we're fulfilling right now..

Great, thanks for that color. And then in the mid-horsepower business, I think you talked about it being mixed but there were some opportunities by year-end.

Could you just give us a little color there?.

The mid-horsepower, in 2018, it did really well; 2019, it's been a little slower growth on it. We're seeing incremental, pick up a little every quarter. And we're actually setting -- increasingly setting more and more of the smaller units or the mid-horsepower units each quarter.

But the turn is keeping up and so we're getting back a number of those too now. We're -- our net between what's said and what we get back is growing. So that's forgetting the incremental gains but it's just not what we typically see in a somewhat of a recovery mode or a decent market.

So 2018 being the decent piece of that and course now it kind of moves into the big horsepower being a decent piece. But we see some competitive openings from the point of others not having good servers -- maintaining good servers and things like that and operators wanting to make some changes there.

So, that's what we're saying and they tend to be more than 1 or 2 or 5 or 10. They tend to be the 20, 30, 40 unit sort of packages people are looking at. So we don't have those, we're bidding them. We're in the midst of marketing that stuff and selling that and hopefully close [indiscernible].

For successful on some of those we'll see a little more incremental pick up in that medium horsepower range..

Okay, thank you. I'll turn it over..

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

Okay, Ross, appreciate it. Thanks, everybody for joining me on the call. Appreciate your time this morning and we're look forward to visiting with you again next year..

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