Good morning ladies and gentlemen, and welcome to The Natural Gas Services Group Third Quarter 2021 Earnings Call. At this time, all participants are in listen-only mode. Your call leader for today's call are Alicia Dada, IR Coordinator; Steve Taylor, Chairman, President and CEO. I'll now turn the call over to Ms. Dada. You may begin..

Thank you, Paul and good morning listeners. 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 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 expectation 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 that stated, I will now turn the call over to Steve Taylor, who is President, Chairman and CEO of Natural Gas Services Group. Steve..

Thank you, Alicia and thank you Paul. And good morning everyone, and welcome to Natural Gas Services Group's Third Quarter 2021 earnings review. Thank you for tuning in. As noted in our earnings release, our overall business is growing both sequentially and on a year-over-year basis.

In comparative year-over-year quarters, total revenue was up 16% in every segment of our business, rental, sales and service and maintenance showed improvement. Sequentially, total revenues increased almost 3% and the sales segment was the only one that declined and it was by a relatively minor $100,000.

Our core compression business continued to recover and grow in the third quarter, our third consecutive quarter of rental revenue growth. Compression rental revenue grew 4% sequentially and 9% on an annual basis, driven by both an increase in active rental horsepower, as well as pricing improvements.

We generated adjusted EBITDA of $5.4 million this quarter, a 19% increase from last quarter, and a 33% increase in operating cash flow for the quarter, up to $7.2 million. As you can tell, this was a relatively good quarter from a revenue, EBITDA and cash flow perspective.

Stronger energy markets certainly provide opportunities to maintain and improve pricing, and we remain optimistic about growth as we complete 2021 and enter the New Year.

We temper our enthusiasm a bit with the realism that exploration and production spending will likely grow incrementally, because capital discipline remains the overriding mantra of domestic producers, but we think the outlook is positive. In addition to these operating highlights, during the quarter, we continued our share repurchase programs.

Year-to-date, through September 30, we have repurchased over 430,000 shares at an average price of approximately $10.24 per share, which represents roughly 3.2% of our outstanding shares. Now, let's look at the financial details of the quarter. Looking further revenues, NGS reported total revenue of $18.2 million for the third quarter of 2021.

This is a 15.7% increase from the same quarter in 2020 or about $2.5 million and as a result of an increase in all revenue streams, mostly due to a $1.3 million increase in rental revenue and $935,000 increase in sales revenues. As you know, the largest component of our sales revenue is compressor sales and it is historically volatile.

While we reported no compressor sales in third quarter for either 2021 or 2020, we saw a significant increase in parts sales during the current quarter. When comparing consecutive quarters, we had an increase in total revenues of 2.8% or almost $500,000.

This is driven by a $580,000 or almost 4% increase in rental revenue, which was partially offset by a decrease in equipment sales of only $100,000. While sales revenues fluctuate with our customers' capital needs, our rental revenues have grown 3.7% and 9% respectively, in both sequential and year-over-year quarters.

Significantly, NGS has posted an increase in rental revenue every quarter of this year. Total adjusted gross margin, which does not include depreciation through the three months ended September 30, 2021 was $7.5 million, a decrease from $7.9 million for the same period ended September 30, 2020.

This is 41% of total revenue compared to 50% gross margin reported in last year's comparative periods. But along with higher revenues we have also seen increased labor costs and setting commissioning and start expenses related to the growth in rental compression deployment, not to mention inflationary costs driven by lubricants or repair parts.

Sequentially, adjusted gross margin for the second quarter of 2021 increased to $7.5 million from $6.6 million in the prior quarter. As a percentage of revenue, adjusted gross margin increased to 41% this quarter compared to 37% in the prior quarter. This increase was due to reduced levels of repair and maintenance costs and start expenses.

If you recall, in the last quarter we set a record number of high horsepower units which inordinately drove higher expenses and correspondingly depressed margins. Our rental revenue still grew this quarter. As predicted the magnitude of cost wasn't as great.

The remaining cost pressures from the upfront expenses incurred in a growing inflationary environment but we are working diligently to control and counteract those. Sales, general and administrative expenses increased 8% over the third quarter of 2020 and 3.8% over the second quarter 2021.

These increases were primarily generated by higher expense accruals. However, as a percentage of revenue, SG&A costs reduced from 16% of revenue last year and were flat at 15% of revenue compared to last quarter. Operating loss for the third quarter of 2021 was $1.6 million compared to a loss of $940,000 in the third quarter of 2020.

This decrease is due to lower rental margins offset by an increase in sales margins as well as an increase in SG&A expense. Sequentially, operating loss decreased by $730,000 from an operating loss of $2.3 million in the second quarter of 2020.

This increase in comparative quarters is primarily due to the aforementioned higher rental revenues and margins. Our net loss after-tax for this quarter was $1.3 million, almost $700,000 less than last quarter's loss of $1.9 million. This compares to a net loss of $563,000 in last year's third quarter.

We reported a loss per diluted share of $0.10 for the third quarter of 2021 compared to a loss of $0.04 per diluted share in the third quarter of last year. Sequentially, this was an improvement over $0.14 per diluted share loss reported in the second quarter of this year.

Adjusted EBITDA for the three months ended September 30, 2021 was $5.4 million, a decrease from $6.2 million for the same period in 2020. Sequentially, adjusted EBITDA increased almost $860,000 or 19%, up from $4.5 million last quarter. This increase was primarily due to higher revenue and lower expenses resulting in higher overall margins.

Total sales revenue, which as a reminder, includes compressors flares and product sales was $1.5 million this quarter. This is an increase from $935,000 year-over-year and is down marginally from $1.6 million last quarter. The change in both comparative quarters is due primarily to the volatility in parts sales.

For this current quarter, we had a total sales adjusted gross margin loss of $90,000. This compares to a negative gross margin of $460,000 in the third quarter 2020, negative gross margins of approximately $200,000 in the second quarter of 2021.

These gross margin improvements are primarily a combination of higher part sales and reduced expenses and losses in our compressor sales business. Although, we have some compressor fabrication projects in progress, our compressor sales business continues to be slow with no sales revenue recognized in all comparative quarters.

However, despite the lack of customers' capital spending, we have lowered our total sales gross margin losses by decreasing our compressor fabrication expenses, posting higher revenues from flare and part sales, absorbing more costs and new rental fleet units being built.

Our sales backlog as of September 30, 2021 was approximately $2 million, which is the same as the prior quarter. Rental revenue in the third quarter of 2021 was $16.2 million compared to $14.9 million, an increase of 9%, since the third quarter of last year.

For the sequential quarters, rental revenue grew $16.2 million from $15.6 million last quarter, an almost 4% increase. Significantly, rental revenue this quarter exceeded our rental revenues in the first quarter of 2020 which was a pre-pandemic quarter.

We successfully traversed the trough of our rental revenues since the start of the pandemic, due to successful execution of our high-horsepower strategy during a very uncertain period.

Rental rates increased by an average of approximately 6% per unit and 3.5% per horsepower sequentially, mainly due to our continued penetration into the larger horsepower markets.

Rental adjusted gross margins this quarter were 46%, a $730,000 decrease from this 55% gross margin on a year-over-year basis, but an $840,000 increase from the 42% gross margin last quarter.

Lease size at the end of September 2021 totaled 2,275 compressors or over 452,000 horsepower, which replaced a net addition of 18 units or 5,480 horsepower during the third quarter. Over the past 12 months, we have added 51 new fleet units totaling just over 14,000 horsepower, 60% of that horsepower being classified in our large horsepower category.

As of September 30, 2021, about 45% of our utilized horsepower is made up of compressor units that are in excess of 400 horsepower per unit. Our horsepower utilization is approximately 64% on a horsepower basis and unit-based utilization was a bit over 53% at the end of the quarter.

Our capital expense for completed gas compressor rental fleet units in the third quarter which does not include work in progress was approximately $6.5 million. Earlier this year, we projected a capital expense budget of $15 million to $20 million for the year.

With almost $18 million capitalized for the first three quarters, we believe we will end the year with our capital expenses above the high-end of this projection.

Stronger-than-anticipated demand and an acceleration of the equipment purchase lease program, we have in place with one of our customers, leads us to increase our estimated capital budget 2021 by 15% to 20%. On a precautionary note, there's a possibility of delivery issues that could impact the timing of some of this added capital spending.

But with demand intact, we'd only delayed these expenses into early 2022. From a balance sheet perspective, we continue to have no debt outstanding at the end of the third quarter with our cash balance at the end of the third quarter at $24.4 million. This compares to cash a year ago of $27.6 million and last quarter of $26.2 million.

In spite of our strong capital spending on committed rental equipment and our stock buyback program, our cash balance in all comparative quarters has continued relatively steady due to our ability to deliver strong operating cash flows.

The combination of our cash balance and untapped credit line continues to provide ample liquidity in nearly every consumable scenario. We generated positive net cash flow from operating activities in this quarter of $7.2 million or 39% of our quarterly revenue.

We also reinvested $2.5 million back into the company through common stock buybacks this quarter. Our total stock buyback in an initial authorization totaled $5 million or 3.5% of our outstanding stock as of September 30, 2021.

On October 1, 2021, our Board authorized the repurchase of an additional $10 million of our common stock of which we have purchased 105,650 shares for $1.2 million through the end of October. We will continue to repurchase shares as we believe the fair value of the enterprise is well above that currently reflected in the public markets.

Our average purchase price for the first nine months of this year is $10.24 per share well below our calculated intrinsic value and the current market values. A final housekeeping note.

In the next couple of weeks, we will renew our shelf registration on Form S-3 with the US Securities and Exchange Commission, which would allow us if needed, to issue debt or equity securities over time using our current financial filings.

This is our second renewal and renewal in our history prior to exploration allows us to effectively extend our existing S-3 filings without additional fees. While we are pleased with the third quarter results, we remain focused on improving margins and profitability as we enter the final months of 2021 into the new year.

Natural Gas Services Group remains one of the few oil field service companies with a strong recurring revenue stream, no debt, a significant cash position, and the ability to consistently generate meaningful operating cash flow.

While the holidays invariably impact activity in the fourth quarter, we are optimistic that our rental business is well-positioned to benefit from higher commodity prices that result in incremental increase in production activity, a backdrop we believe will remain intact rolling to 2022.

Like every other energy services and industrial company, we are feeling some impact due to supply chain issues and inflationary pressures. We are fortunate in that we control our own fabrication process. We have taken steps to minimize and mitigate any disruption.

That said, we are likely to see some challenges related to supply chain disruptions and raw material inflation.

As we enter the Thanksgiving season, I'm truly thankful for the remarkable members of the NGS family able to work every day to make certain that we exceed the expectations of our customers and focus on creating value for all of our stakeholders. Paul, that's the end of my prepared remarks.

So, if you would please open the phone lines for any questions..

Ladies and gentlemen, at this time, we will conduct a question-and-answer session. And our first question comes from Rob Brown from Lake Street Capital. Your line is open..

Hi Steve..

Hi Rob..

Just kind of want to follow-up on sort of your thinking about how the end environment's happening right now with the commodity price changes? Are you seeing -- I know the customers are cautious, but are you seeing kind of extended rental durations? Are you seeing the gas drillers kind of pulling more equipment out and putting it in, or what's sort of the commodity price impact at this point?.

From the -- there's two different worlds, the oil price and the gas price. The oil price, I think as I mentioned we'll see some incremental progress through the quarter and into next year.

It's not going to be rip-roaring increase in activity as you would expect at this kind of price level because it's also mix due to capital conservation that the operators are exhibiting. But I think from the oil standpoint, we feel fairly confident it's going to hold up and we'll see some incremental activity that way.

We're not seeing any real change in terms from that standpoint. So, I think it's just business as usual from an oil standpoint. Gas is interesting. Of course some of the gas prices we've seen recently have been not historically high but relatively high compared to the recent world getting up to $5 or $6.

But there's a real hesitation on the gas side that that's going to last long. I think we're seeing certainly winter coming on. You always get price increases then. We're seeing some storage issues and there's a lot of LNG going out of the country too. So, all those have combined to -- plus the increased demand from coming out of the pandemic.

So, all those have combined to increase that gas price but there's a real concern as to how long that's going to last. So, I think once you get past wintertime, obviously, warm weather depresses pricing a bit. The supply will catch up over time et cetera. So you're not seeing a whole lot of operator money going into drilling, production, et cetera.

And we do see operators a little hesitant to go with longer terms on the gas side. If you're just putting equipment out there, just to move gas, I think there's a real hesitation, and some question as to how long the relatively good price will last. And I tend to agree with them.

I think we'll see some – not horrible prices, but we'll see some lower prices starting the shoulder season next year and going through summer. So we are seeing pushback on – people don't want to go longer terms on the gas side. They're okay with it on the oil side..

Yeah. Yeah. Okay. Okay good.

And then maybe the high-horsepower market what sort of changes have you seen more recently? Is that still an area that is active, or how are – I know, you've kind of moved some equipment from standby to fully committed, but how is that market in terms of new sales?.

Yeah. We think it's going to be good. And again, the high-horsepower market for us, and everybody is a permanent. That's the – that's what's driving a lot of the centralized gas lift due to the oil volumes and oil prices. So the Permian is the result of the equation, as far as what happens from a high-horsepower standpoint.

And again, high horsepower is primarily related to centralized gas lift. So the thing is going to stay active. The visibility is a little more opaque right now. So we want to see, what some operator budgets look like, particularly in this area. But I think generally, we're pretty optimistic that we're going to see continued growth in that place.

And we know of some growth coming our way. We're just not through the full sector and what the full year looks like yet.

Everybody's – in this period everybody is keeping their cards pretty close to their vest and are not making a whole lot of projections out, not really committing to long-term projection from hey build this over this time and stuff like that so – which is I think natural coming out of the pretty uneven period we've had the last year and half.

But we think generally, it's going to be good. We just – it's just hard to put up to quantify it yet..

Yeah. Okay. Great. Thank you. I’ll turn it over..

Thanks, Rob..

Thank you. Our next question comes from Tate Sullivan from the Maxim Group. Your line is open..

Hi. Thank you. Hi, Steve..

Hi, Tate..

I missed your comment on the -- hey. I missed your comment on that.

Did you say – so relative to the previous CapEx guidance for 2021 you increased it by 15% to 20%, or can you just – or is it still 15% to 20% for the full year?.

No. Well, yeah, it was – we originally projected $15 million to $20 million for the full year. But yeah, we're projecting a 15% to 20% increase over that $15 million to $20 million. No confusion, I guess. And obviously, it's $18 million – yeah 15% to 20% is going to apply to the $18 million to $20 million range we're in now..

Perfect.

And then similar to previous years the dynamic of building a higher-horsepower equipment is it already spoken for by clients? Is it – or is some of that on spec in this environment, or I mean, how many units by the end of the year pro forma with a higher spending might you have available for rent? I'm sorry for a couple of questions in there..

From a spec standpoint, it's probably only about one or two. So not a whole lot. Now, we will likely increase that next year, because if we're right that the activity is going to increase on the high-horsepower side, you've got to have that stuff available. You can't wait 6, 9 months to rent something. People want to do it typically.

Now obviously we had a variable situation last two or three years where we had a 2-year build program that was committed on a long term. But that's that build program is essentially over. So, it's now back to the I guess the regular market per se.

So we're going to have to have some spec, 1 to 2 is what we're going to end up with probably by the end of the year, but a good level is probably -- for us anyway right now is probably 4 to 5. So we'll see that more so in 2020 along with any other committed units we've identified.

And we're right now outside of the 1 to 2 spec we anticipate by the end of the year. Right now anything we're building is committed..

Great. And then you mentioned you have -- or I know it will be in the Q, but you may have mentioned it earlier.

What are the current number of rent -- or what were the number of rented compressors out of 3Q, 2021 -- end of 3Q?.

Of the total fleet?.

Yes please..

Unit utilization was 50% and horsepower utilization was about 65%. I think we had 2275 units. So that -- right..

And then with that number -- and with the number of units that you're building at the higher horsepower just a modeling question, if I may.

What do you expect that I've just been tracking the average horsepower for your rented compressors? I mean it's been proceeding every single quarter building higher units, can it get up to 250, or how are you looking at that in terms of the total dynamic in the whole fleet?.

The average horsepower per unit?.

Yes..

Well, right now in this third quarter it's 235 horsepower per unit. And it looks like over the year, we increased about 10 horsepower per unit. So, it takes a while to get the whole fleet up on a per-average-unit basis. So, I wouldn't say we'd be at 250 a year from now maybe 245 and showing the same growth we had.

So like I say, it's hard to move the average on 22 -- almost 2300 compressors. But we anticipate that continue to climb. It's just hard to predict the exact rate on average horsepower per unit..

Great. And last from me just I'd love to hear more about the dynamic currently and understanding the higher lubricant costs and supply chain disruptions.

When you take sales backlog ending at $2 million in the quarter unchanged from the prior quarter do you -- when you accept those sales orders is it almost just saying to your current customer will -- I mean we'll do this for you now? Are you passing on higher pricing, or what are the conversations like when you decide to take a sales over or turn it away?.

Yes, it's a little better than it was 6, 9 months ago. Jobs quoted six months ago were -- and I'm not making this up. If you -- we had some stainless steel requirements there's some packages and they would only hold the quote -- the stainless steel suppliers only hold the quote 24 hours literally 24 hours. That makes it a little tough to quote stuff.

We typically quote on -- the quotes are valid for 30 days. So what we did at that time obviously we tried to pass along what we can or go back or change orders and things like that. We absorbed some of the costs going up and through change orders and optional adders and things like that.

We were able to bring that margin back in closer to what we quoted. But there's certainly an impact on some of that stuff when you try to quote. And obviously operators are reluctant to give you or give us free rein on you need cost increase that comes by because there's -- you can have an issue of or maybe we're not paying attention or whatever.

But it's abating somewhat now from the point of those kind of goods. Now we are seeing price increases on engines compressors. You've seen them in oil in general parts. We're seeing some of that. But those are -- those latter expenses more operating expenses in the form of capital expenses.

So we just got to -- some of the stuff we got to put in longer lead orders. And some other you just got to shop around a little more and try to economize where you can and raise prices where you can. It's a twofold thing trying to keep the cost down and keep the pricing up..

Great. Thank you, Steve. Thanks for answering my question..

Thanks, Tate..

And our next question comes from George Melas from MKH Management. Your line is open..

Great. Thank you. Good morning, Steve..

Hi, George..

Can you talk a little bit more about CapEx? And how much of the CapEx has been from that one program you have with one customer to purchase their lease equipment? And maybe you already have some sense of what CapEx might be like next year and where that -- the composition of that CapEx would be..

Yes. The CapEx this year attributable to the leaseback program, I don't have the exact number, but I'm going to estimate. It's in the $5 million to $6 million range probably one-fourth to one-third of the total. It's accelerated quite a bit the last six months. So it's more than what we had originally anticipated.

So -- and hence the reason to go up a little on capital. It's probably in that $5 million or $6 million range. I'm not going to project what CapEx for next year is yet. We need to get further into this quarter start to see if some operators will give us a little more definitive word on what they're planning.

Certainly, we won't see anything published probably until early next year. Maybe some will tell us a little earlier. But just the conversations we're trying to gather that information as we speak. So I don't exactly know yet. So we'll update our 2022 perspective probably on the next call which will be the full end-of-the-year call..

Okay. Great. Thanks for that. And maybe can you talk a little bit about the competitive environment? You have a number of competitors who are larger but sort of distressed financially. And maybe some updates in that respect from your perspective..

Yes. George, primarily drift not by name but just generally the public competitors because everybody gets to look at them just like they look at us. As I mentioned we've had three-fourth of increasing rental revenue. We've circumvented the globe per se on the trough of the rental revenues from the pandemic.

And we're back up to just a little bit above pre-pandemic levels. And looking at we're about the only one that's in that good a shape from a rental standpoint. Now obviously our sales, is up and down but they don't have sales. They're -- they don't compress or fabricate. So we'll pull that out of the discussion.

So from a rental standpoint, we're doing relatively well compared to competitors. They lost -- and I say, they it's a generalization. They lost more equipment during the pandemic than we did, from a unit standpoint and a horsepower standpoint, and more on a percentage basis. Now, we know that equipment's out there.

And we know they're trying to move it, at relatively we think unattractive prices. And they will unattractive prices move equipment, low price drive utilization. And we'll see some of that and we've already seen some of that. But we're still able to stay ahead and gain share. So no, I'm not rooting for the competition necessarily.

But the sooner they get rid of that older, cheaper stuff the better the market is for everybody and certainly for us, because we tend to have -- our equipment is -- our big horsepower equipment is all brand-new stuff. It's the latest technology; it's the latest commission's profiles, et cetera.

And a lot of the stuff that's being marketed out there now is not new like ours, but maybe five, 10, 15 years old which -- five years old doesn't sound too bad from a compressor age standpoint when you capitalize this stuff over 15 years to 25 years. But certainly from a technology standpoint or emissions standpoint it makes a big difference.

So, the sooner they can get rid of that older stuff and get it out somebody cheap and leave it out there the better off we all are. But generally, just from the public filings that we can see we're doing, pretty good compared to competition..

Okay, great. Congratulations. Thank you..

Thanks George..

And we have no further questions in queue at this time..

Okay. Thanks Paul and thanks everyone for joining on the call. I appreciate your time this morning and look forward to visiting with you again next quarter. Thank you..

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