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Edited Transcript of NGS earnings conference call or presentation 8-Mar-18 4:00pm GMT

Thomson Reuters StreetEvents

Q4 2017 Natural Gas Services Group Inc Earnings Call

MIDLAND Mar 9, 2018 (Thomson StreetEvents) -- Edited Transcript of Natural Gas Services Group Inc earnings conference call or presentation Thursday, March 8, 2018 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alicia Dada

* Stephen C. Taylor

Natural Gas Services Group, Inc. - Chairman, CEO and President

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Conference Call Participants

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* Jason Andrew Wangler

Imperial Capital, LLC, Research Division - MD & Senior Research Analyst

* Joseph Donough Gibney

Capital One Securities, Inc., Research Division - Senior Analyst

* Michael William Urban

Seaport Global Securities LLC, Research Division - MD & Senior Analyst

* Robert Duncan Brown

Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group Fourth Quarter Earnings Call. (Operator Instructions) Your call leaders 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.

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Alicia Dada, [2]

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Thank you, Erica, 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 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, through 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 this call 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?

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [3]

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Thank you, Alicia and Erica, and good morning. And welcome to Natural Gas Services Group's Fourth Quarter 2017 and Full Year Earnings Review.

We're pleased with our full year 2017 results and are encouraged that our fourth quarter results provide an indication of recovery in our business. For the first time since the first quarter of 2015, the beginning of one of the worst cyclical downturns in our generation, we saw a quarterly increase in rental revenue. Our sales revenue for compressors and aftermarket parts and services were also strong throughout the year. Additionally, pricing has shown recent strength, something we are certainly pleased to see. To meet our growing contracted rental demand, we have the largest backlog of compression fabrication work in over 4 years.

As we have previously announced, we entered the larger horsepower arena now 2 years ago and have recently accelerated our penetration into that market. Our activity in this segment is going well and we'll look for it and the rest of our business to grow in 2018.

As we review the financials, I will note that this fourth quarter had a couple of moving pieces in it, primarily the reduction in the federal income tax rate in Q4 and the attended very large increase in net income and some minor inventory adjustments due to lower of cost to market and obsolescence reviews. Considering all these factors, our reportable earnings per share this quarter was $1.42, however, without the effect of the tax decrease and the inventory adjustments, our adjusted earnings would have been $0.05 per share. Now with all that said, let's get to the details.

Starting with total revenue and looking at the year-over-year comparative quarters, our total revenue was essentially flat, rounding to $16.7 million in both the fourth quarter of '16 and '17. Rental revenues were up approximately $1.1 million this quarter compared to the same quarter last year. Our total sales revenue was up a little over $1 million.

For the sequential quarters of the third quarter of '17 compared to the fourth quarter, total revenues were up about 5% or nearly $750,000 to $16.7 million in the fourth quarter of '17 from $15.9 million in the third quarter of '17.

Rental revenues were up by a little over $120,000 this quarter, and total sales increased over 15% or $650,000 compared to the third quarter '17. This is the first quarterly increase of rental revenues we have seen since the first quarter of 2015.

On a full year basis for 2017, total revenues decreased 5.5% to $68 million, and we saw a significant shift in our mix between higher-margin rental revenues and medium margin sales revenue. In 2016, our mix was 80% rentals and 20% sales and shifted in 2017 to a 70-30 mix.

As I refer to gross margin on this call, I'm describing a non-GAAP adjusted gross margin that does not include depreciation. Looking at gross margin and comparing the fourth quarter of '16 to the current quarter, total gross margin declined from $9.1 million to $7.9 million. This decrease was due to a combination of lower overall revenues, softer margins in sales and rentals this quarter and a mixed shift towards sales. I'll get into the specifics on these as we talk about the individual product lines.

Sequentially, total gross margin decreased a little over $385,000 to $7.9 million, which was 47% of total revenue. On a full year basis, 2017's gross margin was $33 million, a decrease from 2016's gross margin of $39.8 million.

Selling, general and administrative expenses for the year-over-year quarters increased a little over $100,000 but was down 1.5% in the sequential quarters. SG&A increased 12% in the full year period, primarily due to noncash stock option acceleration charge taken in the first quarter of 2017.

Operating income and comparative year-over-year quarters is down approximately $750,000, just slightly over $200,000, primarily due to the rental sales mixed shift we experienced and a high level of relatively fixed depreciation expense. Sequentially, operating income fell from $600,000 to a little over $200,000, primarily resulting from the decline in rental margin and a $273,000 inventory charge related to lower cost of market and obsolescence adjustments in the fourth quarter.

Without this adjustment, operating income would have had more than doubled to almost $500,000. On a full year basis, operating income was $1.6 million in 2017, compared to $8.4 million in 2016.

The current quarter and full year's net income was dramatically impacted by the recent tax law changes and the impact from the lower statutory tax rate. As such, I'll discuss net income with or without the legislative impact. Including the tax impact, in the comparative year-over-year fourth quarters, net income increased to $18.7 million this year compared to $1.2 million in the fourth quarter of 2016.

Without the new lowered tax rate, net income decreased to about $350,000 this year compared to $1.2 million in the same quarter in 2016. Sequentially, with the tax law changes, net income rose from a little over $500,000 to $18.7 million, and without the tax law changes, net income declined $170,000.

The full year comparisons for 2017 showed an increase of $13 million from 2016, including the tax effect and a decrease of $5 million without the impact of the tax law changes. You can see that NGS recorded a very large net income gain of $18.35 million due to the recent tax law changes, which resulted in the reduction of the statutory rate from 34% to 21%. This large gain, which by the way, is a noncash item, extends from the new lower 21% tax rate being applied to our deferred tax assets and liabilities, thereby reducing the liability on our balance sheet.

Going forward, we expect, although a lot of variables can change this, that our total effective tax rate including state taxes will be in the 15% to 18% range, compared to our historical rate of 28% to 30%. However, we would likely not see a significant increase in the available cash from a lower rate because we have historically been able to defer a large amount of our federal cash taxes due to our higher levels of investment over the years.

As I refer to EBITDA on the following discussion, it is the non-GAAP measure of adjusted EBITDA, which is the same as EBITDA we have used in prior years but without the impact from the noncash equivalent retirements we experienced in 2016.

On a year-over-year quarterly basis, EBITDA declined from $7 million in the fourth quarter '16 to $5.6 million in the fourth quarter '17, largely due to the mix shift between rentals and sales and lower rental gross margins. Sequentially, EBITDA decreased from $5.9 million to $5.6 million. However, taking into account the previously mentioned inventory adjustments, sequential EBITDA was essentially flat.

Comparing the full year of 2016 and 2017, EBITDA decreased from almost $31 million to about $23 million. EBITDA margin this year averaged 34% of revenue.

On a fully diluted basis, earnings per share this quarter was $1.42 per common share with the tax changes or $0.03 per common share without the tax impact. Our full year EPS was $1.51 per common share including the tax changes and $0.11 without. Without the noncash inventory adjustments and the 2000 tax adjustment, EPS was $0.05 per common share this quarter.

Total sales revenues, which include compressors, flares and aftermarket activities for the year-over-year quarters, increased $1 million or 27% to $4.9 million in the fourth quarter '17. The largest sales increase we saw were in flare sales and compressor parts. Our margins decreased from 29% to 21%, but this was primarily due to the exceptionally high margin sale we had in the fourth quarter of 2016.

On the sequential quarters, total sales revenues increased over $650,000 or 15% to $4.9 million in the fourth quarter '17, again led by flares and the onetime sale of gas engines that contributed to higher parts sales.

Margins decreased from 24% to 21% due to the inventory adjustment we recorded in the fourth quarter of '17. Without that adjustment, the margin would have increased to 26%.

Total sales revenue for the comparative annual periods were up 48% or $6.6 million to $20.2 million. Compressor sales were half that increase, with flares and parts sales splitting the balance of the incremental revenue growth. Total sales gross margin increased from 18% last year to 19% this year.

Compressor sales for the fourth quarter were $2.1 million at an 11% margin, compared to $2.6 million in the fourth quarter '16 at a 25% margin. This wide variance in margin was a multiplying effect of a highly profitable compressor sale last year and the inventory adjustments in this quarter. Considering these changes, the margin would have essentially been the same between periods.

Revenue last quarter was $2.7 million at a 17% margin. Although the gross margins have been somewhat variable, we continue to deliver industry-leading margins.

Although sales softened a bit in the fourth quarter, we ended 2017 with $13.4 million in compressor sales, 1/3 higher than the $10 million recorded in 2016. Additionally, our compressor sales gross margins increased from 12% last year to 13% for the full year.

Without the inventory adjustment, our compressor sales gross margin would have been close to 15% for 2017. Our compressor sales backlog remains strong at approximately $7 million as of December 31, 2017. This compares to $6 million at the end of December 31, 2016.

Rental revenue decreased from $12.5 million in the fourth quarter '16 to $11.4 million for this current quarter. The gross margins coming in at 58% for the current quarter. Sequentially, rental revenues slightly increased from $11.3 million to $11.4 million, again the first sequential increase in 3 years.

Gross margins decreased to 58% this current quarter compared to 62% the prior quarter. This decline was primarily due to higher lubricating oil costs and increased makeready and overhaul expenses. Much like we have seen in past periods of increasing activity, we will likely experience higher makeready expenses going forward as we prepare rental equipment to go out on new rental contracts. Without these higher expenses, rental gross margin would have been 60%.

Looking at rental revenue on a full year basis, revenues were down from $56.7 million to $46 million, with our gross margin averaging 61% throughout 2017. From a pricing perspective, our average fleet rental rate this quarter was down 6% from the year-ago quarter, but up almost 1% from the prior quarter.

In the past, and I've also reported what I called our spot rental pricing, which was the average new set price in the most recent quarter. Now however, with more than larger horsepower equivalent being set, those average rental prices are being skewed so they are no longer meaningful, and I will discontinue reporting them.

Fleet size at the end of 2017 was 2,546 compressors or approximately 370,000-horsepower. This was a net addition of 16 new rental units for the year, all of which were either larger horsepower units or VRUs. We are putting our money where our mouth is, and dedicating a vast majority of our capital spending, which reflects our strategic commitment to these relatively new compressor classes.

Our fleet utilization this quarter was 49.5% to 50%, depending on whether you look at unit or horsepower utilization. Even though we saw an increase in rental revenue this quarter, the utilization has not yet reflected that because of the interplay between the larger horsepower units going out, which contribute more revenue per unit in the smaller horsepower lower revenue equivalent that might come back. We should see some upward changes in the utilization as we get more of a balance between the different horsepower classes going out and coming back.

In 2017, we spent a total of $8.3 million in capital expenses with approximately $6.6 million of that on the new fleet compression. 85% of that spending was in the last half of the year for larger horsepower rental units. This is an increase from 2016 expenditures, which were a total of $4.3 million, with $3.6 million dedicated to compression.

For 2018, we project capital spending of between $20 million to $25 million for rental fleet compression, with 85% to 90% of that being for large horsepower.

We have also committed to constructing our headquarters building for NGS here in Midland. Land has been purchased and construction starting with anticipated occupancy in the first quarter of 2019. Total cost of the building would be a little over $13 million, including the land, but we will occupy only 1/3 of it. We expanded the square footage so that other tenants in the building will essentially pay our way. Our current lease is going to expire midyear. As we start to canvass the market, we were surprised to discover that the cost to rent office space in Midland is now higher on average than Dallas and Houston. This will enable NGS to break in on this investment after 1 or 2 typical lease terms here in addition to being cash flow and earnings accretive.

Going to the balance sheet. As of December 31, 2017, our total debt remains at less than $500,000, with cash in the bank of approximately $69 million. Our cash flow from operations was $17.5 million in 2017 or 26% of revenue. This compares to 2016 when cash flow from operations was $31.8 million, with the majority of the year-to-year difference being changes in working capital, with the biggest change being the inventory increase to build a larger horsepower equipment.

As I've discussed on prior calls, NGS is presently expanding our large horsepower rental offerings. We have historically participated in a small to medium horsepower market. It has served us well and we will continue to compete vigorously in it, but at the request of customers a couple of years ago, we entered the 400-horsepower and 600-horsepower market. Although this was at the depth of the downturn, there were indications that larger horsepower equivalent could be a good market and we started to move into it.

Recently, we had the opportunity to move in to even larger 1,300-horsepower market, again at the request of some customers. And this is what we are presently building. This is an opportunistic situation, but we were able to take advantage of it due to our cash availability and our engineering and fabrication expertise. It's also the right time to enter this market based on its fundamentals. The large horsepower market is experiencing very good utilization, pricing strength is growing and increasing scarcity of this equipment makes the market attractive. We also think there's a fairly long runway of activity to keep the demand for this equipment at a relatively high level.

The size of the higher horsepower market is approximately 75% larger when measured by horsepower with a number of our present customers using the size equipment. It should also open up new geographical areas and customer segments for us to penetrate. We also see the operating profile as being advantageous. A built-in density of horsepower, higher revenue per location, a tendency towards longer average contract terms and a potentially higher incremental margins.

It will take some time, but most of our capital build program is directed to this market, and you'll see our fleet makeup change over time towards higher horsepower. I do hasten to add that we are not abandoning our core fleet and we have seen our smaller equipment start to move. And we will use that cash flow to help fund the move into higher horsepower. Supporting this initiative is our continued strong operational ability and balance sheet. We continue to have no debt, almost $70 million in the bank. We are one of only a handful of companies in the oilfield services space that's never had negative quarterly earnings.

From a macro perspective, activity levels are always subject to oil and gas price dynamics. And counterintuitively, our growth is geared more to oil pricing than natural gas now. The near-term price dynamics look strong and I'm cautiously optimistic about the longer term. U.S. is now the second largest producer of crude oil in the world and will deliver approximately 80% of the incremental oil supply required globally over the next few years. This, of course, means that the Permian basin will lead that effort. With all that, we think 2018 will be a growing year for the company, and I look forward to reporting on our progress in the future.

That's the end of my prepared remarks, and I'll turn the call back to Erica for questions that anyone might have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Rob Brown from Lake Street Capital.

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Robert Duncan Brown, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [2]

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On a larger horsepower market, you talked about kind of a runway there of demand. Can you give us some sense on what's driving that and your view on the length of the runway?

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [3]

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Well, as we mentioned a couple of years ago when we started looking at 400- to 600-horsepower, back then we saw 3 primary drivers. Number one was just larger wells. We're getting extreme lateral lengths, a huge numbers of stages and frac jobs in these wells. So we're getting bigger wells, number one. So the main thing to remember is more volume means more horsepower. So larger wells, number one. We saw a trend towards certainly pad drilling. I think 3/4 of the wells now are pad-drilled, so you've got multiple wellheads per location. That aggregates gas -- it means bigger horsepower. And then you start seeing some centralized gas lift facilities. Still a lot of gas lift is done on a wellhead, well-by-well basis. We start seeing some centralized facilities, too, where they're bringing in multiple wells into larger horsepower. So we saw those 3 things going on 2 or 3 years ago when we started moving into the 400 to 600. This larger market is -- these initial jobs, we've got are some centralized gas lift, so we're seeing that. Plus, you're seeing just a lot more midstream activity in some of these. And in this 1,300 horse range is probably in the smaller to middle part of many midstream requirements, but you're starting to see more pipeline activity out of that, too. So yes, those 4 items look to be driving all this. I don't think -- you're not going to reverse any of those items because they're all, number one, the midstream activity is driven by just the number of wells being drilled and gas need to be moved and out of basins, and the other 3 are economic factors that the operators continue to dwell on.

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Robert Duncan Brown, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [4]

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And then on the makeready activity, how long do you think that you'll see some margin degradation because of that?

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [5]

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That's a double-edged sword. We kind of hoped for long time because that means there's revenue coming after it. But again, it impacts the margins somewhat. So the only thing I've got to go on is if you look back and coming out of the '08, '09 downturn, heading into the oil shale stuff in '10, we had probably 12 to 18 months of some pressure on margins due to some of this makeready activity. Now again, as we've grown fairly quickly so it's a good thing, but you have to remember, when you look at that margin that there's revenue coming behind it. And in addition, that's good margin revenue because those incremental margin on the stuff going out. If we're doing make ready, it's obviously that's the equipment sitting in the yard so incremental margins on this stuff is going up is very high. So you have to spend that money before you make that revenue. But I would estimate -- and boy, this is a rough estimate. As long as we keep growing that rental piece of it, it will -- we could see 12 to 18 months of it. Sorry, I'll remind everybody also, we expense all that. A lot of peers -- I think all of our peers capitalized a fair amount of that -- some of the maintenance. So ours is all expense, so we take the full hit at that time. So at least, you don't have to worry about showing up later somewhere else so -- but it's all fully absorbed when we spend it.

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Robert Duncan Brown, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [6]

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Okay. And just to clarify the CapEx, you gave some numbers, $20 million to $25 million. Was that just the fleet piece? Or do that include the building?

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [7]

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That's just the fleet.

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Robert Duncan Brown, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [8]

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Okay. So add some for building.

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [9]

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Yes. And both of those will be spaced throughout the year. The -- whether you're building the equipment now. The equipment we have more -- the engines and compressors are coming in certainly beforehand on that. So the money going out for capital will be spaced out throughout the year. It's not all going to hit at one time. So whether it's a building or the fleet growth, we'll see it spaced out. And then certainly from a fleet standpoint as the stuff starts going into. Yes, this is all contract -- well, 80% of the build is contract, so as we see that stuff going to service, that will contribute some operating cash back into it, too.

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Operator [10]

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Our next question comes from Mike Urban from Seaport Global.

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Michael William Urban, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [11]

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So you're talking a little bit faster, my fat fingers could type there. The -- on the inventory charge, was that all in the sales side or was that some -- were some of that are allocated to the rental piece?

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [12]

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No, probably, I think 90% of it was on the sale. So it's primarily fabrication inventory.

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Michael William Urban, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [13]

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Okay, got you. And you talked a little bit about the makeready and start-up costs, which makes sense, and as you said, kind of a positive essentially to meet the demand is going up. But what about underlying cost inflation excluding that? In other words, it's a very tight market out there. You're seeing a little bit of pricing at this point, but not a ton? And presumably you've got -- presumably you've got to compete for labor with some of the other parts of the oil pads. What are you seeing on that front? And is that something that you're able to fully offset either from an efficiency or pricing or pass-through perspective?

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [14]

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Well, it's tight. There's -- that's not new news to anybody out here. Yes, I think what the nationwide unemployment is 4%, and I think out here it's about 2%. So everybody wants to work is working, and there's not a -- we don't -- there's not a pool of people sitting around looking for a job. So it gets competitive but we see this every time in these markets. So you end up having to usually pay a little more to get people in. And this is primarily on the fabrication piece. The field side isn't quite as bad. The problem you have here in Midland is everybody's in Midland now. And when activity ramps up, you've got a population base out here between Midland and Odessa of probably no more than 300,000 to 350,000 people. So you don't have a big labor pool to pull from. That's why this unemployment goes down so quick. So the field doesn't have near as much of a problem because it's more scattered out. You can pull from a lot of different places. The fabrication here tends to be the issue. But yes, you have to pay a little more. You have to make it a little -- a better place to work and things like that. But we see it every time. We're able to overcome it every time. As far as covering those cost, it takes all those -- trying to push pricing a little. Certainly, efficiencies wasn't what we're doing, costs controlling ours and things like that. So it's just a multitude of things that we try to do to keep it intact. But there's -- there will be constant pressure for a while on it.

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Michael William Urban, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [15]

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But do you think it, at the very least, can hold the margins flat and maybe improve a little bit if the pricing dynamic gets better? Is that a decent way to think of it?

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [16]

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I think -- no, you're looking at 2 pieces of it here. One is the sales pricing. If you're building stuff to sell -- and that's typically even more so pass it along because we know those costs, we're bidding those costs -- different every day. So those costs are going up, our prices going up. So sales is pretty easy to handle. Certainly, you've got to still be efficient from a competitive standpoint but you're -- you just need to tie -- pass this cost through. From the rental standpoint, yes, those costs get capitalized into the equipment. We had to be careful with those right there as far as how that goes out. Now that's where probably on a more direct operating basis, you have the field comes in to play more so, we're going to watch the labor out there from a gross margin standpoint. Yes, so again like I say, it's a combination of what you can pass through and how efficient you can be in all aspects of the operations.

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Michael William Urban, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [17]

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Okay, got you. And then last one from me, the timing of the rollout in the market of the large horsepower units, still the same unscheduled there and fairly kind of ratable deployment schedule over the next year or so?

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [18]

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Yes. I think -- yes, we had a total of 17 big units awarded to us. 3 or 4 are already out in '17. So we've got -- there are some gaps in the schedule and the schedule moves a little every once in a while. But generally, you could say, over the -- through the end of '18 is they're going to be fairly prorated over that period if -- you might have some bumps and grinds along the way, but we intend on having it all built by the end of the year. And then maybe some drift into first quarter of '19 as far as going before rental rates are implemented.

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Operator [19]

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Our next question comes from Joe Gibney from Capital One.

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Joseph Donough Gibney, Capital One Securities, Inc., Research Division - Senior Analyst [20]

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Just a question on your mix, your average horse, a lot of changes certainly where we've been historically and then where we're going now with the 1,300 units. But just curious, so out of the -- so 85% to 90% of your spend in '18 on the large horsepower, are you including the 400 to 600 in that large horsepower designation? Are you strictly talking about the 1,300 units there? Just trying to understand sort of your build in '18 there from an horsepower perspective. And I'd just be curious as you exited '17, what was your -- the 400 to 600 percentage of your fleet mix, I think you're kind of on maybe 25%-ish? I'm just curious where that's exiting the year.

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [21]

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Yes. Good question. I should have clarified that a little. The -- yes, when we're talking about -- price is a bigger horsepower. We're including the 400- and 600-horsepower units in there. So probably more of a mid to big horsepower build. So the 85% to 90% of the capital going towards big horsepower. We are referencing 400-horsepower and higher. So it's included. Now tell me again on exiting '17, what were you looking for there?

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Joseph Donough Gibney, Capital One Securities, Inc., Research Division - Senior Analyst [22]

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The 400 to 600 horse there, basically the large horsepower percentage of your fleet mix, and was it in that 25% ballpark? Or is it now moving higher now that you have 3 or 4 of these larger 1,300-horsepower units in the fleet?

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [23]

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Now -- 25% of what? You're talking about the build...

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Unidentified Company Representative, [24]

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Maybe total number.

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Joseph Donough Gibney, Capital One Securities, Inc., Research Division - Senior Analyst [25]

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Yes, total number of units maybe is probably an easier way to think about it.

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [26]

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Well, in '17, we didn't -- I think we -- what was our -- in '17, we had $6.6 million in new fleet compression. 85 of that was spent in the last half of the year on larger horsepower. And really that -- there was -- there might have been 200, 300, 400, 600 in there, but the majority of that the last half-year spent was the big 1,300-horsepower units.

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Joseph Donough Gibney, Capital One Securities, Inc., Research Division - Senior Analyst [27]

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Okay, okay. And this shift in the utilization, I was just trying to understand sort of what you're indicating there. Obviously, you've got -- but as you've indicated, puts and takes with larger horsepower going out in the field and then some come back on the smaller horsepower side. But are you kind of sort of expecting flattish here in 1Q and 2Q as we get going, kind of bouncing along in low 50s or upward bias is second half weighted? I was trying to understand what specifically you're talking about, or the cadence of the utilization lift.

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [28]

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Yes. I think the bias will be upwards and the pressure will be upwards. But just to resolve this quarter, we had an increase from rental revenue. There's really no move -- maybe a 20 basis-point movement in utilization -- not really much to talk about. So what we're seeing is the bigger horsepower is starting to go out. And we have historically measured on the buy per unit on a unit utilization, which totally changes as we start moving to bigger horsepower. And we're going to need to start reporting on the horsepower and a unit utilization basis going forward in all aspects whether it's utilization or costs and stuff like that. But -- so I think we'll have -- probably, we're in this bottom trough, have been there essentially all of '17, that utilization has been held in there, in that 49%, 50% range. But I think now we'll -- maybe 1 quarter or 2, it might still be in that trough, but the pressure starts coming up a little from a point that -- certainly, horsepower-wise, it will, but on unit utilization, I think it's going to take a little longer to start showing some appreciable movement on it. But horsepower, we'll see a pretty quick, I think, as we roll through the year. So that's probably not answer, but generally, upward bias. I expect us to see a greater utilization growth in horsepower than units just because the big difference we have in those units. On a revenue basis and horsepower roughly, these bigger 1,300 horse units, our average horsepower before this movement in the big horsepower is about 140-, 150-horsepower. So you're getting a -- almost a 9-10:1 ratio on horsepower on a per unit basis. So that's the dilemma we're seeing in the utilization right now. It's not going to be a real good indicator. Obviously, I'm going to point some more towards revenue and how that represents the growth for the next couple of quarters.

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Joseph Donough Gibney, Capital One Securities, Inc., Research Division - Senior Analyst [29]

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Okay, makes sense. And last one for me, and I'll turn it back. Just an update on the VRU market. You referenced 16 units getting put out there just -- anything new on that front and what you're seeing in that market will be helpful. I appreciate it.

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [30]

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Yes. We're continuing to build those. I think we slotted -- I know we slotted some more in into the build schedule this year. And the -- these guys will probably get the big horsepower on one end, then you'll go looking at the 50- to 100-horsepower VRU market, and we're sold out. So it's the big or the small right now that's active. So we're still putting those out and still building them and will be as long as that market continues to be active. It looks like it might stay active.

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Operator [31]

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Our next question comes from Jason Wangler from Imperial Capital.

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Jason Andrew Wangler, Imperial Capital, LLC, Research Division - MD & Senior Research Analyst [32]

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I was curious -- just to make sure the uptick in costs on the rental side that was -- or I should say on the revenues that didn't have anything really to do with pricing that was more of something you're seeing in first quarter or even more in real time, is that correct?

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [33]

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Yes. Yes, though, no, it's not pricing. Yes, we saw a little -- a better percent increase in pricing sequentially but a lot of that was from the bigger equipment to the contribution it was making. So -- but no, it's -- there's not been a whole lot of -- and the pricing impact to drive revenues up. It's just been activity.

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Jason Andrew Wangler, Imperial Capital, LLC, Research Division - MD & Senior Research Analyst [34]

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Okay. And then the larger unit side, I'm assuming the answer is the Permian, but can you just maybe talk about -- you talked about the addressable market being pretty significant. Is that specifically in your backyard there? Or are there some other areas that you guys are kind of initially working on as you kind of get into that market?

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [35]

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Well, the Permian is going to be the driver, as it is in anything, right, right now. So that's going to be the biggest piece of it in this and in these results we're getting our Permian base. But we think this gives us entrée into the Marcellus, which has been a big horsepower market for a long time, very little wellhead out there. So I think -- we think this gives us an opportunity to start talking to people there. The other areas, everybody needs bigger horsepower essentially in some respects so we think there's opportunities in the Oklahoma area on it, some in the Rockies, maybe probably a little more limited there. But yes, you got some of the basic areas, the Permian, Oklahoma and a little less, Marcellus. So I think those -- mainly what you look at. The other thing we see is the opportunity now to start talking to a little more Midstream companies. We're restrictively wellhead. Midstream guys don't need wellhead compression. It's a segment you don't worry about. But now moving up into the bigger horsepower, and this is more of the bigger horsepower than the 400 to 600. The bigger stuff, you see a lot more opportunities there to start talking to people. So we think there's some geographic expansion we can accomplish besides just some customer penetration in different segments.

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Operator [36]

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At this time, we have no further questions.

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Stephen C. Taylor, Natural Gas Services Group, Inc. - Chairman, CEO and President [37]

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Okay. I thank everybody for joining me on the call. I appreciate your time this morning and look forward to be with you again next quarter. Thanks.

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Operator [38]

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