Q1 2023 Natural Gas Services Group Inc Earnings Call
Participants
Anna Delgado
Stephen C. Taylor; President, Interim CEO & Chairman; Natural Gas Services Group, Inc.
Alejandro Nuno; Former Equity Research Associate; Maxim Group LLC, Research Division
Hale Hoak
Kyle Krueger; Owner of apollo capital; Natural Gas Services Group, Inc.
Robert Duncan Brown; Senior Research Analyst; Lake Street Capital Markets, LLC, Research Division
Presentation
Operator
Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group, Incorporated Quarter 1 2023 Earnings Call. (Operator Instructions)
And I would now like to turn the call over to Ms. Anna Delgado. Please begin.
Anna Delgado
Thank you, Luke. Hello, everyone, and thank you for joining us to discuss our first quarter 2023 financial results. Today's call is being webcast on our Investor Relations website, ngsgi.com. Also available on the site is our earnings press release, which was issued Monday, May 15.
Before I hand the call over, I'd like to remind everyone that, during today's call, including Q&A, we may make forward-looking statements regarding expectations of the company. These forward-looking statements involve known and unknown risks and uncertainties that may cause actual results to differ materially from those expressed or implied on this call. These risks are detailed in our most recent Annual Report on Form 10-K, and as such, may be amended or supplemented by subsequent quarterly reports filed with the Securities and Exchange Commission. The statements made during this call are based upon information known to Natural Gas Services Group as of the date and time of this call, and NGS assumes no obligation to update the information presented in today's call.
With that, I'd like to turn the call over to Steve Taylor, our Chairman of the Board, Interim CEO and President. Steve?
Stephen C. Taylor
Thank you, Anna and Luke, and good morning, everyone. Welcome to our first quarter 2023 earnings conference call. Thank you for joining us this morning. Before taking your questions, I will highlight our financial and operational results for the first quarter that were detailed in our earnings press release yesterday, discuss the current business environment and provide comments on other aspects of our business.
The quarter marked the ninth quarter in a row of rental revenue growth. For the current sequential quarters, rental revenue alone grew almost 11%, while higher rental and sales revenues grew total revenues by 18%. Adjusted rental gross margin slipped 2% due to higher field expenses and a onetime noncash adjustment, but our total adjusted gross margin increased 4% sequentially. SG&A declined 4% and our bottom line net income had a positive swing of over $1 million from last quarter as we posted positive GAAP earnings.
As mentioned in our last earnings call, NGS closed on a substantial line of credit from our bank at the end of February. This was to fund the additional high horsepower equipment we have already contracted as we continue to execute on our growth plan. NGS had a solid and growing quarter. We have added more committed contracts over the past couple of months, our utilization continues to increase and pre-contracted activity remains at a high level for the rest of the year.
With that said, let's look at the results from the first quarter of 2023. Total revenue for the 3 months ended March 31, 2023, increased to $26.6 million from $22.5 million for the 3 months ended December 31, 2023, and or an 18% increase in sequential quarters. The total revenues increased year-over-year from $20.3 million for the 3 months ended March 31, 2022, for a 31% increase.
Rental revenue increased 11% from $20.6 million in the 3 months ending December 31, 2022, compared to $22.7 million in the 3 months ending March 31, 2023. Rental revenue increased to $22.7 million for the first quarter of 2023 from $17.1 million in the first quarter of 2022 for a 33% gain over the past year. Both comparative period increases were primarily the result of the increased deployment of higher horsepower rental units, higher overall utilization across the fleet and rental price increases throughout the year. Rental revenues have strengthened and are now running approximately 85% to 90% of our total revenues in all comparative periods.
As of March 31, 2023, we had 1,245 utilized rented units, representing over 335,000 horsepower compared to 1,276 rented units, representing almost 307,000 horsepower as of March 31, 2022. We ended the first quarter with 66.4% utilization on a per unit basis and 77.4% utilization on a horsepower basis. These are both improvements from the prior quarter. Notably, approximately 96% of our higher horsepower fleet equipment is utilized and drawing rent, while 100% is contracted. The 4% difference represents units waiting to be installed.
Utilized horsepower increased 9% in the first quarter when compared to the year ago period, while revenue per horsepower increased 21% when comparing the same periods, demonstrating the impact of the growth in higher horsepower units and the price increases we have been able to implement over the past year. Our total fleet as of March 31, 2023, consist of 1,875 units with over 433,000 horsepower. Our large horsepower assets comprise approximately 15% of our current utilized fleet by unit count, but these units provide approximately half of our current rental revenue stream.
Sales revenues for the sequential quarters increased from $1.3 million in the fourth quarter of 2023 to $3 million in Q1 2023 -- up from Q4 2022, I'm sorry, to the current quarter. This large increase in sequential revenues was primarily from idle equipment sales from the rental fleet and a doubling of parts revenue from the sale of proprietary pressure control systems. On a year-over-year quarterly basis, sales revenue increased slightly from $2.9 million to $3 million.
As noted in our release this morning, adjusted gross rental margin slightly decreased sequentially from $11.3 million or 55% of revenue in the fourth quarter '22 to $11.1 million or 49% of revenue in the first quarter of 2023. Half of this quarterly decline is due to a noncash reclassification of inventory items from the balance sheet to the income statement, while the balance of that expenses from higher R&M and parts costs.
On a year-over-year basis, our adjusted rental gross margin of $11.1 million in the first quarter of 2023 increased approximately 40% when compared to $7.9 million in the same period in 2022. Our SG&A expenses declined $200,000 in sequential quarters and totaled 17% of revenue this quarter. Sequentially, we reported an operating loss of $314,000 in the fourth quarter of 2022 compared to positive operating income of $402,000 in the first quarter this year. This improvement was primarily due to higher total gross margin, lower SG&A expense and $280,000 less in equipment retirement expense. This compares to operating income of $382,000 for the 3 months ended March 31, 2022.
Our net income in the first quarter of this year was $370,000 or $0.03 per basic and diluted share. This compares to a net loss of $756,000 in the fourth quarter of 2022 or a $0.06 loss per diluted share. In the year ago quarter, our net income was $337,000. Adjusted EBITDA was flat at $7.7 million for the sequential quarters, but increased 15% from $6.8 million from the same period in 2022. Our cash balance as of March 31, 2023, was approximately $7.4 million, with $61 million outstanding under our revolving credit facility.
In the first quarter this year, we realized cash flow from operations of $18.2 million compared to $5 million in the same quarter last year. We used $47.8 million for capital expenditures, $47 million of which was expended on our rental fleet in this current quarter.
The compression market remains very strong, and we continue to see demand for new compression units, especially in the high horsepower range. Last quarter, I mentioned that if opportunities present themselves, we are likely to expand our fleet further to meet demand as long as such expansion meets our return expectations, contract requirements and our cash availability. That said, we, in fact, secured additional contracts this quarter worth approximately $20 million to $25 million.
We also accelerated our build schedule, which brought another similar amount into this current year. This resulted in a large increase in our 2023 committed capital budget from the $95 million originally announced to $150 million currently. This is a large increase, but this projection is supported by present build schedules so that we will add approximately $50 million for each of the next 2 quarters in equipment assets. I'll caution everyone that this may fluctuate to the downside due to supply chain constraints, but this is our best present estimate. Even with this, we are still seeing added demand that we cannot fulfill this year.
I also want to take time to introduce 2 new members that we have recently appointed to our Board, Justin Jacobs and Don Tringali. Justin is the Management Committee Director of Mill Road Capital Management, one of our largest shareholders, and Don is the Chief Executive Officer of Augusta Advisory Group. Both have extensive experience in private and public boards from a financial and governance perspective. A full description of their background is in our recently published proxy. We welcome them and look forward to their contributions to our Board.
As I've just discussed, the demand for our equipment and services continues unabated. Based on our current build orders and already executed contracts, we are essentially sold out this year, and we anticipate this continuing into 2024. It's too early to tell if next year continues at a faster pace as this one, but barring an extraordinary macro event, we anticipate that will be another robust growth year.
Obviously, there can be headwinds, but consensus projected prices for WTI crude from Bloomberg anticipate crude oil in the mid-$80 per barrel range through 2025, another 2-plus years. This is supported by OPEC's recent decision to cut production, the potential of refill its strategic petroleum reserve and the continuing natural decline in production. Presently, approximately 75% of our utilized horsepower is employed in the production of crude oil. So our overall activity is now driven by crude oil pricing and production dynamics.
As far as natural gas, the picture is murkier and not as rosy. Natural gas prices have been extremely volatile over the past few months. Spot prices exceeded $9 per MMBtu in August of 2022, and they are currently at $2.24 at the end of April 2023. That's a 75% decline in price in 8 months. Rigs drilling for natural gas hit their lowest point in 7 years last week. The spike in prices last year was caused by some short-term worry about natural gas supply, but that quickly abated. We are now, unfortunately, stuck in the same natural gas price scenario that we have seen play out over the last decade.
I don't expect a whole lot of support to our business from natural gas prices and activity, but fortunately, only 25% of our utilized horsepower is employed in natural gas projects. However, if we do get any pricing uplift, it will add to the activity we already see. There are a lot of moving parts in the business right now, but I think we're connecting all the dots, and we look forward to continued growth. Thanks for your time, and I look forward to your questions.
Luke?
Question and Answer Session
Operator
Hello? Ladies and gentlemen, at this time, we will conduct a question-and-answer session. (Operator Instructions) Our first question comes from Rob Brown with Lake Street Capital. Rob, go ahead, please.
Robert Duncan Brown
Congrats on a good quarter.
Stephen C. Taylor
Hi, Rob. Yes, thanks.
Robert Duncan Brown
Just wanted to get a sense of kind of demand environment for the high horsepower. It's been strong. How are you kind of seeing it with the current commodity prices? Are you seeing more interest in activity there?
Stephen C. Taylor
Well, the -- yes, the current commodity price, oil commodity price has weakened just a little bit. But we're not -- if we didn't know that, we wouldn't have even known that there's a $70, low-$80 gas or oil price out there. Demand has continued, as I mentioned, essentially unabated. Just mentioned the additional contracts we've gotten. We've tried to speed up some bills to get the stuff out quicker. And we're still seeing demand and it's actually demand that we can't fill this year due to schedules and cash commitments. So it's -- presently, it's just continuing nonstop.
Now, I think -- and we anticipate that continuing on. And if you're starting to look into '24, what you're trying to do now, it's a little tougher because operators aren't really publicizing too much of their 2024 schedules, but just based on continued demand, we're seeing requests for equipment and things like that, '24 looks like it's going to be a -- have a good start. But if everything else continue with the oil price hanging in, and I don't think it has to go up a whole lot more, I mean, the demand is there even at the current price, which is the price that the operators can make money at. We anticipate demand continuing.
Our challenge is now execution. As I mentioned, you're sold out and getting it built, getting it out on time, supply chain continues to be somewhat of an issue, not a killer, but as long as all that stuff stays together, we see that rest of the year and into '24 being good. So demand is there. It's just now, I think, among -- with us and in the industry, generally, is just how to fulfill all of it, and I don't think all the 2023 demand will get fulfilled. It will slide over into '24.
Robert Duncan Brown
Yes. Okay. That's good. And then maybe just review the capital commitment again on kind of what you've sold? And is that capital commitment sort of to fulfill contracts that you have and that's committed at this point? And just provide us -- remind us what it is.
Stephen C. Taylor
Yes. It's essentially the same stuff. The contracts we talked about last quarter were largely precontract, and I say largely, I think there's 90%, 95% precontracted. And the ones we've added this quarter are contracts. So they're not speculative builds or anticipated work, they're signed contracts, and that's why we would hadn't added them and increased the capital budget. It's equipment we've got to build now. So the commitment level still stays at that 90% range. We've got -- the 10% difference is some equipment we've got in there towards the end of the year and into 2014 that have not been committed at this point that are being built, but we fully anticipate that equipment over the next 6 months being rented. So the bottom line is, we're still running a 90% commitment rate on the stuff we're building.
Robert Duncan Brown
Okay. Okay. And I may have missed it when you spoke with the capital -- the CapEx expectations this year, and I guess, the way you're talking, would that be similar next year? What's the CapEx expectations at this point?
Stephen C. Taylor
I don't want to even project 2014 -- '24 yet. I think last call, I was asked that question, I said, well, just based on the difference in what we anticipate the capital budget being and the bank line commitment we had, there's about a $55 million difference. I said, well, if everything stays static, it'd probably be $55 million we spend next year just to finish out the bank commitment. But now the budget this year has grown to where there's very little left in the bank commitment if we execute on everything we've gotten and the committed stuff.
So it's very hard to say what 2024 is going to be right now. Like I mention the operators haven't really put out anything publicly. I mean, anything we hear is pretty much speculation and advance projections from operators. And those are hard to, I guess, commit to right now from a capital budget standpoint. So we're trying to get a better handle on it. But 2024, like I say, I think it's going to be a robust growing year whether we spend $150 million, I -- that's a lot of money for 2 years in a row, and I would be hesitant to say that. But give me another quarter or 2, and we'll have a lot better handle. But it's going to be a decent year. I just don't know if it's going to be -- as I mentioned in the remarks, I don't know if it's going to be as fast paced as this year because this is pretty extraordinary.
Operator
Our next question comes from Tate Sullivan with Maxim.
Alejandro Nuno
It's Alejandro Nuno on for Tate Sullivan. Congratulations on the quarter.
Stephen C. Taylor
Who is this?
Alejandro Nuno
It's Alejandro Nuno on for Tate Sullivan.
Stephen C. Taylor
Okay. Alejandro, how are you?
Alejandro Nuno
Good. Congrats on the quarter. Just kind of following up on the CapEx comments. How much of the increased CapEx guidance is for the 2,500 horsepower market? I think last quarter, you talked about it being about 1/3 or half of the $95 million commitment. So I wanted to see if we're increasing it now that we've increased the CapEx guidance as well.
Stephen C. Taylor
No. Actually, the majority of it is 1,500 horsepower units. So we didn't change the 2,500 horsepower number. It's just primarily we've had a lot of interest in the 1,500 horsepower equipment.
Alejandro Nuno
Great. And then again, just kind of following up on the price increases. Should we see continuous price increases throughout 2023? Or do you think the -- can you kind of just give us a little more of a rundown on what we should be looking at as you see price increases throughout the rest of the year?
Stephen C. Taylor
Well, from a new equipment standpoint, we may primarily because engines are continuing to get more expensive, compressors are more expensive, building is more expensive. So from a new build cost of goods sort of thing, we're still seeing increases. And if they continue like they are, we're going to have to increase the rental rate on new equipment going forward. We'll probably look at it, we constantly look at it, but we'll make an assessment in the next quarter or so and just see what we see from an inflationary standpoint there.
From the existing fleet, it's more of an operating expense question. And the inflationary increases from the operating standpoint, being labor, lubricants and stuff like that, have -- they're still going up a little bit, they mitigated somewhat recently, but we're keeping an eye on it, and we'll just have to see what, again, make an assessment on the next quarter as to what that pricing is looking like. But we're seeing a little slowdown in some stuff, but it just -- it continues on. It's not as extreme as it was last year, but -- in the earlier part of this year, but we're still going to watch it a bit.
I think there's still price increases going on in the industry, as we speak. And I think that's more so a catch-up to what we had already done versus maybe doing enough last year. So there's still some price increasing going on and still some costs going up. But as far as we go, we're just going to look at that very carefully probably in the next quarter or so and determine if we need to do it. There's getting to be some pricing fatigue from customers, which is -- we know what they're talking about because we're getting a little over, too, from our suppliers, but we just got to make an overall assessment and see what and where it puts us.
Operator
Thank you very much. (Operator Instructions) We have Hale Hoak with Hoak & Co.
Hale Hoak
Steve, it's Hale. Congrats on a good quarter. Just to follow up a little bit on the CapEx questions and asking a little differently. If no new equipment orders came in and you just fulfilled what you're currently obligated to fulfill, when would all of those units be in service? Is it 6 months from now or 12 months from now or how far out until all of them are in place?
Stephen C. Taylor
Well, the -- yes, look at the build schedule, of course, it's the buildup about the third quarter then decline, and this is from the standpoint of the build schedule being, okay, this is completed equipment and equipment we can start to place on contract and rental. So you get the typical sign wave. So all of the equipment would be -- and from a time delay standpoint, let's just say, equipment that gets built and we receive it in Q2 will be installed and start generating revenue sometime in Q3. So you got about a lag like that. So all the equipment that we're building this year, I will anticipate being installed and all deploying 100% rent by the end of Q1 '24.
Hale Hoak
Okay. Great. I just was thinking about you're going to have a -- you had a nice quarter now, but you're going to have a quarter with a real step function change in earnings power and, I guess, later this year or early next year and was just trying to get my hands around the timing of that. But congrats and also congrats on added some guys to your Board. I think it looks like you'll get good perspective, and we'll talk to you soon.
Stephen C. Taylor
Okay. Yes, appreciate the call.
Operator
Our next question -- our last question comes from Kyle Krueger with Apollo Capital.
Kyle Krueger
Steve, a couple of questions for you. Fantastic increase in revenues during the quarter, year-over-year operating income was basically flat, would have expected significantly more operating leverage than that with that dramatic of a revenue increase, and I see some couple of the onetime factors. But is that revenue increase going to lead to significant profit prosperity going forward? And if so, what's the timing associated with that? When will we start to see the earnings leverage come through?
Stephen C. Taylor
Well, I think just like talking to Hale there a second ago, we'll see the majority of it. Q1 was the beginning of the kind of the CapEx build. So as I mentioned, we're going to start getting the majority of the equipment in Q2 and Q3. So the second half is going to look a lot different than the first half of the year when we're just starting out. So we're going to be getting the equipment, getting installed, getting the rent starts and things like that. So I think you'll start to see some real improvements all the way up and down the income statement and start in the second half. And it will just build. We'll have -- I think you'll see a Q3, Q4 and Q1 increase pretty consistently going that way.
Kyle Krueger
Yes. Yes. Any idea that you could give us as to what the expected incremental operating margin associated with a dollar revenue increase could be? I mean, I would imagine it would be quite substantial. I mean 20%, 30% that will start to see flow through off of that dramatic ramp in revenue?
Stephen C. Taylor
Yes, the revenues is -- the increase that we're going to see, say, the next year, next 4 quarters or so, it'll be (inaudible). I would guess for every (inaudible) dollar revenue we see go up, we're going to see a commensurate 20% to 30% increase in -- additional in operating income. So I don't think you're too far off of that because we're going to start seeing pretty substantial increases in a lot of stuff, revenue. This is new equipment going out and this new equipment is carrying higher prices in some of the existing equipment out there. And so there's a lot of levers in the income statement that will start to be pulled as we go through, our SG&A is going to get better or predicted that. So we're going to have a lot of tailwinds going forward. So yes, I don't think you're too far off on your operating leverage, you think?
Kyle Krueger
Yes. Okay. Now, typically, you guys have played in lower horsepower space, 250-ish, I think, was the average horsepower of your installed fleet going back 2, 3 years ago, now you're moving up into the 1,500 and beyond range. Is the manufacturing and fabrication process similar enough that you can guarantee customers contractual run time performance? Or is this really a new piece of equipment for you that is needing to have run time performance in order to perform according to what ordinary field level statistics might be?
Stephen C. Taylor
Well, it's a magnitude difference in the equipment. So you're right, say, 5-plus years ago, our typical build was a 200, 250 horsepower unit. Now, we're routinely building 1,500 and stepping into the 2,500 horsepower. So you get a magnitude change in just the horsepower and the size of the equipment. You get a big change in how it's operated and maintained in the field. But from a design standpoint and how you can maintain run time, some of it's -- some of the basic stay the same. They're all our designs. We've built a fair amount of the bigger stuff. But currently, in probably the last couple of quarters, we've outsourced the majority of the big horsepower our designs. So it's -- we've found a couple of good fabricators that have good quality and will build at a good price for us. And so we're using the outsourced model more so now than we ever have in the past from -- certainly from an additional horsepower standpoint.
But from a run time, we've always guaranteed high run times on equipment. Now, on this bigger equipment, the customers typically demand even higher run time on them because now you're starting to get into critical infrastructure when you're getting into centralized compression, maybe touching some midstream stuff or any downtime, especially on a gas lift or production perspective is very profitable or very expensive for the operator. So the more downtime you can give them, the more money they make. Number one, that drives rental rates up because your manpower gets more, your monitoring costs get more, et cetera. But we are able to deliver very high run time on this stuff.
But you do have to spend a little more money to do it, and that drives some of our rates, too. But your customers are typically okay paying those higher rates if you can give them that kind of run time because 1% or 2% additional run time on the higher end, I mean, into the higher 90% run time range, is very profitable when you're lifting thousands of barrels of oil a day from centralized stations. So it's more critical now than actually has been in the past with the medium horsepower.
Kyle Krueger
And these are -- these being kind of brand-new units for you guys and you're outsourcing the production and fabrication of them. Isn't it a new piece of equipment? And are you sure that they're performing according to contractual specifications? And are you confident -- how are you confident enough with really very few units out in the field now with accumulated performance, how are you confident to spend up to $150 million and take what has been a pristine balance sheet to one that, on a current run rate basis, has 3x debt-to-EBITDA going presumably significantly higher.
Stephen C. Taylor
Yes. Well, I mean, we're -- we've dealt with this equipment. The engines and compressors were having built for us in this equipment is #1 from the industry standpoint, long-standing, excellent quality goods. So there's no issue with the quality of the engines and the compressors. And that's from the industry standpoint. From the NGS standpoint, we've been dealing in the same engines and compressors for 4 to 5 years. So we've also got some history with it, and we're building more and more each day. And with this equipment and the value of it and the run time expectations or service expectations, every one of these big units are extensively monitored. There's probably, and there maybe more, 30 to 40 monitoring points constantly on this equipment to track what's going on, what's good, what's bad, et cetera.
So we've got an extremely high level of confidence in the equipment we're putting out. We're getting a lot of support from the factory and the suppliers and everything else on this stuff. So that's really not that doesn't keep us awake at night. The -- we lose sleep over making sure we can make the run time and things like that, more of a service aspect than an equipment aspect.
Kyle Krueger
Yes. Yes. Okay. And could you update us, Steve, on the CEO -- the full-time CEO replacement search? What kind of candidates you're coming up with? And --
Stephen C. Taylor
Well, we've been -- we've had a search going on, as I mentioned in the past. Now, with the 2 new directors on the Board, which we announced a couple of weeks ago, 3 weeks ago, I think we're going to -- we want to involve them in that. And so we're taking a look at where we are, where we've been, what we're going to do, et cetera, et cetera. So no -- I mean, the candidates are what you'd expect. We were trying to find different levels of experience, whether it's equipment experience, financial experience, et cetera. So that criteria, to this point, hasn't changed, but we are taking a little bit of a pause and reassessing with our new Directors, the candidates we've identified so far, the profiles we want and things like that. But we'll -- it'll -- it's going along, but it will resume to a fuller extent in the future.
Kyle Krueger
Yes. And have you expanded that exercise to include sort of a full scope strategic review with these new Directors coming on, which presumably with a CEO transition so important. Are you including outright sale up to and including the outright sale of the company with respect to how the new Directors and the CEO search is moving forward?
Stephen C. Taylor
Well, the new Directors didn't come on from the point of doing anything in particular with the company, except increasing shareholder value, right? And we've made no bones about the fact that we're going to look at the company from the perspective of we've got this organic growth plan going on. And we've got the big bank line and making sure that's assessed correctly. We're going forward the way we want and things like that. But I think whether it's 2 new directors or the existing Board before, we're always constantly looking at what's the horizon, what's the future hold, what direction do we want to go, what are the strategies and things like that. So that's really not going to change. Now, certainly, we got 2 new perspective, 2 new eyes looking at things, which is great. That's from a business standpoint, that's always what we ought to do. We're going to continue to assess our strategies. But our strategy right now is what I've just talked about, executing on our growth plan, putting in a lot of new equipment, satisfying demand and stuff like that. So really, that's the point we're at right now, just making sure we're as tight as we can be on our present plan.
Kyle Krueger
Okay. Best of luck going forward, looking forward to seeing the leverage come through based on dramatic increase in revenue.
Operator
And that was our last question. Mr. Taylor, go ahead.
Stephen C. Taylor
Okay. Thanks, Luke, and thanks, everyone, for your time and joining our call, and I look forward to updating you on the next earnings call next quarter. Thank you.
Operator
Thank you, everyone. This concludes today's conference call. Again, thank you for attending.
