Natural Gas Services Group Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 15, 2023

There are 7 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group Inc. Quarter 2 2023 Earnings Call. At this time, all participants are in a listen only mode. Operator assistance is available at any time during this conference by pressing 0 pound. I would now like turn the call over to Ms.

Operator

Ana Delgado. Please begin.

Speaker 1

Thank you, Luke, and good morning, everyone. Before we begin, I remind you that during this call, we will make forward looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934 based on our current beliefs and expectations as well as assumptions made by and information currently available to Natural Gas Services Group's leadership team. Although we believe that expectations reflected in such forward looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Call. Please refer to our latest filings with the United States Security and Exchange Commission for the factors that may cause actual results to differ commentary from those in the forward looking statements made during this call.

Speaker 1

In addition, our discussion today will reference certain non GAAP financial measures, including EBITDA, adjusted EBITDA and adjusted gross margin, among others. Call. For reconciliations of the non GAAP financial measures to our GAAP financial results, please see yesterday's press release in our Forms 8 ks, 10 ks, 10 Q furnished to the SEC. I will now turn the call over to Steve Taylor, our Chairman and Interim President and CEO. Steve?

Speaker 2

Thank you, Anna and Luke, and good morning, everyone. Welcome to our Q2 2023 Earnings Conference Call. Thank you for joining us this morning. Before taking your questions, I'll highlight our financial and operational results for the Q2, discuss the current business environment and provide comments on other aspects of our business. Reflecting on the quarter, total revenue and rental revenue grew when compared to both sequential and year over year quarters.

Speaker 2

Sequentially, our sales revenues declined, but our strategically important rental revenues continue to grow at a brisk pace, reflecting our 10th consecutive quarter of rental revenue growth. Our overall gross margins improved, led by higher rental margins and lower operating expenses, and operating income and net income both increased over the comparative quarters. We're starting to see the results of our 2023 capital program in our revenues, Margins and Bottom Lines. The overall environment in our industry continues to be positive and we anticipate further improvement. Total revenue for the 3 months ended June 30, 2023 increased to $27,000,000 from $26,600,000 for the 3 months ended March 31, 2023, or a 1.3% increase in sequential quarters.

Speaker 2

Call. Total revenues increased year over year from $19,900,000 for the 3 months ended June 30, 2022 for a 35% increase. The small increase in sequential total revenue was due to a $1,400,000 drop in sales revenues in the Q1. Group, although that was offset by an increase in rental revenues in our service and maintenance business. By the way, now and going forward, segment.

Speaker 2

We will be referring to our service and maintenance business as Aftermarket Services. There is no change in the revenue components that make up this segment, The aftermarket services or AMS conforms closer to how our industry generally refers to it. Rental revenue increased 6% from $22,700,000 in the 3 months ending March 31, 2023, compared to $24,100,000 in the 3 months ending June 30, 2023. Rental revenue increased to 24 $1,000,000 in the Q2 of 2023 from $18,100,000 in the Q2 of 2022 for a 33% gain over the past year. Group.

Speaker 2

Both comparative period increases were primarily the result of the increased deployment of high horsepower rental units, higher overall horsepower utilization across the fleet and Rental Price Increases Throughout the Year. Rental revenues now compose approximately 85% to 90% of our total revenues in all comparative periods. Adjusted gross rental margin increased sequentially from $11,100,000 or 49 percent of revenue in Q1 2023, the $12,800,000 or 53% of revenue in the Q2 of 2023. This is a 15% increase in gross rental margin dollars since last quarter. On a year over year basis, our adjusted rental gross margin of $12,800,000 in Q2 of 2023 increased approximately 42% when compared to $9,000,000 in the same period in 2022.

Speaker 2

Inc. In the comparative year to date 6 month periods, our rental revenues have increased 33%, while adjusted gross margins grew by 42%. Call. As of June 30, 2023, we had 1249 utilized rental units, representing over 372,000 horsepower compared to 1281 rented units, representing just over 311,000 horsepower as of June 30, 2022. The net decrease in fleet units was due to the combination of a sale of rental units to a customer and the retirement of idle units, both of which happened in 2022.

Speaker 2

Inc. In spite of that, we had an approximate 20% increase in horsepower over the past 12 months. We ended the second quarter with 65.4 percent utilization on a per unit basis and 78.6% utilization on a horsepower basis. While unit utilization remained relatively flat, horsepower utilization increased from 77.4% in the Q1 of this year. Utilized horsepower increased 5.7% in the 2nd quarter when compared to the year ago period, segment, where revenue per horsepower increased 15.5% 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 last year.

Speaker 2

Our total fleet as of June 30, 2023 consisted of 1911 units at 473,884 horsepower or 250 horsepower per unit. Our average horsepower per unit has grown by 19% per unit over the last year. Notably, approximately 97% of our high horsepower fleet equipment is utilized and drawing rent. Of our $150,000,000 capital budget this year, approximately 90% of it is presently committed to long term agreements, with a balance anticipated to be contracted in the Q3 of this year. As of June 30, 2023, we have shipped and set approximately 50% of the units and horsepower anticipated in the 2023 capital expense budget.

Speaker 2

Presently, our large horsepower assets comprise approximately 17% of our current utilized fleet by unit count and over half of our utilized horsepower and current rental revenue stream. Approximately 5 years ago, NGS decided to enter the large horsepower market. At this time, with more than half our utilized horsepower and revenues emanating from larger units, segment. I think we can say that we're an established player in this market segment. Sales revenues for the sequential quarters decreased from $3,000,000 in the Q1 this year to $1,600,000 in the 2nd quarter.

Speaker 2

2 thirds of the 2nd quarter decrease was from a non recurring idle equipment sale that occurred in the Q1. The balance was the typical quarterly fluctuation we experienced in parts sales. On a year over year quarterly basis, sales revenue increased slightly from $1,300,000 to $1,600,000 Our SG and A expenses increased approximately $300,000 in sequential quarters and totaled 18% of revenue. Segment. Sequentially, we reported increased operating income of $712,000 in the Q2 of 2023 compared to $402,000 in the Q1 this year, a 77% increase.

Speaker 2

This improvement was primarily due to higher rental revenues and gross margin. Negatively impacting our operating income this quarter was a software obsolescence charge we took. Without that, operating income would have been roughly twice what we reported. In either event with or without the software charge, operating income this year improved over the operating income of $658,000 for 3 months ended June 30, 2022. Our net income in the Q2 of 2023 was $504,000 or $0.04 per basic and diluted share.

Speaker 2

This compares to a net income of $370,000 in the Q1 of the year or $0.03 per basic and diluted share. Incorporated. In the year ago quarter, our net loss was $70,000 or 0 point 0 $1 Adjusted EBITDA increased 27 percent $9,900,000 from the Q1 number of $7,800,000 and increased 48% from $6,700,000 for the same period in 2022. Our cash balance as of June 30, 2023 was approximately $4,300,000 call. In the Q2 this year, we realized cash flow from operations of $22,600,000 compared to $13,200,000 in the same quarter last year.

Speaker 2

At the end of this quarter, we've utilized $93,500,000 for capital expenditures, dollars 90,300,000 of which was expended on our rental fleet. Outstanding debt on our revolving credit facility as of June 30, 2023 was $100,000,000 The leverage ratio was 2.53 and our fixed charge coverage ratio was 4.17. These are both well within bounds of the covenants and the company is in compliance with all terms, conditions and covenants of the credit agreement. Last quarter, I remarked that we thought the activity we were experiencing would continue the balance of this year and likely into 2024. Based on what we're seeing and hearing internally and from customers, We think this positive forecast continues to be correct.

Speaker 2

We are in an undersupplied market and we see little relief to it soon. Industry utilization is high. There is no appreciable capacity being added to the industry. Lead times for major components are long. Customer inquiries from established and new customers continue to flow in and we have the ability to increase prices to ensure Commodity prices and future production and consumption data all So seem to support present activity.

Speaker 2

It's been a long time since we've had this kind of positive dynamic in activity and pricing, There appears to be a greater capital discipline from customers and competitors that may help sustain this environment. In the past, there's a mantra used when the industry was going through repeated boom bust cycles. It was, and excuse my colloquial messaging. Please, Lord, give us one more boom. We promise not to screw it up this time.

Speaker 2

It's taken a few decades for this to sink in, but maybe we have it right. However, There's always caution required in a volatile commodity based industry like ours. There will be another downturn at some point, Well, thank you NGS has somewhat mitigated that impact with long term contracts, good pricing, exceptionally strong customers and contracts and Long Live Equipment. We are bullish on our industry over the next couple of years and hope to take advantage of the strong environment. Thank you for your time.

Speaker 2

I look forward to your questions.

Operator

Ladies and gentlemen, at this time, we will conduct a question and answer You can press 7 pound again at any time to remove yourself from the queue. Our first question comes from Rob Brown with Lake Street Capital. Go ahead, please.

Speaker 2

Good morning, Steve. Hey, Rob.

Speaker 3

Just wanted to get a little bit into your comments about the positive environment and sort of demand. How do you see that impacting your capital plan, I guess throughout the rest of this year and into next year and what's sort of the visibility on that Connectivity.

Speaker 2

Well, it's not going to impact it too much this year because like I mentioned, 90% of all that Capital is contracted and committed, and we anticipate the balance coming in the contract during Q3. So that's pretty well set. As far as 2024, as I mentioned, we're receiving inbound calls on customer requirements, customer needs, items like that. We haven't really started to put together anything formal Yes, they will want to announce at this time on that, but certainly it looks pretty strong. Now we'll feel a little better obviously as you get towards the end of the year People start, people I say, meaning customers will start publicly signaling budgets and announcing budgets and things like that.

Speaker 2

Up to that point, it's Pretty informal, pretty much conversational as to what might or might not be required. But as I mentioned, we're pretty bullish on Certainly, the balance of this year because that's baked in, but 2024 is looking pretty strong. And we'll see how 2024 flows into 2025, but there's already been comments made by some that customers are looking at in even 25, primarily just because of the lead times on equipment now. And the tightness we're seeing in the market has caused the customer population to look out further than It was actually been required in the past, but we're getting to the point of where 2024 certainly will become a in 2025 will become the next realized projection. But right now, no specific numbers, but We think 2024 is going to be a pretty good year.

Speaker 3

Okay, great. And then where are you at in terms of your sort of weighted average contract duration. I think many of these high horsepower contracts were longer term. I guess, where What's sort of your contract duration at this point and what's the incremental contract being signed at?

Speaker 2

Any new contracts and that includes anything that we've got committed this year that were that has either been put out or will be put out the rest of this year is on the bigger horsepower, the 1500, 2500 horsepower It's 5 years, without exception. We don't need to and see a reason to go below that tenure. Overall, with some horsepower being put out about 5 years ago on 3 to 5 year contracts. Our average right now is in that 3 to 5 year range. But we've actually had some contracts just go month to month over the past year or so, based on some of the first stuff we put out, the 3 or 4 year terms that we put out 3 or 4 years ago.

Speaker 2

So those are actually on a month to month, even on the, say, 1500 horsepower range equipment. But we've only had, I think, overall this time, maybe less than A handful of units be terminated, but then they're immediately re rented. And terminations weren't typically due to anything other than needing to move equipment around or put it on some other locations in that respect. It wasn't due to lack of need. So I think as I've mentioned in the past, these are minimum term contracts.

Speaker 2

So for example, the 5 year stuff we're putting out now, that's a minimum term, but that doesn't mean they come back after 5 years. That just means that's a minimum financial and contractual commitment the customer makes to get that equipment right now. But we're seeing we're already seeing equipment approach in 1 to 2 years beyond contract term. And that's what we expect when we first entered into this and that's playing out. But To answer your original question, we're in that on average, probably into that 3 to 5 year range across the whole high horsepower fleet.

Speaker 3

Okay, great. And then, are you seeing the market strength in the medium horsepower area as well? Or is this

Speaker 2

It's primarily large horsepower. There's been Group. The medium horsepower hangs in there okay. Where you start getting Some volatility more so is in some of the smaller horsepower, which is primarily natural gas directed because it's smaller, lower pressure, lower volume type equipment and very sensitive to natural gas prices, whether it's $2 or $3 which is kind of the range it's running. So we see more movement in and out in that market.

Speaker 2

The medium horsepower is single well gas lift and Obviously, neither one of those, the smaller to medium horsepower are as robust and active as a large horsepower. But they tend to just kind of hang in there and go up and down a little, etcetera. But and that's why you see some of the just the unit utilization flat, but The horsepower utilization climbing pretty aggressively, primarily from the large horsepower.

Speaker 3

Okay, great. Thank you. I'll turn it over.

Speaker 2

Thanks, Rob.

Operator

Thank you very much. And our next question comes from Hale Hoch with Hoch and Company. Please go ahead. Hello, I'm sorry, Hale Hoch. Please go ahead and ask your question.

Speaker 4

Hi, Steve.

Speaker 2

Hey, Hale.

Speaker 4

Congrats on a nice quarter. As you and I've talked in the past, I'm excited and supportive of your Growth Plan and the transition of the business and the balance sheet. The one thing that I think would be helpful for people though is if you could Maybe work your way into giving a little bit more guidance or return information on the capital that you're spending. It seems like you're on a run rate to maybe exiting the year at close to $50,000,000 of EBITDA. And maybe on the next quarterly call, you could give some guidance on what you're seeing for 2024 and your growth plans.

Speaker 4

But Based on our math and compared to your peer group, this could be a $15 or $20 stock At some point, and I think it's going to be easier to get there if you could maybe articulate guidance and growth CapEx plans.

Speaker 2

Yes. No, good point. And we're sensitive to that, and we're getting the models tightened up so we can give reliably A little more detail and granularity in some of that stuff. We've traditionally not given a whole lot of guidance From that, usually the context of the remarks will give people enough information about but you're right, it's With the debt, the large amounts of capital, etcetera, it's something we need to be a little more expansive about. So We will.

Speaker 2

We're working towards that, recognize that, and we will give additional color on in that respect, next quarter.

Speaker 4

That sounds great. Congratulations again.

Speaker 2

Okay. Thanks a lot. Group.

Operator

Thank you very much. And that £7 Our next question comes from Tim O'Toole with Petra Capital Management. Go ahead please.

Speaker 5

Good morning, Steve. How are you?

Speaker 2

Hey, Tim. Good. You?

Speaker 5

I'm quite well. And actually, I'd also like to I mean, I usually don't dial in and speak through any of these things, but I'd like to also congratulate you on executing you just planned. And also kind of on your positioning as you came into this cycle, clearly, you had Securities and Exchange Commission. A very solid balance sheet to start this effort with, kind of unlike a lot of your peers who have carried historically a lot of debt, which I think constrained them in terms of being able to really invest in this cycle. Couple of things that I'd like to get a little more color on, if we can.

Speaker 5

One is that I know that labor, especially skilled labor in the Permian, especially, but probably a lot of the oil basins has remained fairly tight. I think it's becoming a little more manageable, and you're getting paid for it a little bit better. However, I got to believe it's still on the tight side. And I'm wondering if you could characterize, maybe You haven't been able to slice and dice the data this way, but I wonder if you could characterize the kind of run rate of what might be excess expenses because of the high activity level and the fact you probably had to continue to contract or some of the labor to put all these compression sets in place.

Speaker 2

Yes. You're right, labor continues to be tight. We're able to keep up with it, but it is a it's more of a battle than it has been in the past just on a point of Finding people and bringing them on, etcetera. In the Permian and it's tight everywhere, but it's not as bad as out here. Yes, we've got operations in different parts of the country and you're always looking for good people and having a little turnover in some areas, but it's exceptional out here.

Speaker 2

This is you've got the Most active oilfield in the U. S. And one of the most active in the world here with 2 towns of 150,000 people each. So there's not a big labor pool and it's been exhausted for a little bit. I think the last official figures I saw, the unemployment is about 2%.

Speaker 2

And when you're down to that number, you're essentially fully employed because those 2% are really not the ones you want coming in. Segment. So we're having to look a little harder and And a little wider too because most of what gets hired now are rotators or commuters, people that we have to bring in from outside the area. So Louisiana, Oklahoma, various other places. And these are the service techs.

Speaker 2

These are the field guys that maintain the equipment and keep it running and primarily the higher horsepower technicians that are harder to find. So you got to look in different places all the time Yes, and we do that, we're able to keep up, but it is approaching a full time job just to do that. Of course, environment like that drives cost, labor cost. So We do have an impact from that. You also have an impact from essentially having to feed and shelter, whoever you bring in.

Speaker 2

So it's a room and board thing. The incremental, say, the premium cost on doing this, and I'm just talking about the Permian, I'm not About the whole company because that would dilute the cost a bit. But just from the Permian standpoint, I'd estimate based on, say, premium labor costs and mobilization, demobilization costs for people, It's it would be in the 15% to 20% range of our labor cost out here. It's appreciable and we pay attention to it and try to manage it, But it's very hard to mitigate it. It's such a competitive market.

Speaker 2

You pretty much if you want good people, you pretty well have target them and pay them what they are what the market is a little above and get them on the payroll.

Speaker 5

Well, part of the genesis of the question, and I don't know if you put some color on this, and it's maybe on the early side to ask the question in terms of when it's likely to normalize. But your activity level in terms of setting new equipment is always extraordinarily high this year. Probably stays fairly strong going into the first half of twenty twenty four, I'm going to guess. But At some point, that should normalize and doing and kind of managing logistics and personnel should become operationally a little easier, Not necessarily cheaper, but better to optimize and be able to manage your costs down a little bit. And I'm wondering if you have a sense for kind of that timeline.

Speaker 5

And again, maybe on a quarterly run rate basis, what might be excess? Is it $1,000,000 of excess expense a quarter? Is it a few $100,000 or is it even more than $1,000,000 And again, Getting very precise on that would probably be a challenge, but I'm wondering if you have a bit of a feel in terms of because I'm just trying to obviously get a sense Corp. What things look like as you go through the middle of next year, I got to believe that some of these operating costs start to abate a little bit.

Speaker 2

Yes. Cost from a labor standpoint, I don't really see much relief on that for Really a couple of years. As I mentioned, 2023 is busy. We already know the whole year is active and essentially sold out. We're thinking 2024 is going to be busy too.

Speaker 2

So as long as it is, There's going to be a pull on labor. And especially, we'll know it's getting better when we can start finding local people, but that's a long way away. We're still going to be having to bring in people to supplement the small labor force here. So I don't see Really much abatement in labor pressures for probably a couple of years. It's contingent upon the activity remain like we think it's going to remain.

Speaker 2

Okay. And then over time, it will. And unless you get some upside in the interim that leads to downturn, which can happen, but we don't anticipate it. So I think we still got 18 months to 24 months of Have a labor pressure on some of that and labor availability too. From a finite number standpoint, It probably is from a total labor standpoint.

Speaker 2

A $1,000,000 probably would not be too far off, if you're thinking about the 15% to 20% premium.

Speaker 5

Okay. All right. Cool. Great. And actually, there's another there's a related question.

Speaker 5

I think you alluded to this perhaps in the last quarter or the quarter before. But SG and A is running around 18%, I think, of revenues. And I think you've mentioned that, that should settle out to something more like 14, if I'm remembering correctly. And do You have some sort of a timeline on that, and I'm not even sure if my numbers are correct. I'm going by recollection not notes at this point.

Speaker 2

Yes. No, we anticipate Q3 and Q4 being lower. There's some legacy costs that the last of which we experienced in Q2, those are gone. So I think that I don't remember exactly. I think I might have even probably shouldn't even Get myself in trouble here.

Speaker 2

I think I'd even talked about maybe 12% or 13% in the past, but I'll take your 14% since we're at 18%.

Speaker 5

All right.

Speaker 2

But no, we'll see those come down Q3 and Q4.

Speaker 5

Okay, great. And then this is a kind of a quick question on some of the numbers. There's a couple of things I want to try to work through that are numbers related. One is the software impairment. You kind of called out enough information to back into something, but it kind of looks like the accounting earnings might have been around $0.09 or $0.10 without that, although I'm not sure how the tax effect that number exactly.

Speaker 5

Does that sound about right?

Speaker 2

Well, the I think the software impairment was 720,780. If you just take the 7.8 divided by roughly Yes, we got about 12,500,000 shares. Just that quick math and I'm not represent any of it being pre tax or tax or whatever, but that's $0.06 So it is an appreciable charge.

Speaker 5

Yes, yes. Okay. All right. Yes, it wasn't kind of it wasn't kind of set out as a kind of a normalized number. So I was just trying to get a sense for that because the stock is still fairly inefficient and not broadly covered.

Speaker 5

So Getting numbers off of a research base is not is still challenging. Another question yes, okay, a couple of things. Another is, I think you alluded to this and maybe I have this number right, but I've been trying to look at your fleet as kind of A tale of 2 fleets really, although you break it down into small, medium and large. I kind of look the rest of the industry and yourselves are benefiting from this trend in high horsepower stuff. You demark that around 400 horsepower.

Speaker 5

And if you looked at the fleet above 400 horsepower and below 400 horsepower, The fleet above 400 horsepower, did you say that the utilization rate for that part of the fleet is 97%?

Speaker 2

Yes.

Speaker 5

So then the stuff that's smaller, so your medium and small horsepower, What would be the utilization on that part of the fleet? It's probably no better than 50%, I would guess, or probably in that approximate range.

Speaker 2

No, it's in the 60% to 65% range on the small and medium. It's not horrible. It's just not where we want it.

Speaker 5

Right. And you have been kind of calling that a little bit that you're doing it judiciously and Not writing it down, not taking $0.20 on the dollar, but taking kind of $0.01 on the book or something, as I recall.

Speaker 2

Yes, the utilization numbers can be a little misleading from a couple of standpoints. From number 1, the way Everybody seems to calculate it differently. Some of us do it the same, some of us do it differently. But Yes, you can read people's Qs and Ks and see how they calculate. There's some differences there.

Speaker 2

So ours, we just we're not smart enough to Get fancy with it. We just take what we owe and compare it against what's running and that's the utilization, right? Nothing fancy about it. Okay. But also from a financial perspective, you may look at 60%, 65%, That's what's the financial impact of that.

Speaker 2

Yes, from a when you look at the book value of this equipment, Just about all of our small horsepower is depreciated out. So there's little book value Even on the books on a lot of that stuff. And the medium horsepower generally require about 2 thirds depreciated On that stuff. So you've got we've got a lot of units in that small and medium horsepower from a unit standpoint, Just not as much horsepower. And really, the book value impact is relatively small, too.

Speaker 2

And we have over time called out certain sizes either that had gotten down to much lower utilization that didn't make any sense or some areas that we just had more in the fleet than we thought was prudent.

Speaker 5

Okay, great. There's you touched on something before And let me know if I'm taking I can get back in the queue if there are people in the queue. But you touched on this before. You put in a big slug of equipment for specifically one particular customer a handful of years ago. I think you said 3, 4, 5 years ago.

Speaker 5

And some of that stuff has come off of their long term contracts, still utilized. They're still very busy, as I understand things, and still heavily Permian weighted. So that stuff is still being utilized. But one of the things that I was wondering about and maybe you could fill this in is that If you were to take one of those pieces of equipment, let's say, a 1500 horsepower unit, You basically could put that to because the market is so tight, you could put that to work at probably higher rates than it certainly went in at to begin with. And one of the dynamics I'm wondering about as we get through this period of putting new equipment into service and then renewing those contracts down the line with some of your newer customers.

Speaker 5

Is What would be if you looked at that 1500 horsepower unit, if you were to do some maintenance CapEx on that unit and then place it in another long term contract, let's say, 5 years. What would that dynamic look like? In other words, Your annualized recurring revenue from the new contract would be higher by something, maybe 20%, I don't know what the number is. That maintenance number, would it be 10% of the original cost of the equipment? What's the order of magnitude of that?

Speaker 5

And then what would be The cost to set that into a new location and thus a new contract.

Speaker 2

Well, the easy question first, the cost to move it from one location to another is borne by the customer. So we don't have any financial impact from that. Our impact from that is primarily manpower, right? Help them get it out, help them reset it up, stuff like that. So that's primarily a customer expense.

Speaker 2

From the point of if you have a unit coming off, let's say, been on contract for 3 or 5 years or maybe it's gone month to month and they don't need it anymore. We can put those out at higher rates. Those rates vary, but typically if you go to maybe a 3 or 4 year old one, those rates now are Probably 20%, maybe even 25% higher on some of these units. So definitely, they would go out at the higher new rate. Now you get that, but we're also Getting some of those rates up too because you can look back at those older rates and Know that you've got okay, you kind of fixed your capital expense back then and you're set there, but all the other maintenance and operating costs have gone up.

Speaker 2

And we all know the inflation environment and supply chain issues and stuff like that, and Yes, all that's gone up. So we are going back on all those contracts and asking the customers for increase And being successful, it's not everybody understands what's going obviously, suppliers and the customers too. So to protect and preserve and hold on to that equipment, It's just more expensive to do it for the customer and us too because we've got these costs we've got to pay. So we're not just waiting for stuff to come off and then we raise the rate. We are trying to be proactive in going back and getting that from what we've got there.

Speaker 2

From the maintenance standpoint, when you pull a unit off, you generally We need to go through it to make it ready for the next contract from the point of certainly tune ups from the point Making them runnable, but typically you need some sort of major or minor overhaul. And that can those costs can vary all over the board. So I don't want to say how much of How much it might be, but if you're into a 20% rental increase, say, get one off, raise your rate 20%, it goes to the next The overall impact from a maintenance standpoint is not going to be different than if it just stay on the location because after so many hours, Whether it's at that location or it's moved or some other location, after so many hours, you got to do maintenance on it. And You might just have a you might do it a little quicker if it comes off 10000 hours before we're scheduled, But it's just a cost of money essentially. It's not really a maintenance cost.

Speaker 2

It's just you might have to do a little quicker to get out to the location than you otherwise would.

Speaker 5

Okay. So one of the things I'm trying to deal to model a little bit and let's talk about this for a minute is that if I look at your trailing 4 quarters of discretionary cash flow, which is the metric that a lot of your compression peers use for a variety of reasons. One is that there's in some cases, they're supporting dividends that are they need to cover. So they utilize that as a coverage basis also. But basically one of my points as you may recall is that, that discretionary cash flow is really your accounting earnings.

Speaker 5

And over the last 5 or 6 years, you haven't shown much in the way of accounting earnings, but you've generated a ton of internal capital from your operations, from your discretionary cash flow that you've recycled and reinvested into the newer fleet that you're able to deploy at this point. But to get to that discretionary cash flow number, I try to look at I'm trying to back into some sort of a maintenance CapEx number, which would include some of the maintenance CapEx on the trucks and your facilities, but also the kind of stuff on the bigger machines that you'd have to invest to reset something into a 5 year contract. Your fleet is still new enough, so there's probably not a ton of that in there yet, but at some point over time that'll become part of the model. And I don't know if you can kind of verify this, but it seems like your discretionary cash flow over the past 4 quarters has been on the order of about $35 ish million and that equates to something like $2.80 a share. I've had you My internal model said something like 260 to 280, but that also suggests that maybe for 2023, That also suggests that you may run a little higher than that this year, but also be able to grow that next year.

Speaker 5

I don't know if you have the numbers to be able to verify whether that Q80 number is kind of a good number or a ways off. And I also wonder if you'll Start to look at discretionary cash flow as a metric just because your other compression peers do, and it does seem like a germane

Speaker 2

Yes, I hesitate to hazard a guess right now on the discretionary number you've got, Tim. I can take into a little more and get back to Yes, on how we're looking at it.

Speaker 5

Okay.

Speaker 2

But yes, it is a valid and good number To keep watching and keep an eye on. As you note, a lot of our competitors do it from the point of couple of them are MLPs, that's very important to Limited Partners. And it shows coverage on dividends, coverage on debt, etcetera. Yes, we haven't had to use it too much in the past because we didn't have either. But you're right, it's one we watch closely, of course, at discretionary cash flow.

Speaker 2

Certainly in times of high activity like now and Potentially going forward, it gets eaten up becomes less discretionary, right? It gets eaten up pretty quick by just activity in CapEx. But Let me dive into the numbers a little more with you offline, and we can talk through that one.

Speaker 5

Okay. No, I appreciate that. And I would love to follow-up in the next couple of weeks. But to Hale's point earlier, The peers are trading, I think, Archrock maybe at 7 or 8 times discretionary cash flow. And I think, Kodiak, who just came public, is probably in the 6 ish number, I want to say.

Speaker 5

And you're at $10.5 or whatever it is today on my numbers, that's it's sort of 4 times. So it's a number of multiple points away. It does seem to be a number that the industry focuses on. I am going to Steve, thanks very much for the feedback, and I would look forward to chatting with you in the next couple of weeks. I'm going to jump off because there may be some more people that want to ask questions and I've been on for a bit.

Speaker 5

Appreciate the feedback and we'll look forward to just talking to you soon.

Speaker 2

Okay, real good. Thanks, Tim.

Speaker 5

Thank you.

Operator

Thank you very much. Our last question comes from Kyle Krieger with Apollo Capital. Go ahead. Go ahead, please.

Speaker 6

Thank you for taking my question, Steve.

Speaker 2

Hi, Kyle.

Speaker 6

Hi. The balance sheet transformation has been nothing short of dramatic, of course. And I have a follow-up to Mr. Hoag's question on return. Presumably looking at the horsepower and the fact and the utilization on the high horsepower stuff you're putting out would indicate that you're putting this stuff out on 5 year fully paid leases with good credit, which is a great model.

Speaker 6

The only thing to solve for is, what is the corporate return hurdle that you are imputing into that, number 1. So that's my first question. What's your return bogey In those 5 year full payout leases. And the second thing is, are you protected at all Against inflation on the inputs that you guys are required to provide over that period of time.

Speaker 2

Yes, I'll take your last question first. Some contracts have Inflationary Protection and yes, but frankly, most don't. Now the ones that Don't, we actually have not had any trouble getting price increases. I think Those are good to have. But even if you have, just like any contract, even if you have something in there and the market doesn't Agree with what you're doing.

Speaker 2

For example, you can have inflationary increases, but if the market is slow, activity slow, things like this. You may have the contractual ability to go and ask for something, but you probably don't have in reality The marketability to go in there and ask for it from the point that your customer may not accept it. So I think contractually gives you a little more leverage, but it does not prevent you from getting your cost where they need to be. So number 1, you can go in certainly after the expiration of contracts. That's not very satisfying when you have 3 to 5 year contracts.

Speaker 2

But typically, those 3 to 5 year contracts, what we've seen The last few years, you can go in and ask for and justify price increases that will keep us whole. So, although most of our contracts don't have it, we are starting to put more and more in. We haven't been impacted negatively by not being able to get in the price increases we want. From the corporate hurdle on what we want to do, interest rates now, you can look at those and Hopefully, they're mitigating somewhat. We'll see.

Speaker 2

It depends on what people think about what the Fed may do. But that's into the 8%, 9%, 10% realm, probably 8% or 9% currently. So certainly, you've got to Factor that into that plus the return you want. And we'll give More color on that in the Q3 call, just like Hale had mentioned, I think that's a valid comment. And We'll go into a little more detail on what we see as the returns, what the returns implied by the price we're charging and things like that.

Speaker 5

Hello?

Operator

Mr. Krieger. Do you have any follow-up?

Speaker 6

No. Thank you very much, Steve. Appreciate it.

Speaker 2

Thanks, Kyle. Call.

Operator

Thank you very much. Mr. Taylor, we don't have any further questions.

Speaker 2

Okay. Thanks, Luke. And thank you everybody for participating in our call. I look forward to updating you on our progress in the next quarter. Thanks again.

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Earnings Conference Call
Natural Gas Services Group Q2 2023
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