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NGS > SEC Filings for NGS > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for NATURAL GAS SERVICES GROUP INC

Form 10-Q for NATURAL GAS SERVICES GROUP INC


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The discussion and analysis of our financial condition and results of operations are based on, and should be read in conjunction with, our condensed financial statements and the related notes included elsewhere in this report and in our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the SEC.

Overview

We fabricate, manufacture, rent and sell natural gas compressors and related equipment. Our primary focus is on the rental of natural gas compressors. Our rental contracts generally provide for initial terms of six to 24 months. After the initial term of our rental contracts, most of our customers have continued to rent our compressors on a month-to-month basis. Rental amounts are paid monthly in advance and include maintenance of the rented compressors. As of September 30, 2012, we had 1,680 natural gas compressors totaling 233,241 horsepower rented to 99 third parties compared to 1,545 natural gas compressors totaling 215,704 horsepower rented to 99 third parties at September 30, 2011.

We also fabricate natural gas compressors for sale to our customers, designing compressors to meet unique specifications dictated by well pressures, production characteristics and particular applications for which compression is sought. Fabrication of compressors involves the purchase by us of engines, compressors, coolers and other components, and then assembling these components on skids for delivery to customer locations. The major components of our compressors are acquired through periodic purchase orders placed with third-party suppliers on an "as needed" basis, which presently requires a two to three month lead time with delivery dates scheduled to coincide with our estimated production schedules. Although we do not have formal continuing supply contracts with any major supplier, we believe we have adequate alternative sources available. In the past, we have not experienced any sudden and dramatic increases in the prices of the major components for our compressors. However, the occurrence of such an event could have a material adverse effect on the results of our operations and financial condition, particularly if we were unable to increase our rental rates and sales prices proportionate to any such component price increases.

We also manufacture a proprietary line of compressor frames, cylinders and parts, known as our CiP (Cylinder-in-Plane) product line. We use finished CiP component products in the fabrication of compressor units for sale or rental by us or sell the finished component products to other compressor fabricators. We also design, fabricate, sell, install and service flare stacks and related ignition and control devices for onshore and offshore incineration of gas compounds such as hydrogen sulfide, carbon dioxide, natural gas and liquefied petroleum gases. To provide customer support for our compressor and flare sales businesses,


we stock varying levels of replacement parts at our Midland, Texas facility and at field service locations. We also provide an exchange and rebuild program for screw compressors and maintain an inventory of new and used compressors to facilitate this business.

We provide service and maintenance to our customers under written maintenance contracts or on an as required basis in the absence of a service contract. Maintenance agreements typically have terms of 6 months to 1 year and require payment of a monthly fee.

The oil and natural gas equipment rental and services industry is cyclical in nature. The most critical factor in assessing the outlook for the industry is the worldwide supply and demand for natural gas and the corresponding changes in commodity prices. As demand and prices increase, oil and natural gas producers increase their capital expenditures for drilling, development and production activities. Generally, the increased capital expenditures ultimately result in greater revenues and profits for services and equipment companies.

In general, we expect our overall business activity and revenues to track the level of activity in the natural gas industry, with changes in domestic natural gas production and consumption levels and prices more significantly affecting our business than changes in crude oil and condensate production and consumption levels and prices. We also believe that demand for compression services and products is driven by declining reservoir pressure in maturing natural gas producing fields and, more recently, by increased focus by producers on non-conventional natural gas production, such as coalbed methane, gas shales and tight gas, which typically requires more compression than production from conventional natural gas reservoirs.

Demand for our products and services was strong throughout most of 2008, but in 2009 and early 2010 the demand declined due to lower natural gas prices, decreased demand for natural gas and the economic recession. This began to show signs of easing during the later part of 2010 and throughout the first quarter of 2011. Since then, natural gas prices have had only slight movements up followed by downward movements. Opportunities have developed in non-conventional shale plays. While shale plays continued to offer opportunities, natural gas prices have stalled, leaving demand for compression in conventional areas uncertain.

For the remainder of 2012, our forecasted capital expenditures will be directly dependent upon our customers' compression requirements and are not anticipated to exceed our internally generated cash flows. Any required capital will be for additions to our compressor rental fleet and/or addition or replacement of service vehicles. We believe that cash flows from operations will be sufficient to satisfy our capital and liquidity requirements for the foreseeable future. We may require additional capital to fund any unanticipated expenditures, including any acquisitions of other businesses, although that capital may not be available to us when we need it or on acceptable terms.

Natural gas prices continue at levels that do not encourage energy companies to invest capital in natural gas projects. In addition, the domestic economy has not fully recovered. Notwithstanding the continuing weak economy and financial uncertainty, we believe the long-term trend in our market is favorable. We believe this outlook is supported by the growth in our revenue through the nine months of 2012 compared to the same period in 2011.

Results of Operations

Three months ended September 30, 2012, compared to the three months ended
September 30, 2011.

The table below shows our revenues and percentage of total revenues of each of
our product lines for the three months ended September 30, 2012 and 2011.

                                                                 Revenue
                                             Three months ended September 30, (in thousands)
                                                     2012                          2011
Sales                                    $            4,935      26 %     $   4,807         27 %
Rental                                               14,120      73 %        12,672         72 %
Service and Maintenance                                 235       1 %           222          1 %
Total                                    $           19,290               $  17,701


Total revenue increased from $17.7 million to $19.3 million, or 9%, for the three months ended September 30, 2012, compared to the same period ended September 30, 2011. Of the $1.6 million increase in revenue, $1.5 million was related to compressor rentals in the three months ended September 30, 2012 compared to the three month period ended September 30, 2011. We also had increased compressor sales revenue. Comparing the three months ended September 30, 2012 to the same period in 2011, sales revenue increased 2.7% and rental revenue increased 11.4%. Service and maintenance revenue increased by 5.9%, but represents only 1% of total revenue.

Sales revenue increased from $4.8 million to $4.9 million for the three months ended September 30, 2012, compared to the same period ended September 30, 2011. This increase is the result of a firming of demand for our products due to consistent energy industry activity related to higher levels of capital authorizations. This activity was due to continued attention to unconventional plays in which the project economics depend on oil prices rather than natural gas prices. This activity resulted in consistent compressor units sold to third parties from our Tulsa and Midland operations. There was also a slight increase in demand for flares.

Rental revenue increased from $12.7 million to $14.1 million for the three months ended September 30, 2012, compared to the same period ended September 30, 2011. This increase is the result of higher oil and natural gas industry drilling and demand for low to mid horsepower compression. We ended the quarter with 2,236 compressor packages in our rental fleet, up from 2,076 units at September 30, 2011. The rental fleet had a utilization of 75.1% as of September 30, 2012 compared to 74.4% utilization as of September 30, 2011. This utilization increase is mainly the result of more compressor rental units in our inventory being matched to customer requirements and being returned to service as well as fewer units being returned from operation. In the event that natural gas prices increase we should be able to rent more of the available units.

Our overall operating margin percentage remained relatively flat for the three months ended September 30, 2012 compared to the same period ended September 30, 2011. The margin stability is mainly the result of our ability to hold the line on costs related to compressor sales, and improved product pricing with fewer strategically competitive bids during the period and fewer projects requiring new and complex designs.

Selling, general, and administrative expense increased to $2.0 million from $1.6 million, a 25.0% increase for the three months ended September 30, 2012, as compared to the same period ended September 30, 2011. This increase is mainly due to higher commissions and salaries and a small increase in staffing levels. Our staffing increase is mainly in support of operational demands. Overall staffing increased from 259 to 268 employees between the periods.

Depreciation and amortization expense increased to $4.0 million for the three months ended September 30, 2012, compared to $3.5 million for the period ended September 30, 2011. This was the result of new gas compressor rental units being added to the rental fleet from September 30, 2011 to September 30, 2012. We added a net of 160 compressors to our rental fleet during the twelve month period.

Provision for income tax increased to $1.6 million from $1.4 million, or 14.3%, and is the result of the increase in taxable income. We had an effective tax rate of 38% in both periods.

Nine months ended September 30, 2012, compared to the nine months ended September 30, 2011.

The table below shows our revenues and percentage of total revenues of each of our product lines for the nine months ended September 30, 2012 and 2011.

                                                     Revenue
                                  Nine months ended September 30, (in thousands)
                                              2012                               2011
Sales                   $           28,015                           40 %   $ 10,586  23 %
Rental                              41,529                           59 %     35,153  75 %
Service and Maintenance                630                            1 %        774   2 %
Total                   $           70,174                                  $ 46,513

Total revenue increased from $46.5 million to $70.1 million, or 50.8%, for the nine months ended September 30, 2012, compared to the same period ended September 30, 2011. The increase includes a non-recurring sale of rental units from our fleet


to a single customer. In addition, we had an increase in other compressor and flare sales. This increase was also the result of increased compressor rental revenue. Comparing the nine months ended September 30, 2012 to the same period in 2011, sales revenue increased 164.2% and rental revenue increased 17.9%. Service and maintenance revenue decreased by 18.6%.

Sales revenue increased from $10.6 million to $28.0 million for the nine months ended September 30, 2012, compared to the same period ended September 30, 2011. This increase is the result of a non-recurring sale of rental units from our fleet to a single customer and higher purchase demand for our products due to greater energy industry activity from higher levels of capital authorizations. This activity was due to greater attention to unconventional plays in which the project economics depend on oil prices rather than natural gas prices. This activity increase resulted in more compressor units sold to third parties from our Tulsa and Midland operations. There was also a slight increase in demand for flares.

Rental revenue increased from $35.2 million to $41.5 million for the nine months ended September 30, 2012, compared to the same period ended September 30, 2011. This increase is the result of higher oil and natural gas industry drilling and demand for low to mid horsepower compression. We ended the quarter with 2,236 compressor packages in our rental fleet, up from 2,076 units at September 30, 2011. The rental fleet had a utilization of 75.1% as of September 30, 2012 compared to 74.4% utilization as of September 30, 2011. This utilization increase is mainly the result of more compressor rental units in our inventory being matched to customer requirements and being returned to service as well as fewer units being returned from operation. In the event that natural gas prices increase we should be able to rent more of the available units.

Our overall operating margin percentage remained relatively flat for the nine months ended September 30, 2012 compared to the same period ended September 30, 2011. The margin stability is mainly the result of our ability to control costs related to compressor sales and rentals and some firming of prices. We had fewer custom projects requiring complex design.

Selling, general, and administrative expense increased to $6.1 million, a 38.7% increase for the nine months ended September 30, 2012, as compared to the same period ended September 30, 2011. This increase is mainly due to higher commissions and salaries and increased staffing levels. Our staffing increase is mainly in support of operational demands. Overall staffing increased from 262 to 268 employees between the periods.

Depreciation and amortization expense increased to $11.6 million for the nine months ended September 30, 2012, compared to $10.3 million for the same period ended September 30, 2011. This was the result of new gas compressor rental units being added to the rental fleet from September 30, 2011 to September 30, 2012. We added a net of 160 compressors to our rental fleet during the twelve month period.

Other income and expense decreased for the nine months ended September 30, 2012, as compared to the same period ended September 30, 2011. The decrease was due to a gain on sale of our former headquarters and manufacturing facility in the first quarter of 2011.

Provision for income tax increased to $5.6 million from $4.1 million, or 36.6%, and is the result of the increase in taxable income. We had an effective tax rate of 38% in both periods.


Liquidity and Capital Resources

Our working capital positions as of September 30, 2012 and December 31, 2011 are
set forth below:

                                  September 30,      December 31,
                                       2012              2011
                                           (in thousands)
Current Assets:
Cash and cash equivalents        $        30,924    $       16,390
Trade accounts receivable, net             3,731             5,679
Inventory, net                            26,652            26,965
Prepaid income taxes                         167               109
Prepaid expenses and other                   481               360
Total current assets                      61,955            49,503
Current Liabilities:
Line of credit                                 -                 -
Accounts payable                           2,059             3,730
Accrued liabilities                        8,774             3,644
Current portion of tax liability              75                75
Deferred income                            3,505             4,863
Total current liabilities                 14,413            12,312
Total working capital            $        47,542    $       37,191

Historically, we have funded our operations through public and private offerings of our equity securities, subordinated debt, bank borrowings and cash flow from operations. Proceeds from these sources were primarily used to pay debt and to fund the manufacture and fabrication of additional units for our rental fleet of natural gas compressors.

For the nine months ended September 30, 2012, we invested $25.8 million in equipment for our rental fleet and service vehicles, exclusive of the $8.7 million in equipment sold from our rental fleet. Even though we have idle rental equipment, at times we do not have the specific type of equipment that our customers require, therefore we have to build new equipment to satisfy their needs. We financed this activity with cash flow from operations and cash on hand. During this period we also made $90,000 in principal payments on our credit line.

Cash flows

At September 30, 2012, we had cash and cash equivalents of $30.9 million compared to $16.4 million at December 31, 2011. Our cash flow from operations of $31.5 million was offset by capital expenditures of $17.1 million, net of the $8.7 million in equipment sold from our rental fleet, during the nine months ended September 30, 2012. We had working capital of $47.6 million at September 30, 2012 compared to $37.2 million at December 31, 2011. At September 30, 2012 and December 31, 2011, we had total debt of $927,000 and $1.0 million, respectively, and is all related to our line of credit and classified as long term. We had positive net cash flow from operating activities of $31.5 million during the first nine months of 2012 compared to $24.1 million for the first nine months of 2011. The cash flow from operations of $31.5 million was primarily the result of the net income of $9.1 million and the non-cash items of depreciation of $11.6 million, a decrease in accounts payable of $3.5 million, and deferred taxes of $5.6 million.

Uncertain Economy Strategy

For the remainder of the fiscal year 2012 and into 2013, our overall plan during the uncertain economy is to continue monitoring expenses in line with the anticipated level of activity, fabricate rental fleet equipment only in direct response to market requirements, emphasize marketing of our idle gas compressor units and limit bank borrowing. Capital expenditures for the year ended December 31, 2012 are not anticipated to exceed our internal cash generating capacity. We believe that cash flows from


operations will be sufficient to satisfy our capital and liquidity requirements through 2012 and beginning of 2013. We may require additional capital to fund any unanticipated expenditures, including any acquisitions of other businesses.

Bank Borrowings

On December 31, 2010, we established a $20 million senior secured revolving credit agreement (subject to a right, on an uncommitted basis, to increase the commitments thereunder to up to $40 million) with JP Morgan Chase Bank, N.A. On December 31, 2011, we amended and renewed the Credit Agreement, which was set to expire on December 31, 2011 (the "Amended Credit Agreement"). The Amended Credit Agreement increased our aggregate commitment amount from $20 million to $30 million, subject to collateral availability. We also have a right to request from the lender, on an uncommitted basis, an increase of up to $20 million on the aggregate commitment (which could potentially increase the commitment amount to $50 million). The maturity date was extended to December 31, 2014, and the interest rate terms were amended.

Borrowing Base. At any time before the maturity of the Amended Credit Agreement, we may draw, repay and re-borrow amounts available under the borrowing base up to the maximum aggregate availability discussed above. Generally, the borrowing base equals the sum of (a) 80% of our eligible accounts receivable plus (b) 50% of the book value of our eligible general inventory (not to exceed 50% of the commitment amount at the time) plus (c) 75% of the book value of our eligible equipment inventory. JPMorgan Chase Bank (the "Lender") may adjust the borrowing base components if material deviations in the collateral are discovered in future audits of the collateral. We had $29.0 million borrowing base availability at September 30, 2012 under the terms of our Amended Credit Agreement.

Interest and Fees. Under the terms of the Amended Credit Agreement, we have the option of selecting the applicable variable rate for each revolving loan, or portion thereof, of either (a) LIBOR multiplied by the Statutory Reserve Rate (as defined in the Amended Credit Agreement), with respect to this rate, for Eurocurrency funding, plus the Applicable Margin ("LIBOR-based"), or (b) CB Floating Rate, which is the Lender's Prime Rate less the Applicable Margin; provided, however, that no more than three LIBOR-based borrowings under the agreement may be outstanding at any one time. For purposes of the LIBOR-based interest rate, the Applicable Margin is 1.50%. For purposes of the CB Floating Rate, the Applicable Margin is 1.25%. For the nine month period ended September 30, 2012, our weighted average interest rate was 1.5%.

Accrued interest is payable monthly on outstanding principal amounts, provided that accrued interest on LIBOR-based loans is payable at the end of each interest period, but in no event less frequently than quarterly. In addition, fees and expenses are payable in connection with our requests for letters of credit (generally equal to the Applicable Margin for LIBOR-related borrowings multiplied by the face amount of the requested letter of credit) and administrative and legal costs.

Maturity . The maturity date of the Amended Credit Agreement is December 31, 2014, at which time all amounts borrowed under the agreement will be due and outstanding letters of credit must be cash collateralized. The agreement may be terminated early upon our request or the occurrence of an event of default.

Security. The obligations under the Amended Credit Agreement are secured by a first priority lien on all of our inventory and accounts and leases receivables, along with a first priority lien on a variable number of our leased compressor equipment the book value of must be maintained at a minimum of 2.00 to 1.00 commitment coverage ratio (such ratio being equal to (i) the amount of the borrowing base as of such date to (ii) the amount of the commitment as of such date.)

Covenants. The Amended Credit Agreement contains customary representations and warranties, as well as covenants which, among other things, limit our ability to incur additional indebtedness and liens; enter into transactions with affiliates; make acquisitions in excess of certain amounts; pay dividends; redeem or repurchase capital stock or senior notes; make investments or loans; make negative pledges; consolidate, merge or effect asset sales; or change the nature of our business. In addition, we also have certain financial covenants that require us to maintain on a consolidated basis a leverage ratio less than or equal to 2.50 to 1.00 as of the last day of each fiscal quarter.

Events of Default and Acceleration. The Amended Credit Agreement contains customary events of default for credit facilities of this size and type, and includes, without limitation, payment defaults; defaults in performance of covenants or other agreements contained in the loan documents; inaccuracies in representations and warranties; certain defaults, termination events or similar events; certain defaults with respect to any other Company indebtedness in excess of $50,000; certain bankruptcy or insolvency events; the rendering of certain judgments in excess of $150,000; certain ERISA events; certain change in control events and the defectiveness of any liens under the secured revolving credit facility. Obligations under the Amended Credit Agreement may be accelerated upon the occurrence of an event of default.


As of September 30, 2012, we were in compliance with all covenants in our Amended Credit Agreement. A default under our Credit Agreement could trigger the acceleration of our bank debt so that it is immediately due and payable. Such default would likely limit our ability to access other credit. At September 30, 2012 our balance on the line of credit was $927,000.

Contractual Obligations and Commitments

We have contractual obligations and commitments that affect the results of
operations, financial condition and liquidity. The following table is a summary
of our significant cash contractual obligations:

                                           Obligations Due in Period (in thousands of dollars)
Cash Contractual
Obligations             2012(1)         2013        2014        2015         2016        Thereafter       Total
Line of credit
(secured)               $       -     $     -     $   927     $     -     $      -     $          -     $   927
Interest on line of
credit(2)                       9          37          37           -            -                -          83
Purchase obligations          300         300         300         300          300            2,453       3,953
Other long-term
liabilities                     -           -           -         507            -                -         507
Facilities and office
leases                         66         190          41          30           30               23         380
Total                   $     375     $   527     $ 1,305     $   837     $    330     $      2,476     $ 5,850

(1) For the three months remaining in 2012.

(2) Assumes an interest rate of 4.0% and no additional borrowings.

Critical Accounting Policies and Practices

There have been no changes in the critical accounting policies disclosed in the Company's Form 10-K for the year ended December 31, 2011.

Recently Issued Accounting Pronouncements

In September 2011, FASB issued ASU 2011-08, Testing Goodwill for Impairment. Under the amendments in this Update, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. If the carrying amount of a reporting unit exceeds its fair value, then the entity is required to perform the second step of the . . .

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