NATURAL GAS SERVICES GROUP, INC. The discussion and analysis of our financial condition and results of operations are based on, and should be read in conjunction with, our condensed, consolidated financial statements and the related notes included elsewhere in this report and in our Annual Report on Form 10-K for the year endedDecember 31, 2019 filed with theSEC . This report and our Annual Report on Form 10-K contain certain forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended, and information pertaining to us, our industry and the oil and natural gas industry that is based on the beliefs of our management, as well as assumptions made by and information currently available to our management. All statements, other than statements of historical facts contained in this report as well as our Annual Report on Form 10-K, including statements regarding our future financial position, growth strategy, budgets, projected costs, plans and objectives of management for future operations, are forward-looking statements. We use the words "may," "will," "expect," "anticipate," "estimate," "believe," "continue," "intend," "plan," "budget" and other similar words to identify forward-looking statements. You should read statements that contain these words carefully and should not place undue reliance on these statements because they discuss future expectations, contain projections of results of operations or of our financial condition and/or state other "forward-looking" information. We do not undertake any obligation to update or revise publicly any forward-looking statements. Although we believe our expectations reflected in these forward-looking statements are based on reasonable assumptions, no assurance can be given that these expectations or assumptions will prove to have been correct. Please read Item 1A, Risk Factors, in our Annual Report on Form 10-K for the year endedDecember 31, 2019 , as it contains important factors that could cause actual results to differ materially from the expectations reflected in the forward-looking statements.
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 typically provide for initial terms of six to 24 months, with our larger horsepower units having contract terms of up to 60 months. After the initial term of our rental contracts, many of our customers have continued to rent our compressors on a month-to-month basis. Rental amounts are billed monthly in advance and include maintenance of our rented compressors. As ofMarch 31, 2020 , we had 1,383 natural gas compressors totaling 298,143 horsepower rented to 92 customers compared to 1,364 natural gas compressors totaling 238,566 horsepower rented to 97 customers atMarch 31, 2019 . 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 our purchase of engines, compressors, coolers, and other components, and our assembling of these components on skids for delivery to customer locations. The major components of our compressors packages are acquired through periodic purchase orders placed with third-party suppliers on an "as needed" basis, which presently require lead times between two to three months 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 ourMidland, 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 six months to one year and require payment of a monthly fee.
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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 oil and natural gas and the corresponding
changes in commodity prices. As demand and prices increase, oil and natural gas
producers typically increase their capital expenditures for drilling,
development and production activities, although recent equity capital
constraints and demands from institutional investors to keep spending within
operating cash flow have meaningfully restrained capital expenditure budgets of
domestic exploration and production companies. Generally, increased capital
expenditures ultimately result in greater revenues and profits for service and
equipment companies.
In general, we expect our overall business activity and revenues to track the
level of activity in the oil and natural gas industry, with changes in crude oil
and condensate production and consumption levels and prices affecting our
business more than changes in domestic natural gas production and consumption
levels and prices. In recent years we have increased our rentals and sales in
unconventional oil shale plays, which are more dependent on crude oil prices.
With this shift towards oil production, the demand for overall compression
services and products is driven by two general factors; an increased focus by
producers on artificial lift applications, e.g., production enhancement with
compression assisted gas lift; and declining reservoir pressure in maturing
natural gas producing fields, especially unconventional production. These types
of applications have historically been serviced by wellhead size compressors,
and continue to be, but there has also been an economic move by our customers
towards centralized drilling and production facilities, which have increased the
market need for larger horsepower compressor packages. We recognized this need
over the past two to three years and have been shifting our cash and fabrication
resources towards designing, fabricating and renting gas compressor packages
that range from 400 horsepower up to 1,380 horsepower. While this is a response
to market conditions and trends, it also provides us with the opportunity to
compete as a full-line compression provider.
We typically experience a decline in demand during periods of low crude oil and
natural gas prices. Low crude oil and natural gas prices experienced throughout
2016 continued into mid-2017. In the latter half of 2017, we saw an increase in
oil prices and activity that continued during most of 2018. During 2019, we
witnessed a moderation of crude oil prices as well as drilling and completion
activity levels. During the first quarter of 2020, we saw a substantial decline
in the prices for oil and natural gas. Activity levels of exploration and
production companies have been and will be dependent not only on commodity
prices, but also on their ability to generate sufficient operational cash flow
to fund their activities. Generally, though, we feel that production activities
(in which we are involved) will fare better than drilling activity.
Recent Events
OnJanuary 30, 2020 , theWorld Health Organization ("WHO") announced a global health emergency because of a new strain of coronavirus known as COVID-19 due to the risks it imposes on the international community as the virus spreads globally. InMarch 2020 , the WHO classified the COVID-19 outbreak as a pandemic, based on the rapid increase in exposure globally. The effects of the COVID-19 outbreak, including actions taken by businesses and governments to contain the spread of the virus, have resulted in a significant, rapid decline in global andU.S. economic conditions. This significant drop in economic activity has caused global demand for crude oil to drastically decline. According to theInternational Energy Agency's ("IEA") Oil Market Report forApril 2020 , global crude oil demand during the second quarter of 2020 is expected to decline 23.1 million barrels per day compared to the second quarter of 2019, a decrease of more than 20%. InMarch 2020 , discussion betweenOPEC andRussia ("OPEC+") resulted inSaudi Arabia significantly discounting the price of its crude oil, as well asSaudi Arabia andRussia significantly increasing their oil supply inApril 2020 . The dramatic decline in crude oil demand combined with this increase in supply resulted in unprecedented storage issues and a resulting severe lack of takeaway capacity for oil producers. As a result, crude oil prices reached record or multi-year lows in April. West Texas Intermediate ("WTI") crude oil traded below$20 per barrel and Brent crude oil traded below$30 per barrel during the second half of April, including an anomalous trading day where WTI traded at negative values on low volume close to the end of a contract trading month. OnMay 6, 2020 , WTI closed at$23.99 per barrel, while Brent closed at$29.72 per barrel. Given current price levels and takeaway issues, domestic producers have been rapidly shutting in production, and drilling and completion activities among exploration and production companies have dramatically declined. InApril 2020 , OPEC+ agreed to cut production by 9.7 million barrels per day starting inMay 2020 , and the IEA is projecting global oil production to drop by approximately 12 million barrels per day inMay 2020 . Nevertheless, given the massive decline in crude oil demand due to COVID-19, the imbalance in the global oil markets is expected to keep prices down through the remainder of 2020. 20 -------------------------------------------------------------------------------- These issues have resulted in an increasing number of unit returns and shut-in notices from our customers duringApril 2020 . While we witnessed minimal change in our unit and horsepower utilization during the first quarter of 2020 compared to year-end 2019, we expect a meaningful drop in utilization among our small and medium horsepower units during the second and third quarters of 2020. Accordingly, we expect this drop in utilization and pricing pressures to negatively impact our rental revenue, rental margins and overall financial performance for the remainder of 2020. In addition, given the current economic and industry backdrop, we expect compressor sales to be minimal for the remainder of 2020, as exploration and production companies have significantly reduced their capital expenditures budgets. We have implemented various cost cutting measures with respect to operating expenses and capital expenditures. Our operating expense reductions include reductions in our headcount from both layoffs and attrition, wage freezes, centralization of certain processes for better cost control, and the enlistment of our suppliers in our cost cutting efforts. We continue to review additional opportunities to become more efficient. In addition, as we have done during prior downturns, we have reduced our capital expenditures budget. After we spent$6.7 million in capital expenditures during the first quarter of 2020, we plan to only incur another$5-$7 million in capital expenditures for the remainder of 2020, bringing our 2020 capital expenditures budget to$12-$14 million , down from$69.9 million in 2019. Finally, in keeping with current commercial precautions and practices in our industry, we have implemented new guidelines to mitigate health risks to our employees and customers during this outbreak. We have adopted remote and staggered work processes at ourMidland headquarters, and have adapted our field and fabrication work processes as well. To date, our field operations have continued largely uninterrupted, as theU.S. Department of Homeland Security designated our industry as part of our country's critical infrastructure. Remote work and work process adjustments related to COVID-19 have not impacted our ability to maintain operations or caused us to incur significant costs. In addition, we have not experienced any supply chain issues in connection with the COVID-19 outbreak. The full impact of the COVID-19 outbreak continues to evolve as of the date of this report. As such, it is uncertain as to the full magnitude that the pandemic will have on the Company's financial condition, liquidity, and future results of operations. Management is actively monitoring the global situation on its financial condition, liquidity, operations, suppliers, industry, and workforce. Given the daily evolution of the COVID-19 outbreak and the global responses to curb its spread, the Company is not able to estimate the effects of the COVID-19 outbreak on its results of operations, financial condition, or liquidity during 2020. Results of Operations
Three months ended
The table below shows our revenues and percentage of total revenues of each of
our product lines for the three months ended
Revenue Three months ended March 31,
(in thousands)
2020 2019
Rental $ 16,100 90 % $ 13,387 74 %
Sales 1,450 8 % 4,125 23 %
Service and Maintenance 340 2 % 479 3 %
Total $ 17,890 $ 17,991
Total revenue remained relatively flat at $17.9 million for the three months
ended March 31, 2020 compared to $18.0 million for the same period ended March
31, 2019 . This outcome was due to higher rental revenue (20.3% increase) during
the first quarter of 2020 due to a greater number of large horsepower units
being rented offset by lower sales revenue (64.8% decrease) primarily due to
reduced compressor sales.
Rental revenue increased to $16.1 million for the three months ended March 31,
2020 compared to $13.4 million for the same period ended March 31, 2019 . As of
March 31, 2020 , we had 2,316 compressor packages in our fleet, down from 2,567
units at March 31, 2019 , due to the retirement of 327 units (with 39,758
horsepower) during the third quarter of 2019. Despite this decrease due to unit
retirement, the Company's total unit horsepower increased by 7.5% to 437,750 at
March 31, 2020 compared to 407,210 horsepower at March 31, 2019 , which reflects
the addition to the Company's fleet of 55 high
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horsepower compressors with 67,880 horsepower over the past 12 months. As of
March 31, 2020 , we had 1,383 natural gas compressors totaling 298,143 horsepower
rented to 92 customers, compared to 1,364 natural gas compressors totaling
238,566 horsepower rented to 97 customers as of March 31, 2019 . The rental fleet
had a unit utilization as of March 31, 2020 and 2019, respectively, of 59.7% and
53.1%, while our horsepower utilization for the same periods, respectively, was
68.1% and 58.6%. The rise in both utilizations was mainly the result of the rise
in demand for our higher horsepower units as well as unit retirements during the
third quarter of 2019.
Sales revenue decreased to $1.5 million from $4.1 million for the three months
ended March 31, 2020 compared to the same period ended March 31, 2019 . This
decrease in mostly attributable to a decrease in compressor sales and, to a
lesser extent, decreases in flare and parts sales. Sales are subject to
fluctuations in timing of industry activity related to capital projects and, as
such, can vary substantially between periods.
Selling, general, and administrative ("SG&A") expenses decreased to $2.2 million
for the three months ended March 31, 2020 compared to $2.5 million for the three
months ended March 31, 2019 . This 13.3% decrease was largely due to a decrease
in our deferred compensation liability that resulted in a net unrealized gain on
deferred compensation ($0.35 million ) that was partially offset by higher
professional services ($0.1 million ) during the first quarter of 2020.
Depreciation and amortization expense increased 11.9% to $6.2 million for the
three months ended March 31, 2020 compared to $5.6 million for the three months
ended March 31, 2019 . This increase was the result of larger horsepower units
being added to the fleet. We added 86 units (approximately 72,000 horsepower) to
our fleet over the past 12 months. Fifty-five of those units were 400 horsepower
or larger (including 46 at 1,380 horsepower), representing 94% of the horsepower
added.
Our operating loss increased to a loss of $273,000 for the three months ended
March 31, 2020 compared to a loss of $145,000 for the three months ended March
31, 2019 . This increased operating loss was mainly due to lower sales revenue
and higher depreciation expense mostly offset by higher rental revenues, lower
cost of revenues, and lower SG&A expenses.
Our other (expense) income decreased to net expenses of $0.2 million for the
three months ended March 31, 2020 compared to income of $0.3 million for the
same period in 2019. This decrease was primarily attributable to a net
unrealized loss on company-owned life insurance of $0.3 million during the first
quarter of 2020.
We recorded an income tax benefit of $4.5 million for the three months ended
March 31, 2020 compared to income tax expense of $58,000 for the three months
ended March 31, 2019 . For interim periods, our income tax benefit (expense) is
computed based upon our estimated annual effective tax rate and any discrete
items that impact the interim periods. Our estimated annual effective tax rate
differs from the U.S. federal statutory rate of 21%. On March 27, 2020 , the
Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was enacted in
response to the economic impact caused the COVID-19 pandemic. The CARES Act
allows federal net operating losses ("NOL") incurred in 2018, 2019, and 2020 to
be carried back to each of the five preceding taxable years to generate a refund
of previously paid federal income taxes. The Company generated significant NOLs
during 2018 and 2019, and plans to carryback these losses for five years.
Accordingly, the Company recorded a current income tax benefit of $4.9 million
for the three months ended March 31, 2020 , in addition to an increase to its
prepaid income taxes of $15.0 million and an increase to its deferred income tax
liability of $10.1 million as of March 31, 2020 . This current income tax benefit
was partially offset by a write-off of a deferred tax asset of approximately
$0.4 million related to vesting of restricted stock during the first quarter of
2020.
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Liquidity and Capital Resources
Our working capital positions as ofMarch 31, 2020 andDecember 31, 2019 are set forth below:March 31 ,December 31, 2020 2019 (in thousands)
Current Assets:
Cash and cash equivalents
9,106
Inventory 19,424 21,080
Federal income tax receivable 14,992 -
Prepaid income taxes 68 40
Prepaid expenses and other 225 597
Total current assets 58,279 42,415
Current Liabilities:
Accounts payable 2,255 1,975
Accrued liabilities 3,020 2,287
Line of credit 417 417
Current operating leases 187 189
Deferred income 1,190 640
Total current liabilities 7,069 5,508
Total working capital $ 51,210 $ 36,907
For the three months ended March 31, 2020 , we invested $6.7 million in rental
equipment, property and other equipment. During the first quarter of 2020, we
added $5.8 million in new equipment to our rental fleet and $0.9 million in
vehicles. Our investment in property and equipment also includes any changes to
work-in-progress related to our rental fleet jobs at the beginning of the period
compared to the end of the period. Our rental work-in-progress decreased by $1.7
million during the three months ended March 31, 2020 . We financed our investment
in rental equipment, property and other equipment with cash flow from operations
and cash on hand.
Cash flows
At March 31, 2020 , we had cash and cash equivalents of $13.1 million compared to
$11.6 million at December 31, 2019 . Our cash flows from operating activities of
$8.3 million were partially offset by capital expenditures of $6.7 million
during the three months ended March 31, 2020 . We had working capital of $51.2
million at March 31, 2020 compared to $36.9 million at December 31, 2019 . On
March 31, 2020 and December 31, 2019 , we had outstanding debt of $417,000 , which
is all related to our line of credit. We generated cash flows from operating
activities of $8.3 million during the first three months of 2020 compared to
cash flows used in operating activities of $3.7 million for the first three
months of 2019. Our cash flows from operating activities of $8.3 million were
primarily the result of net income of $4.1 million , adding back non-cash items
of depreciation and amortization of $6.2 million , stock-based compensation of
$0.5 million , deferred income tax expense of $0.3 million , utilization of
deferred tax assets through NOL carrybacks of $10.1 million , and a net positive
change in various working capital and other items of $1.7 million against the
negative impact of an increase in prepaid income taxes and prepaid expenses of
$14.6 million .
Strategy
For the remainder of the fiscal year 2020, given the state of the economy and
our industry due to the outbreak of COVID-19 and the subsequent collapse of
crude oil prices, our plan is to minimize capital expenditures and reduce
expenses. For the remainder of 2020, our forecasted capital expenditures are not
anticipated to exceed our internally generated cash flows and our cash on
hand. Any required capital will be for additions to our compressor rental fleet
and/or additions or replacements of service vehicles. We believe that cash flows
from operations, our current cash position and our line of credit will be
sufficient to satisfy our capital and liquidity requirements for the foreseeable
future.
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--------------------------------------------------------------------------------Bank Borrowings
We have a senior secured revolving credit agreement the ("Amended Credit
Agreement") with JP Morgan Chase Bank, N.A. (the "Lender") with an aggregate
commitment of $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 ). We had $29.5 million borrowing base
availability at March 31, 2020 under the terms of our Amended Credit Agreement,
and our balance on the line of credit was $417,000 . For further information, see
Note 6, Credit Facility.
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 as of
Obligations Due in Period
(in thousands)
Cash Contractual Obligations 2020 (1) 2021 2022 2023 2024 Thereafter Total
Line of credit (secured) $ 417 $ - $ - $ - $ - $ - $ 417
Interest on line of credit (2) 9 - - - - - 9
Purchase obligations (3) 215 250 160 - - - 625
Other long-term liabilities - - 39 - - - 39
Lease liabilities (including
interest) 154 174 47 38 38 168 619
Total $ 795 $ 424 $ 246 $ 38 $ 38 $ 168 $ 1,709 (1) For the nine months remaining in 2020. (2) Assumes an interest rate of 2.88% and no additional borrowings. (3) Vendor exclusive purchase agreement related to paint and coatings.
The Company also has a remaining contractual obligation related to the
construction of a new corporate office of approximately
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
Recently Issued Accounting Pronouncements
Please read Note 2, Summary of Significant Accounting Policies, Recently Issued Accounting Pronouncements in our condensed consolidated financial statements in this report.
Off-Balance Sheet Arrangements
From time-to-time, we enter into off-balance sheet arrangements and transactions that can give rise to off-balance sheet obligations. As ofMarch 31, 2020 , the off-balance sheet arrangements and transactions that we have entered into include operating lease agreements and purchase agreements. We do not believe that these arrangements are reasonably likely to materially affect our liquidity or availability of capital resources. Special Note Regarding Forward-Looking Statements Except for historical information contained herein, the statements in this report are forward-looking and made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties, which may cause our actual results in future periods to differ materially from forecasted results. Those risks include, among other things, the loss of market share through competition or otherwise; the 24
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introduction of competing technologies by other companies; a prolonged, substantial reduction in oil and natural gas prices, which could cause a decline in the demand for our products and services; and new governmental safety, health and environmental regulations, which could require us to make significant capital expenditures. The forward-looking statements included in this Form 10-Q are only made as of the date of this report, and we undertake no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. A discussion of these and other risk factors is included in our Annual Report on Form 10-K for the year endedDecember 31, 2019 filed with theSEC .
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