Natural Gas Services Group, Inc. — FY 2016 Form 10-K
Business context and reporting period. The company manufactures, fabricates, rents and services natural-gas compression equipment, primarily for U.S. unconventional oil and gas production, and also sells flare systems. This 10-K covers the fiscal year ended December 31, 2016; Q4 figures are identified separately below.
Financial performance
| Metric | FY 2016 | FY 2015 | Change |
|---|---|---|---|
| Revenue | $71.7 million | $95.9 million | Down 25.3% |
| Operating income | $8.4 million | $15.1 million | Down 44.3% |
| Net income | $6.5 million | $10.1 million | Down 36.3% |
| Diluted EPS | $0.50 | $0.79 | Down $0.29 |
| Operating cash flow | $32.8 million | $41.6 million | Down $8.8 million |
| Capital expenditures | $4.3 million | $12.5 million | Down $8.2 million |
| Adjusted gross margin (non-GAAP) | $39.8 million; 55.5% | $53.3 million; 55.5% | Dollar amount down 25.3% |
| Adjusted EBITDA (non-GAAP) | $30.8 million | $42.4 million | Down 27.3% |
Revenue mix in 2016 was rental $56.7 million (79.2%), equipment sales $13.6 million (19.0%), and service and maintenance $1.3 million (1.8%). Rental revenue fell 25.8% and sales fell 26.4%; service and maintenance grew 36.0%. The filing’s non-GAAP measures are company-defined and should not be treated as substitutes for GAAP results.
Q4 2016: Revenue was $16.7 million, operating income $1.0 million and net income $1.2 million, versus Q4 2015 revenue of $25.8 million, operating income of $4.6 million and net income of $3.3 million.
Liquidity and debt. At year-end, cash and cash equivalents were $64.1 million, current assets $99.8 million, current liabilities $6.5 million and working capital $93.3 million. Total assets were $293.5 million and stockholders’ equity $233.0 million. The company had $417,000 drawn on its $30 million secured revolving credit facility, with approximately $29.5 million of borrowing-base availability; the facility matures December 31, 2017. The company reported compliance with its covenants. Operating cash flow exceeded capital spending, and cash increased by $28.6 million during the year.
Material changes and operating developments
- Rental fleet utilization declined to 51.3% from 69.3% at year-end 2015. Rented compressors fell to 1,298 from 1,818, and horsepower rented fell to 186,328 from 256,204.
- In Q4, management retired 63 rental units (7,749 horsepower) and recorded a $545,000 non-cash loss, reducing the units’ carrying value to the estimated value of reusable components. This followed a $4.4 million retirement loss in 2015.
- SG&A declined 18.0% to $9.0 million, primarily due to lower stock compensation and executive incentive bonuses. The effective tax rate fell to 23.6% from 33.5%, including the effect of research and development credits.
- Sales backlog was approximately $6.0 million at year-end, up from $4.1 million, and was expected to be fulfilled in the first half of 2017.
Outlook, commentary and risks
Management reported signs of increased activity in the second half of 2016 and anticipated further improvement in exploration and production activity during 2017, but expected a slow recovery and delayed benefit to compression demand. It cautioned that 2017 revenue could remain under pressure amid market uncertainty; activity, rental growth and fabrication were expected to improve only modestly. Planned 2017 capital spending was to depend on customer requirements and was not expected to exceed internally generated cash flow. Management believed available cash, operating cash flow and the credit line would fund expected needs, and expected to extend or replace the credit facility before its 2017 maturity, but gave no assurance of renewal on favorable terms.
- Results are highly exposed to volatile oil and natural gas prices, customer capital budgets, drilling and completion activity, rental rates and fleet utilization.
- Customer concentration is material: Devon Energy and Occidental together generated about 40% of 2016 revenue. Three customers represented 44% of year-end receivables, increasing collection and concentration risk.
- Most rented compressors were month-to-month; 1,009 of the 1,298 units rented at year-end were on that basis. Cancellations or lower-rate renewals could further weaken revenue and equipment recovery.
- Environmental, emissions, safety and product-liability requirements may increase costs. Historical contamination could create remediation exposure; the company reported no current cleanup order and no material environmental expenditure anticipated under then-current requirements.
- The company recognized $5.6 million of 2016 sales revenue under bill-and-hold arrangements, compared with $4.0 million in 2015. Inventory review resulted in a $563,000 adjustment to remove obsolete inventory and bring it to estimated market value; year-end inventory allowance was $15,000.
- The 2016 goodwill review found no impairment, despite reduced rental utilization; further deterioration could prompt future impairment. The auditor issued an unqualified opinion on the financial statements and internal controls, and management concluded controls were effective.
Important facts for investors to verify
- Whether utilization, rental pricing, customer retention and backlog improved after year-end, and whether the reported 2017 recovery translated into revenue and cash flow.
- Renewal or replacement of the $30 million credit facility before its December 31, 2017 maturity, including borrowing availability, covenants and pricing.
- Receivable aging and collections from major customers, especially given revenue and receivables concentration.
- The collectability and accounting support for bill-and-hold revenue, and the adequacy of inventory, asset-retirement and impairment estimates.
- Actual 2017 capital spending and the effect of commodity prices, environmental regulation and customer spending on fleet utilization and margins.