Natural Gas Services Group, Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; filed March 18, 2019. The filing reports annual results, with quarterly figures also provided for Q4.
Business context
The company manufactures, fabricates, rents and services natural-gas compressors and sells flare systems, primarily to U.S. oil and gas producers. Compressor rental is its largest business. At year-end, its fleet comprised 2,572 compressors totaling 398,765 horsepower; 1,361 units were rented to 94 customers. Fleet utilization rose to 52.9% from 49.5% a year earlier.
Financial performance and position
- Revenue: $65.5 million, down 3.3% from $67.7 million in 2017. Rental revenue increased 3.7% to $47.8 million; sales declined 19.5% to $16.3 million; service and maintenance was essentially flat at $1.4 million.
- Profit: Operating income fell to $0.6 million from $1.6 million. Net income was $0.4 million, or $0.03 per diluted share, versus $19.9 million, or $1.51, in 2017. The prior-year result included an $18.4 million tax benefit from the 2017 Tax Act.
- Q4: Revenue was $16.2 million; operating income was $0.1 million and net loss was $0.3 million, or $0.02 per share. Q4 2017 net income of $18.7 million was largely driven by the tax-law benefit.
- Margins: Adjusted gross margin, a non-GAAP measure, was $31.8 million, or 48.5% of revenue, compared with $33.0 million, or 48.7%, in 2017. Rental margin fell to 56.6% from 60.7%, partly due to deployment costs; sales margin improved to 22.8% from 19.4%. Adjusted EBITDA was $22.9 million, approximately flat with 2017.
- Cash flow and investment: Operating cash flow was $23.4 million, up from $17.5 million. Investing cash outflow was $40.0 million, principally reflecting $39.8 million of rental equipment and property expenditures. Cash decreased $16.6 million to $52.6 million.
- Liquidity and debt: Current assets were $96.4 million and current liabilities $10.9 million, yielding working capital of $85.5 million. Debt was $0.4 million under a $30 million revolving facility, with $29.5 million of borrowing-base availability reported. The facility matures December 31, 2020; the company reported covenant compliance at year-end.
- Balance sheet: Total assets were $305.4 million and stockholders’ equity $260.2 million. Inventory was $31.0 million, up from $26.2 million.
Changes, outlook and management commentary
Rental revenue and utilization improved, but lower equipment sales and reduced rental margins constrained results. Revenue has fallen about 32% since 2014, while utilization declined from 76.0% at year-end 2014 to 52.9% at year-end 2018. Backlog increased to $14.8 million from $7.8 million and was scheduled primarily for completion by the end of Q3 2019.
Management expected activity to increase gradually during 2019 as oil prices recovered, but cautioned that the delayed response of compression demand could keep revenue under pressure and growth modest. Planned 2019 capital spending was to depend on customer requirements and was not expected to exceed internally generated cash flows. The company was completing a new Midland corporate office, expected to cost approximately $12 million; $4.3 million remained contractually due for construction at year-end, with completion expected in early 2019.
Risks, contingencies and unusual items
- Customer concentration: Occidental Permian accounted for 28% of 2018 revenue and 26% of year-end receivables. The filing warns that losing a major customer or a collection problem could materially affect results and cash flow.
- Industry exposure: Demand, utilization and pricing are sensitive to volatile oil and gas prices, customer capital spending, short-term rental renewals, competition and credit conditions. Environmental, emissions and hydraulic-fracturing regulation could also affect customers and demand.
- Tax matter: The company recorded a $547,000 tax adjustment and $55,000 of accrued penalty and interest related to a potential position on the deductibility of executive compensation. Management said the effect on prior-year results was not material.
- Internal controls: Management identified a material weakness in controls over the tax provision, specifically controls to identify and account for nondeductible expenses. Management and the auditor concluded internal control over financial reporting was ineffective at December 31, 2018; the auditor issued an adverse opinion on ICFR. Management planned remediation during 2019. The auditor gave an unqualified opinion on the financial statements.
- Other matters: No goodwill or intangible impairment was recorded. Management did not expect ordinary-course legal proceedings to have a material effect and reported no material cleanup order. The company noted potential environmental liabilities and insurance coverage limitations.
Most important facts for investors to verify
- Whether the tax-control material weakness was remediated as planned, and whether subsequent filings report additional tax adjustments or control deficiencies.
- Whether rental utilization, rental margins and revenue improved after year-end, and whether the $14.8 million backlog converted to sales as scheduled.
- Whether Occidental Permian concentration and related receivable exposure changed, and whether collections remained timely.
- Actual 2019 capital spending, completion cost of the new office, and cash and borrowing availability after the substantial 2018 investment program.
- The basis and limitations of non-GAAP adjusted gross margin and adjusted EBITDA; neither substitutes for GAAP earnings or cash flow.