NATURAL GAS SERVICES GROUP INC - Annual Report: 2010 (Form 10-K)

 

 

 

Colorado		75-2811855
(State or other jurisdiction of incorporation or organization)		(I.R.S.  Employer Identification No.)
508 W. Wall St, Suite 550 Midland, Texas		79701
(Address of principal executive offices)		(Zip Code)
Registrant’s telephone number, including area code:		(432) 262-2700
Securities registered pursuant to Section 12(b) of the Act:
Title of each class		Name of each exchange on which registered
Common Stock, $.01 par value		New York Stock Exchange

 

At March 8, 2011, there were 12,186,053 shares of common stock outstanding.

 

 

 

FORM 10-K
NATURAL GAS SERVICES GROUP, INC.
TABLE OF CONTENTS
Item No.				Page
PART I
Item 1.		Business		1
Item 1A.		Risk Factors		7
Item 1B.		Unresolved Staff Comments		16
Item 2.		Properties		16
Item 3.		Legal Proceedings		16
Item 4.		(Removed and Reserved)		17
PART II
Item 5.		Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		17
Item 6.		Selected Financial Data		20
Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		22
Item 7A.		Quantitative and Qualitative Disclosures About Market Risk		31
Item 8.		Financial Statements and Supplementary Data		32
Item 9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		32
Item 9A.		Controls and Procedures		32
Item 9B.		Other Information		34
PART III
Item 10.		Directors, Executive Officers and Corporate Governance		34
Item 11.		Executive Compensation		34
Item 12.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		34
Item 13.		Certain Relationships, and Related Transactions, and Director Independence		34
Item 14.		Principal Accounting Fees and Services		34
PART IV
Item 15.		Exhibits, Financial Statement Schedules		35

·	conditions in the oil and natural gas industry, including the demand for natural gas and wide fluctuations in the prices of oil and natural gas;

·	regulation or prohibition of new well completion techniques;

·	competition among the various providers of compression services and products;

·	changes in safety, health and environmental regulations;

·	changes in economic or political conditions in the markets in which we operate;

·	failure of our customers to continue to rent equipment after expiration of the primary rental term;

·	the inherent risks associated with our operations, such as equipment defects, malfunctions and natural disasters;

·	our inability to comply with covenants in our debt agreements and the decreased financial flexibility associated with our debt;

·	future capital requirements and availability of financing;

·	fabrication and manufacturing costs;

·	general economic conditions;

·	events similar to September 11, 2001; and

·	fluctuations in interest rates.

 

 

·	the increasing demand for and limited supply of energy, both domestically and abroad;

·	continued non-conventional gas exploration and production;

·	environmental considerations which provide strong incentives to use natural gas in place of other carbon fuels;

·	the cost savings of using natural gas rather than electricity for heat generation;

·	implementation of international environmental and conservation laws;

·	the aging of producing natural gas reserves worldwide; and

·	the extensive supply of undeveloped non-conventional natural gas reserves.

 

·

Compressor fabrication.  Fabrication involves the assembly of compressor components manufactured by us or other third parties into compressor units that are ready for rental or sale.  In addition to fabricating compressors for our rental fleet, we engineer and fabricate natural gas compressors for sale to customers to meet their specifications based on well pressure, production characteristics and the particular applications for which compression is sought.

·

Compressor manufacturing.  We design and manufacture our own proprietary line of reciprocating compressor frames, cylinders and parts known as our “CiP”, or Cylinder-in-Plane, product line.  We use the finished components to fabricate compressor units for our rental fleet or for sale to third parties.  We also sell finished components to other fabricators.

·

Flare fabrication.  We design, fabricate, sell, install and service flare stacks and related ignition and control devices for the onshore and offshore incineration of gas compounds such as hydrogen sulfide, carbon dioxide, natural gas and liquefied petroleum gases.  Applications for this equipment are often environmentally and regulatory driven, and we believe we are a leading supplier to this market.

·

Parts sales and compressor rebuilds.  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 part of our business.

·

Expand rental fleet.  We intend to increase the size of our rental fleet by fabricating compressor units in numbers that correspond to the growth of the market and in relation to market share gains we may experience.  We believe our growth will continue to be primarily driven through our placement of small to medium horsepower wellhead natural gas compressors for non-conventional natural gas production, which is the single largest and fastest growing segment of U.S. gas production according to data from the Energy Information Administration.

·

Geographic expansion.  We will continue to consolidate our operations in existing areas, as well as pursue focused expansion into new geographic regions as opportunities are identified. We presently provide our products and services to a customer base of oil and natural gas exploration and production companies operating in New Mexico, Texas, Michigan, Colorado, Wyoming, Utah, Oklahoma, Pennsylvania, West Virginia and Kansas.

·	Expand our ‘secondary’ product lines.   In addition to our primary rental and engineered product business lines, we will emphasize the growth of our other products, e.g., flares, CiP compressor products and general compressor maintenance and repair services.

·	Selectively pursue acquisitions.  We will continue to evaluate potential acquisitions that would provide us with access to new markets or enhance our current market position.

 

 

·

Superior customer service.  Our emphasis on the small to medium horsepower markets has enabled us to effectively meet the evolving needs of our customers.  We believe these markets have been under-serviced by our larger competitors which, coupled with our personalized services and in-depth knowledge of our customers’ operating needs and growth plans, have allowed us to enhance our relationships with existing customers as well as attract new customers.  The size, type and geographic diversity of our rental fleet enable us to provide customers with a range of compression units that can serve a wide variety of applications.  We are able to select the correct equipment for the job, rather than the customer trying to fit its application to our equipment.

 

·

Diversified product line.  Our compressors are available as high and low pressure rotary screw and reciprocating packages.  They are designed to meet a number of applications, including wellhead production, natural gas gathering, natural gas transmission, vapor recovery and gas and plunger lift.  In addition, our compressors can be built to handle a variety of gas mixtures, including air, nitrogen, carbon dioxide, hydrogen sulfide and hydrocarbon gases.  A diversified product line helps us compete by being able to satisfy widely varying pressure, volume and production conditions that customers encounter.

·

Purpose built rental compressors.  Our rental compressor packages have been designed and built to address the primary requirements of our customers in the producing regions in which we operate.  Our units are compact in design and are easy, quick and inexpensive to move, install and start-up.  Our control systems are technically advanced and allow the operator to start and stop our units remotely and/or in accordance with well conditions.  We believe our rental fleet is also one of the newest.

·	Experienced management team.  On average, our executive and operating management team has over 30 years of oilfield services industry experience.  We believe our management team has successfully demonstrated its ability to grow our business both organically and through selective acquisitions.

·

Broad geographic presence.  We presently provide our products and services to a customer base of oil and natural gas exploration and production companies operating in New Mexico, Texas, Michigan, Colorado, Wyoming, Utah, Oklahoma, Pennsylvania, West Virginia and Kansas.  Our footprint allows us to service many of the natural gas producing regions in the United States.  We believe that operating in diverse geographic regions allows us better utilization of our compressors, minimal incremental expenses, operating synergies, volume-based purchasing, leveraged inventories and cross-trained personnel.

·

Long-standing customer relationships.  We have developed long-standing relationships providing compression equipment to many major and independent oil and natural gas companies.  Our customers generally continue to rent our compressors after the expiration of the initial terms of our rental agreements, which we believe reflects their satisfaction with the reliability and performance of our services and products.

 
 

·	owners and operators of sites, and

·	persons who disposed of or arranged for the disposal of "hazardous substances" found at sites.

·	the prevention of discharges, including oil and produced water spills, and

·	liability for drainage into waters.

·	the level of oil and natural gas production;

·	the level of oil and natural gas inventories;

·	domestic and worldwide demand for oil and natural gas;

·	the expected cost of developing new reserves;

·	the cost of producing oil and natural gas;

·	the level of drilling and completions activity;

·	inclement weather;

·	regulatory and other federal and state requirements in the United States;

·	the ability of the Organization of Petroleum Exporting Countries and other large producers to set and maintain production levels and prices for oil;

·	political conditions in or affecting oil and natural gas producing countries;

·	terrorist activities in the United States and elsewhere;

·	the cost of developing alternate energy sources;

·	environmental regulation; and

·	tax policies.

 

·	issuance of administrative, civil and criminal penalties;

·	denial or revocation of permits or other authorizations;

·	reduction or cessation in operations; and

·	performance of site investigatory, remedial or other corrective actions.

·	we may not be able to continue to obtain insurance on commercially reasonable terms;

·	we may be faced with types of liabilities that will not be covered by our insurance, such as damages from significant product liabilities and from environmental contamination;

·	the dollar amount of any liabilities may exceed our policy limits; and

·	we do not maintain coverage against the risk of interruption of our business.

·	our ability to obtain additional financing for working capital, acquisitions, capital expenditures and other purposes may be limited;

·	a significant portion of our cash flow from operations may be dedicated to the payment of principal and interest on our debt, thereby reducing funds available for other purposes; and

·	our significant leverage could make us more vulnerable to economic downturns.

·	sell assets at disadvantageous prices;

·	obtain additional financing; or

·	refinance all or a portion of our indebtedness on terms that may be less favorable to us.

·	comply with a minimum leverage ratio;

·	comply with a commitment coverage ratio; and

·	not exceed specified levels of debt;

·	comply with limits on asset sales

 

 

·	accurately assess the number of additional officers and employees we will require and the areas in which they will be required;

·	attract, hire and retain additional highly skilled and motivated officers and employees;

·	train and manage our work force in a timely and effective manner;

·	upgrade and expand our office infrastructure so that it is appropriate for our level of activity; and

·	improve our financial and management controls, reporting systems and procedures.

 

 

 

·	directors are elected for three-year terms, with approximately one-third of the board of directors standing for election each year;

·	cumulative voting is not allowed, which limits the ability of minority shareholders to elect any directors;

·	the unanimous vote of the board of directors or the affirmative vote of the holders of not less than 80% of the votes entitled to be cast by the holders of all shares entitled to vote in the election of directors is required to change the size of the board of directors; and

·	directors may be removed only for cause and only by the holders of not less than 80% of the votes entitled to be cast on the matter.

Location		Status		Square Feet		Uses
Tulsa, Oklahoma		Owned and Leased		91,780		Compressor fabrication, rental and services
Midland, Texas		Owned		58,000		Compressor fabrication, rental and services
Midland, Texas (1)		Owned		24,600		Compressor fabrication, rental and services
Lewiston, Michigan		Owned		15,360		Compressor fabrication, rental and services
Midland, Texas		Leased		13,135		Corporate offices
Bloomfield, New Mexico		Leased		7,000		Office and parts and services
Bridgeport, Texas		Leased		4,500		Office and parts and services
Midland, Texas		Owned		4,100		Parts and services
Godley, Texas		Leased		5,000		Parts and services
Colleyville, Texas		Leased		512		Sales
				223,987

 
 

 

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

 

(1)	Total number of shares to be issued upon exercise of options granted to employees, officers, and directors under our 1998 stock option plan.

(2)	Total number of shares to be issued upon exercise of options granted outside of our 1998 stock option plan to Stephen C. Taylor, our Chief Executive Officer, under the terms of his employment agreement.

ITEM 6.

SELECTED FINANCIAL DATA

In the table below, we provide you with selected historical financial data.  We have derived this information from our audited financial statements for each of the years in the five-year period ended December 31, 2010.  This information is only a summary and it is important that you read this information along with our audited financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Item 7 below, which discusses factors affecting the comparability of the information presented.  The selected financial information provided is not necessarily indicative of our future results of operations or financial performance.

		Year Ended December 31,
		2006				2007				2008				2009				2010
		(in thousands, except per share amounts)
STATEMENTS OF INCOME AND OTHER INFORMATION:
Revenues		$	62,729			$	72,489			$	85,336			$	67,796			$	53,908
Costs of revenue, exclusive of depreciation shown separately below			39,308				41,106				44,994				32,157				24,750
Gross margin(1)			23,421				31,383				40,342				35,639				29,158
Depreciation and amortization			6,020				7,470				9,925				11,686				11,927
Other operating expenses			5,270				5,324				5,842				6,190				5,867
Operating income			12,131				18,589				24,575				17,763				11,364
Total other income (expense)			(256	)			144				(355	)			(536	)			(64	)
Income before income taxes			11,875				18,733				24,220				17,227				11,300
Income tax expense			4,287				6,455				8,627				6,212				4,272
Net income available to common stockholders		$	7,588			$	12,278			$	15,593			$	11,015			$	7,028
Net income per common share:
Basic		$	0.67			$	1.02			$	1.29			$	0.91			$	0.58
Diluted		$	0.66			$	1.01			$	1.28			$	0.91			$	0.58
Weighted average shares of common stock outstanding:
Basic			11,405				12,071				12,090				12,096				12,108
Diluted			11,472				12,114				12,143				12,118				12,210
EBITDA(2)		$	19,541			$	27,358			$	34,887			$	29,519			$	23,421

										As of December 31,
		2006				2007				2008				2009				2010
BALANCE SHEET INFORMATION:						(in thousands)
Current assets		$	55,170			$	55,222			$	47,032			$	56,203			$	48,338
Total assets			135,552				153,233				181,050				186,871				188,769
Long-term debt (including current portion)			18,392				13,950				16,572				13,195				2,000
Stockholders’ equity			101,201				114,380				130,450				142,098				150,591

 

 

 

Non-GAAP Financial Measures

·

it is widely used by investors in the energy industry to measure a company’s operating performance without regard to items excluded from the calculation of EBITDA, which can vary substantially from company to company depending upon accounting methods and book value of assets, capital structure and the method by which assets were acquired, among other factors;

·	it helps investors to more meaningfully evaluate and compare the results of our operations from period to period by removing the impact of our capital structure and asset base from our operating structure; and

·	it is used by our management for various purposes, including as a measure of operating performance, in presentations to our Board of Directors, as a basis for strategic planning and forecasting, and as a component for setting incentive compensation.

·	EBITDA does not reflect our cash expenditures, or future requirements for capital expenditures or contractualcommitments;

·	EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

·	EBITDA does not reflect the cash requirements necessary to service interest or principal payments on our debts;and;

·	although depreciation and amortization are non-cash charges, the assets being depreciated and amortized willoften have to be replaced in the future, and EBITDA does not reflect any cash requirements for suchreplacements.

		Year Ending December 31,
		2006			2007			2008			2009			2010
		(in thousands)
Net Income		$	7,588		$	12,278		$	15,593		$	11,015		$	7,028
Interest expense, net			1,646			1,155			742			606			194
Income taxes			4,287			6,455			8,627			6,212			4,272
Depreciation & amortization			6,020			7,470			9,925			11,686			11,927
EBITDA		$	19,541		$	27,358		$	34,887		$	29,519		$	23,421
Other operating expenses			5,270			5,324			5,842			6,190			5,867
Other expenses (income)			(1,390)			(1,299)			(387)			(70)			(130)
Gross Margin		$	23,421		$	31,383		$	40,342		$	35,639		$	29,158

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

		Year Ended December 31,
		2008				2009				2010
		(in thousands)
Sales		$	41,380			$	21,657			$	12,370
Rental			42,864				45,146				40,670
Service and maintenance			1,092				993				868
Total		$	85,336			$	67,796			$	53,908

       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 coal bed methane, gas shale and tight gas, which typically requires more compression than production from conventional natural gas reservoirs.

·	revenue recognition;

·	estimating the allowance for doubtful accounts receivable;

·	accounting for income taxes;

·	valuation of long-lived and intangible assets and goodwill; and

·	valuation of inventory.

 

·	significant underperformance relative to expected historical or projected future operating results;

·	significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and

·	significant negative industry or economic trends.

 

 

 

Provision for income tax decreased from $8.6 million to $6.2 million, or 28.0%, and is the result of the decrease in taxable income.

		2009			2010
		(in thousands)
Current Assets:
Cash and cash equivalents		$	23,017		$	19,137
Trade accounts receivable, net			7,314			5,279
Inventory, net			24,037			21,489
Prepaid income taxes			1,556			2,103
Prepaid expenses and other			279			330
Total current assets			56,203			48,338
Current Liabilities:
Current portion of long-term debt			3,378			
Line of credit			7,000			2,000
Accounts payable			2,239			3,364
Accrued liabilities			1,485			2,151
Current portion of tax liability			1,708			
Deferred income			90			389
Total current liabilities			15,900			7,904
Total working capital		$	40,303		$	40,434

 

 

Cash Contractual Obligations			2011			2012			2013			2014			Thereafter			Total
Line of credit (secured)				2,000															2,000
Interest on line of credit				58															58
Purchase obligations				956			956			956			956			436			4,260
Other long term liabilities													528						528
Facilities and office leases				309			244			167			17						737
Total			$	3,323		$	1,200		$	1,123		$	1,501		$	436		$	7,583