Natural Gas Services (NGS) - 2018 Q4 - Annual Report

FORM 10-K Filing Information The registrant, Natural Gas Services Group, Inc, filed its Annual Report on Form 10-K for fiscal year 2018 - The registrant, Natural Gas Services Group, Inc, filed its Annual Report on Form 10-K for the fiscal year ended December 31, 2018[2] Registrant Information | Attribute | Value | | :---------- | :---- | | Registrant Name | NATURAL GAS SERVICES GROUP, INC | | State of Incorporation | Colorado | | IRS Employer ID No. | 75-2811855 | | Principal Executive Offices | 508 W Wall St Suite 550, Midland, Texas 79701 | | Telephone Number | (432) 262-2700 | | Commission File Number | 1-31398 | | Securities Registered (NYSE) | Common Stock, $01 par value | | Well-Known Seasoned Issuer | No | | Required to File Reports | Yes | | Filed All Required Reports | Yes | | Interactive Data File Submitted | Yes | | Accelerated Filer Status | Accelerated filer | | Shell Company | No | | Market Value of Non-Affiliate Equity (June 30, 2018) | ~$306,723,300 | | Common Stock Outstanding (March 5, 2019) | 13,193,044 shares | Special Note Regarding Forward-Looking Statements The report contains forward-looking statements subject to risks and uncertainties that could cause actual results to differ - This Annual Report on Form 10-K contains forward-looking statements regarding future financial position, growth strategy, budgets, projected costs, plans, and objectives, identified by words like 'may,' 'will,' 'expect,' 'anticipate,' 'estimate,' 'believe,' 'continue,' 'intend,' 'plan,' and 'budget'[11] - The company cautions against undue reliance on these statements, as actual results could differ materially due to various factors, including conditions in the oil and natural gas industry, economic challenges, regulatory changes, competition, and operational risks[11][12] Part I Business Overview The company provides natural gas compression equipment and services, primarily for non-conventional U.S. production Company Profile and Core Business - Natural Gas Services Group, Inc is a leading provider of small to medium horsepower compression equipment to the natural gas industry, with an emerging position in the large horsepower market[15] - The company manufactures, fabricates, and rents natural gas compressors for non-conventional natural gas and oil production, provides maintenance services, and sells custom-fabricated compressors and flare systems[15] - Net income for 2017 included an $18.4 million net income tax benefit due to a reduction in corporate income tax rates[18] Key Financial Highlights (Year Ended December 31) | Metric | 2018 (Millions) | 2017 (Millions) | Change (%) | | :-------------------- | :-------------- | :-------------- | :--------- | | Revenue | $65.5 | $67.7 | -3.3% | | Net Income | $0.426 | $19.9 | -97.9% | | Diluted EPS | $0.03 | $1.51 | -98.0% | | Current Assets | $96.4 | N/A | N/A | | Cash & Equivalents | $52.6 | N/A | N/A | | Current Liabilities | $10.9 | N/A | N/A | | Line of Credit Outstanding | $0.417 | N/A | N/A | | Stockholders' Equity | $260.2 | N/A | N/A | Industry Overview and Business Outlook - The market for compression equipment is highly dependent on the natural gas and oil industry's capital expenditures, which are influenced by volatile commodity prices, global economic activity, and environmental regulations[21] - Demand for compression moderated since 2016 due to an uncertain price environment, but higher oil prices exiting 2018 and continuing into 2019 are expected to lead to increased E&P activity[22] - The company anticipates long-term increased demand for oil and natural gas, driven by factors such as increasing energy demand, continued non-conventional gas exploration, environmental incentives for natural gas, and the aging of producing reserves[25][27][28] - Growth in rental compression capacity is partly driven by the trend toward outsourcing by energy producers, allowing them to conserve capital for exploration and production[26] U.S. Energy Consumption Growth (Year-Ended November) | Commodity | 2018 vs 2017 | 2017 vs 2016 | | :---------- | :----------- | :----------- | | Oil | +2.5% | +1.0% | | Natural Gas | +9.8% | -1.1% | Operating Segments and Services Gas Compressor Rental Business - The rental business focuses on non-conventional natural gas and oil production, providing small to medium horsepower compression equipment, with an emerging position in the large horsepower market[28] - Rental contracts typically have initial terms of six to twenty-four months, with most customers retaining equipment beyond the initial term[28] Rental Fleet Statistics (as of December 31) | Metric | 2018 | 2017 | | :-------------------------- | :----- | :----- | | Total Compressors in Fleet | 2,572 | 2,546 | | Total Horsepower in Fleet | 398,765 | 369,961 | | Rented Compressors | 1,361 | 1,259 | | Rented Horsepower | 230,089 | 184,382 | | Number of Customers | 94 | 87 | | Utilization Rate | 52.9% | 49.5% | Engineered Equipment Sales - The company fabricates custom natural gas compressors for sale, designs and manufactures its proprietary 'CiP' reciprocating compressor frames, cylinders, and parts, and fabricates/sells flare systems[33] - It also provides parts sales and compressor rebuild programs, including an exchange and rebuild program for screw compressors[33] Service and Maintenance - The company offers 'as needed' service and maintenance for customer-owned compressors, including routine inspections, wear-particle analysis, and condition-based or time-based overhauls to maximize component life and unit availability[32] Strategic Initiatives - During economic downturns, the strategy is to reduce expenses and fabricate equipment only in response to market demand[33] - Long-term growth strategies include prudently expanding the rental fleet, focusing on larger horsepower units, consolidating operations in existing areas while expanding geographically, growing secondary product lines (flares, CiP products, maintenance), and selectively pursuing acquisitions[33][34] Core Competitive Advantages - Key competitive strengths include superior customer service, a diversified product line (high/low pressure rotary screw and reciprocating packages for various applications), purpose-built rental compressors (compact, easy to move/install, advanced controls), an experienced management team, broad geographic presence across U.S natural gas producing regions, and long-standing customer relationships[34] Key Customer Relationships - The loss of Oxy or Devon could materially adversely affect the company's business, financial condition, results of operations, and cash flows[36] Major Customer Revenue Concentration | Customer | 2018 Revenue % | 2017 Revenue % | 2016 Revenue % | | :--------- | :------------- | :------------- | :------------- | | Occidental Permian, LTD (Oxy) | 28% | 20% | 19% | | Devon Energy Production, Inc (Devon) | N/A | 15% | 21% | Major Customer Accounts Receivable Concentration (as of December 31) | Customer | 2018 Accounts Receivable % | 2017 Accounts Receivable % | | :--------- | :------------------------- | :------------------------- | | Occidental Permian, LTD (Oxy) | 26% | 14% | Sales and Marketing Approach - The sales force focuses on direct contact, technical assistance, print literature, direct mail, and referrals to develop relationships with current and potential customers[37] - Sales and marketing efforts emphasize enhancing customer cash flow through product design, fabrication, manufacturing, installation, and customer support[37] Competitive Landscape - The company faces competition from larger equipment and service providers with greater financial resources and market recognition[38] - Competition is based on price, customer service, flexibility, and the quality/reliability of compressors and services[38] - Increased size and geographic breadth offer significant advantages in the compressor industry, as sales, support, and maintenance personnel requirements do not increase proportionately with fleet size[39] Sales Backlog - The 2018 sales backlog is scheduled to be fulfilled primarily by the end of the third quarter of 2019[40] Sales Backlog (as of December 31) | Year | Backlog Amount (Millions) | | :--- | :------------------------ | | 2018 | $14.8 | | 2017 | $7.8 | Workforce Information - As of December 31, 2018, the company had 273 employees, none of whom were represented by a labor union, and maintains good relations with its employees[41] Insurance Coverage - The company maintains customary liability insurance, including environmental cleanup, but excludes product warranty insurance as most components are covered by manufacturers[42] - There is a risk that insurance may not cover all losses, or that rates could fluctuate, leading to less coverage or higher costs[42] Regulatory Compliance Environmental Regulations - Operations are subject to numerous federal, state, and local laws and regulations concerning hazardous materials, oilfield waste, and other waste disposal[43] - Compliance costs have not been significant to date, and no material capital expenditures for environmental control are anticipated in the foreseeable future, though future costs could become material[44] Waste Management and Disposal - The company generates regulated wastes under RCRA and is subject to strict liability under CERCLA for hazardous substance releases, including potential cleanup costs and damages[47] - Historical operating and disposal practices, including those by third parties on owned/leased properties, could lead to future remediation requirements, though no such orders are currently in place[46][48] Clean Water Act Compliance - The Clean Water Act (CWA) and Oil Pollution Act of 1990 regulate pollutant discharges into U.S waters, requiring permits and spill prevention measures[49][50][51] - While the company's compression operations do not generate process wastewaters, customer violations could indirectly impact its operations negatively[51] Air Emissions Regulations - Operations are subject to federal, state, and local Clean Air Act regulations, imposing limits on air pollutants from stationary engines and requiring new emission control equipment for engines built after July 1, 2008[52] - Recent EPA regulations (e.g, for hazardous air pollutants, NAAQS, methane/VOC emissions from oil/gas production) could lead to stricter permitting, increased costs for pollution control, and potential negative impacts on customers and the business[53][54][55] - Existing environmental control procedures are believed to be adequate and in substantial compliance, with no material adverse effect anticipated from current requirements, though future changes could lead to material compliance costs[56][57] Occupational Safety and Health - The company is subject to OSHA and comparable state statutes, governing employee health and safety and requiring disclosure of hazardous materials[59] - Management believes the company is in compliance with these requirements[59] Intellectual Property - The company's success relies more on technical competence, creativity, and marketing abilities than on individual patents, trademarks, or copyrights[60] - The company does not own any unexpired patents but continues to use technology previously covered by an expired patent, which is not considered material to the business[60] Supply Chain and Raw Materials - Fabrication of rental compressors involves purchasing engines, compressors, coolers, and other components from third-party suppliers, typically with three to six months lead time[61] - While there are no formal continuing supply contracts, adequate alternative sources are believed to be available, and sudden dramatic price increases for components have not occurred historically, though such an event could materially affect operations[61] Publicly Available Information - The company makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements, and Code of Business Ethics available free of charge on the Investor Relations section of its website (www.ngsgi.com)[62](index=62&type=chunk) Glossary of Industry Terms - The report includes a glossary defining specialized terms used in the natural gas compressor business, such as 'CiP' (Cylinder-in-Plane), 'coal bed methane,' 'flare,' 'gas lift,' 'gas shale,' 'oil shale,' 'reciprocating compressors,' 'screw compressors,' and 'tight gas'[63][64][65][66][67][68] Risk Factors The company faces significant risks from the volatile oil and gas industry, competition, and environmental regulations Industry-Specific Risks - Adverse macroeconomic conditions and low oil/natural gas prices can negatively impact revenue and profitability by reducing customer capital expenditures and affecting the collectability of receivables[70][71] - The industry is highly competitive, with larger players having greater financial resources, potentially leading to reduced profitability and loss of market share[73][74] - A reduction in demand or prices for natural gas, particularly from unconventional sources, could adversely affect the business, as evidenced by a 32% revenue decline and a drop in compressor utilization from 76.0% in 2014 to 52.9% in 2018[75][78] - The industry's cyclical nature leads to volatile results, with periods of low demand intensifying competition and resulting in lower rental rates[79] - Increased regulation or a ban on hydraulic fracturing techniques, as well as investigations into produced water disposal, could reduce demand for compressors and introduce operational uncertainty[80][81][82] - The company is subject to extensive environmental laws, with potential liabilities for cleanup costs, damages, and penalties for non-compliance, which could harm its financial condition[83][84][85] Company-Specific Risks - A majority of compressor rentals are short-term (six months or less), and non-renewal or inability to re-rent at comparable rates could materially impact revenue and cost recovery[86] - The company is exposed to substantial liability claims from product accidents or failures, which may exceed insurance coverage or lead to increased premiums[87][90] - Reliance on a few major customers (one customer accounted for 28% of 2018 revenue and 26% of accounts receivable) means the loss of such customers could adversely affect operations and cash flow[88] - The loss of key executive management members, particularly CEO Stephen C Taylor, could materially affect business operations due to reliance on their leadership and expertise[89] - Erosion of customer financial condition, driven by weak oil/gas markets, could lead to reduced spending on products and services, impacting the company's growth[92] - Inability to employ and retain qualified technical personnel, due to high demand and limited supply, could hamper operations or increase costs[93] - Expansion of the compressor rental fleet and business growth require substantial capital, which may not always be available on acceptable terms, potentially impacting financial condition[94][95] - The company's debt levels, though currently low ($417,000 outstanding on a $30 million line of credit as of December 31, 2018), could limit future financing and make the company vulnerable to economic downturns if fully utilized[96][99] - The credit agreement contains covenants (e.g, minimum leverage ratio, commitment coverage ratio) that limit operating and financial flexibility; a breach could accelerate debt and allow the bank to foreclose on assets[101][102] - Failure to successfully acquire or integrate additional businesses could limit growth and negatively impact results, due to complexities, costs, and potential loss of key employees/customers[103] - Failure to effectively manage growth and expansion could strain management and resources, impairing the ability to hire, train, and upgrade infrastructure[104] - Liabilities under warranties and indemnification provisions, especially for complex equipment in harsh environments, could materially affect earnings and reputation[105][106] - Changes in income tax laws, regulations, or audit assessments could result in increased tax provisions and affect operating results[107][108] - Failure to maintain effective internal controls over financial reporting could lead to unreliable financial reports, fraud, and a decrease in stock price[109] - The company is exposed to risks from computer system failures or cyber security threats, which could disrupt operations or lead to data loss, although measures are in place to minimize these risks[110][111] Common Stock Risks - The trading price of common stock is subject to substantial fluctuations due to various factors, including business strategy, financial results, market conditions, and oil/natural gas prices[112] - Substantial future sales of common stock by institutional investors (22.7% ownership) or directors/officers (6.2% ownership) could negatively impact the stock price[113] - A relatively low number of outstanding shares contributes to limited liquidity and potential price volatility[114] - Future issuance of debt or equity securities could dilute existing ownership and impose restrictions on operations[115] - If securities analysts downgrade the stock or cease coverage, the stock price could decline due to reduced market visibility[116] - Provisions in governing documents, such as staggered board terms, lack of cumulative voting, and high vote requirements for board changes, could hinder a change in control[117] Unresolved Staff Comments There are no unresolved staff comments - The company has no unresolved staff comments[118] Properties The company owns and leases facilities for fabrication, rental, services, and corporate offices across multiple states - Construction of a new 45,000 sq ft corporate office in Midland, Texas, purchased in 2017, is underway with an expected cost of approximately $12.0 million and completion in late Q1 or early Q2 2019[120] - The company believes its properties are generally well maintained, in good condition, and adequate for its purposes[121] Material Facilities (as of December 31, 2018) | Location | Status | Square Feet | Uses | | :--------------- | :------------- | :---------- | :------------------------------------ | | Tulsa, Oklahoma | Owned and Leased | 91,780 | Compressor fabrication, rental and services | | Midland, Texas | Owned | 70,000 | Compressor fabrication, rental and services | | Lewiston, Michigan | Owned | 15,360 | Compressor fabrication, rental and services | | Midland, Texas | Owned | 45,000 | Corporate office* | | Midland, Texas | Leased | 13,135 | Corporate office | | Bloomfield, New Mexico | Owned | 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 | | Vernal, Utah | Leased | 3,200 | Parts and services | | Carrollton, Ohio | Leased | 2,600 | Parts and services | | Loveland, Colorado | Leased | 2,400 | Parts and services | | Wheeler, Texas | Leased | 2,160 | Parts and services | | Grapevine, Texas | Leased | 800 | Sales | Legal Proceedings The company is involved in ordinary course legal proceedings not expected to have a material financial impact - The company is a party to various legal proceedings in the ordinary course of business, but management believes any ultimate liability will not materially affect its financial position, results of operations, or cash flow[122] - There are no current bankruptcy, receivership, reorganization, adjustment, or similar proceedings, and no awareness of threatened litigation[122] Mine Safety Disclosures This item is not applicable to the company's operations - Mine Safety Disclosures are not applicable to Natural Gas Services Group, Inc[123] Part II Market for Common Equity and Stockholder Matters The company's common stock trades on the NYSE under 'NGS' with no dividends paid as earnings are retained for growth Common Stock Market Information - The company's common stock trades on the New York Stock Exchange under the symbol 'NGS'[125] - As of December 31, 2018, there were 15 record holders of common stock The closing price on March 4, 2019, was $18.37 per share[126] Common Stock High and Low Sales Prices | Year | Quarter | Low Price | High Price | | :--- | :------ | :-------- | :--------- | | 2018 | First Quarter | $23.30 | $29.10 | | 2018 | Second Quarter | $21.90 | $26.55 | | 2018 | Third Quarter | $20.80 | $24.00 | | 2018 | Fourth Quarter | $15.42 | $21.10 | | 2017 | First Quarter | $24.50 | $32.05 | | 2017 | Second Quarter | $22.85 | $28.80 | | 2017 | Third Quarter | $22.80 | $29.25 | | 2017 | Fourth Quarter | $24.35 | $29.05 | Dividend Policy - The company has not declared or paid any dividends on its common stock to date and does not anticipate paying cash dividends in the future, intending to retain earnings for business growth[130] - Future dividend payments are at the discretion of the Board of Directors and are subject to earnings, capital requirements, and restrictions in the company's credit agreement[130] Equity Compensation Plan Summary Equity Compensation Plans (as of December 31, 2018) | Plan Category | Securities to be issued upon exercise of outstanding options (a) | Weighted-average exercise price of outstanding options (b) | Securities remaining available for future issuance (c) | | :------------------------------------------ | :------------------------------------------------------- | :------------------------------------------------------- | :------------------------------------------------------- | | Stock Option Plan | 283,686 | $20.46 | 318,503 | | Restricted Stock / Unit Plan | 214,630 | $25.51 | 45,533 | | Total | 498,316 | | 364,036 | Equity Security Repurchases - No repurchases of equity securities were made by the company or on its behalf during the year ended December 31, 2018[132] Unregistered Securities Sales - The company made no sales of unregistered securities during the year ended December 31, 2018[133] Selected Financial Data This section provides a five-year summary of historical financial data and reconciles non-GAAP financial measures Five-Year Summary Financial Data Statements of Income and Other Information (in thousands, except per share amounts) | Metric | 2018 | 2017 | 2016 | 2015 | 2014 | | :---------------------------------------------------------------- | :----- | :----- | :----- | :----- | :----- | | Revenues | $65,478 | $67,693 | $71,654 | $95,919 | $96,974 | | Costs of revenues, exclusive of depreciation and amortization | 33,695 | 34,743 | 31,872 | 42,655 | 43,147 | | Loss on retirement of rental equipment | — | — | 545 | 4,370 | — | | Depreciation and amortization | 22,049 | 21,302 | 21,796 | 22,758 | 21,507 | | Selling, general and administrative expenses | 9,096 | 10,081 | 9,011 | 10,989 | 10,334 | | Operating income | 638 | 1,567 | 8,430 | 15,147 | 21,986 | | Total other income, net | 113 | 36 | 35 | 117 | 172 | | Income before income taxes | 751 | 1,603 | 8,465 | 15,264 | 22,158 | | Income tax expense (benefit) | 325 | (18,248) | 1,996 | 5,117 | 8,030 | | Net income | $426 | $19,851 | $6,469 | $10,147 | $14,128 | | Net income per common share: Basic | $0.03 | $1.55 | $0.51 | $0.81 | $1.14 | | Net income per common share: Diluted | $0.03 | $1.51 | $0.50 | $0.79 | $1.11 | | Weighted average shares of common stock outstanding: Basic | 12,965 | 12,831 | 12,702 | 12,567 | 12,434 | | Weighted average shares of common stock outstanding: Diluted | 13,233 | 13,110 | 12,935 | 12,793 | 12,721 | | Adjusted EBITDA | $22,869 | $22,919 | $30,814 | $42,407 | $43,675 | | Adjusted gross margin | $31,783 | $32,950 | $39,782 | $53,264 | $53,827 | | Cash flows from: Operating Activities | $23,414 | $17,452 | $31,785 | $41,566 | $33,742 | | Cash flows from: Investing Activities | $(40,010) | $(12,791) | $(3,414) | $(12,270) | $(52,280) | | Cash flows from: Financing Activities | $16 | $453 | $191 | $55 | $276 | | Net change in cash and cash equivalents | $(16,580) | $5,114 | $28,562 | $29,351 | $(18,262) | Balance Sheet Information (as of December 31, in thousands) | Metric | 2018 | 2017 | 2016 | 2015 | 2014 | | :-------------------------------- | :----- | :----- | :----- | :----- | :----- | | Current assets | $96,399 | $108,226 | $95,359 | $68,074 | $49,631 | | Total assets | $305,401 | $298,310 | $293,524 | $285,553 | $282,712 | | Long-term debt (including current portion) | $417 | $417 | $417 | $417 | $417 | | Stockholders' equity | $260,181 | $257,319 | $232,954 | $223,981 | $210,587 | Non-GAAP Financial Measures Adjusted EBITDA - Adjusted EBITDA is a non-GAAP measure defined as earnings (net income) from operations before interest, taxes, loss on retirement of rental equipment, depreciation, and amortization[139] - Management uses Adjusted EBITDA to evaluate operating performance, compare results across periods, and for strategic planning and incentive compensation, acknowledging its limitations as an analytical tool[139][140] Adjusted EBITDA Reconciliation (in thousands) | Metric | 2018 | 2017 | 2016 | 2015 | 2014 | | :------------------------------ | :----- | :----- | :----- | :----- | :----- | | Net income | $426 | $19,851 | $6,469 | $10,147 | $14,128 | | Interest expense | 69 | 14 | 8 | 15 | 10 | | Income tax expense (benefit) | 325 | (18,248) | 1,996 | 5,117 | 8,030 | | Loss on retirement of rental equipment | — | — | 545 | 4,370 | — | | Depreciation and amortization | 22,049 | 21,302 | 21,796 | 22,758 | 21,507 | | Adjusted EBITDA | $22,869 | $22,919 | $30,814 | $42,407 | $43,675 | Adjusted Gross Margin - Adjusted Gross Margin is a non-GAAP measure defined as total revenue less costs of revenues, excluding depreciation and amortization expense[143] - Management uses it as a supplemental disclosure to focus on current operating performance, excluding historical asset costs, indirect SG&A, financing impacts, and income taxes[143][144] Adjusted Gross Margin Reconciliation (in thousands) | Metric | 2018 | 2017 | 2016 | 2015 | 2014 | | :-------------------------------------- | :----- | :----- | :----- | :----- | :----- | | Operating Income | $638 | $1,567 | $8,430 | $15,147 | $21,986 | | Depreciation and amortization | 22,049 | 21,302 | 21,796 | 22,758 | 21,507 | | Selling, general, and administration expenses | 9,096 | 10,081 | 9,011 | 10,989 | 10,334 | | Loss on retirement of rental equipment | — | — | 545 | 4,370 | — | | Adjusted Gross Margin | $31,783 | $32,950 | $39,782 | $53,264 | $53,827 | Management's Discussion and Analysis This section analyzes the company's financial position and operational results for 2018, 2017, and 2016 Business Overview and Strategy - The company's primary focus is on renting natural gas compressors, with contracts typically having initial terms of six to 60 months, often continuing month-to-month thereafter[150] - The company also fabricates and sells custom natural gas compressors, manufactures its proprietary CiP product line, designs/sells flare systems, and provides service/maintenance[151][152][153] - The growth strategy focuses on the compressor rental business, which historically yields higher margins (high 50% to low 60%) compared to compressor sales (mid 20% range)[155] - Business activity and revenues are expected to track the natural gas industry, driven by declining reservoir pressure and increased focus on non-conventional gas production[157] - Capital expenditures for fiscal year 2019 are forecasted to be directly dependent on customer compression requirements and are not anticipated to exceed internally generated cash flows[159] Rental Compressor Fleet (as of December 31, 2018) | Metric | Value | | :-------------------------------- | :---- | | Total Compressors Rented | 1,361 | | Total Horsepower Rented | 230,089 | | Number of Customers | 94 | | Compressors Rented Month-to-Month | 779 | Revenue by Operating Category (in thousands) | Category | 2018 | 2017 | 2016 | | :-------------------- | :----- | :----- | :----- | | Rental | $47,766 | $46,046 | $56,717 | | Sales | $16,269 | $20,208 | $13,621 | | Service and maintenance | $1,443 | $1,439 | $1,316 | | Total | $65,478 | $67,693 | $71,654 | Critical Accounting Policies Revenue Recognition - The company adopted ASC 606, Revenue from Contracts with Customers, on January 1, 2018, using the cumulative effect method, with no significant changes or adjustments to equity at adoption[163][164] - Revenue is recognized when performance obligations are satisfied and control of products/services transfers to the customer, with rental revenue recognized over time (ASC 840) and service revenue recognized under ASC 606[165][166] - Sales revenue from custom/fabricated compressors and flare systems is recognized upon completion and shipment, or when the customer accepts title under bill and hold arrangements[167][168][169] Revenue from Bill and Hold Arrangements | Year Ended December 31 | Revenue (Millions) | | :--------------------- | :----------------- | | 2018 | $8.3 | | 2017 | $4.6 | Allowance for Doubtful Accounts - The company performs ongoing credit evaluations and maintains a provision for estimated credit losses based on historical experience and specific customer issues[174] - One customer accounted for 26% of accounts receivable at December 31, 2018, and 14% at December 31, 2017, posing a concentration risk[174] Allowance for Doubtful Accounts Balance (as of December 31) | Year | Balance (Thousands) | | :--- | :------------------ | | 2018 | $291 | | 2017 | $569 | Income Tax Accounting - The company estimates federal and state income taxes, assessing temporary differences for deferred tax assets and liabilities, and establishing a valuation allowance if recovery is not probable[175] - The 2017 Tax Act led to broad changes, with certain income tax effects reflected in 2017 financial results, including a re-measurement of deferred tax assets and liabilities[177] - ASC Topic 740 requires a recognition threshold and measurement attribute for tax positions, ensuring a 'more likely than not' standard for sustainability upon examination[178] Asset and Goodwill Valuation - The company annually assesses impairment of identifiable intangibles, long-lived assets, and goodwill, or whenever circumstances indicate carrying value may not be recoverable[180] - Impairment is measured using a projected discounted cash flow method, considering factors like underperformance, changes in asset use, negative industry trends, and stock market decline[180][184] - A qualitative analysis in Q4 2018, considering financial metrics, stock performance, and demand, concluded no impairment of goodwill or indefinite-lived intangibles was incurred[181] Inventory Valuation - Inventory is valued at the lower of actual cost and net realizable value, with cost determined by the weighted average method[182] - A provision for excess and obsolete inventory is recorded based on estimated demand and production requirements; a $1,360 adjustment was made in 2018 to remove obsolete inventory[182] Inventory Allowance Balance (as of December 31) | Year | Balance (Thousands) | | :--- | :------------------ | | 2018 | $19 | | 2017 | $15 | Performance Trends and Outlook - Customers are expected to be cautious with capital investments due to a slow recovery in natural gas and oil prices, leading to modestly higher activity levels in 2019[183] - The company anticipates continued price pressure from competitors and moderated growth in rental operations due to the sluggish recovery[183] - Despite the low energy price environment, the long-term market trend is believed to be favorable[160] Results of Operations 2018 vs. 2017 Financial Performance - The increase in rental revenue was driven by higher average oil and natural gas prices, leading to increased unit deployment and demand for higher horsepower units[188] - Sales revenue decreased due to economic uncertainty and reduced capital spending in the energy industry, despite the company's strategy to maintain rental revenues as a larger component of total revenue[189] - The decrease in operating income was primarily due to a 3.4% drop in rental margins, attributed to costs incurred in deploying units[190] - The income tax provision changed from an $18.2 million benefit in 2017 (due to the 2017 Tax Act) to a $325,000 expense in 2018, which included a $547,000 tax adjustment for an uncertain tax position[193] Revenue by Product Line (in thousands) | Product Line | 2018 Revenue | 2018 % of Total | 2017 Revenue | 2017 % of Total | Change % | | :------------------ | :----------- | :-------------- | :----------- | :-------------- | :------- | | Rental | $47,766 | 72.9% | $46,046 | 68.0% | +3.7% | | Sales | $16,269 | 24.8% | $20,208 | 29.9% | -19.5% | | Service & Maintenance | $1,443 | 2.3% | $1,439 | 2.1% | +0.3% | | Total Revenue | $65,478 | | $67,693 | | -3.3% | Rental Fleet Utilization (as of December 31) | Year | Utilization Rate | | :--- | :--------------- | | 2018 | 52.9% | | 2017 | 49.5% | Operating Income and Expenses (in thousands) | Metric | 2018 | 2017 | Change % | | :-------------------------------- | :----- | :----- | :------- | | Operating Income | $638 | $1,567 | -59.3% | | Selling, General, & Administrative | $9,096 | $10,081 | -9.8% | | Depreciation and Amortization | $22,049 | $21,302 | +3.5% | | Provision for Income Tax | $325 | $(18,248) | N/A (from benefit to expense) | 2017 vs. 2016 Financial Performance - Rental revenue decreased due to reduced demand from lower average oil and natural gas prices, leading to units being returned[196] - Sales revenue increased significantly, reflecting demand from customers' investments in non-conventional shale plays, despite lagging crude oil prices and economic uncertainty[197] - Operating income decreased primarily due to the 18.8% drop in rental revenue[198] - The $18.2 million income tax benefit in 2017 was a direct result of the 2017 Tax Act, which required re-measurement of deferred tax assets and liabilities at the new federal statutory rate[202][203] Revenue by Product Line (in thousands) | Product Line | 2017 Revenue | 2017 % of Total | 2016 Revenue | 2016 % of Total | Change % | | :------------------ | :----------- | :-------------- | :----------- | :-------------- | :------- | | Rental | $46,046 | 68.0% | $56,717 | 79.2% | -18.8% | | Sales | $20,208 | 29.9% | $13,621 | 19.0% | +48.4% | | Service & Maintenance | $1,439 | 2.1% | $1,316 | 1.8% | +9.3% | | Total Revenue | $67,693 | | $71,654 | | -5.5% | Rental Fleet Utilization (as of December 31) | Year | Utilization Rate | | :--- | :--------------- | | 2017 | 49.5% | | 2016 | 51.3% | Operating Income and Expenses (in thousands) | Metric | 2017 | 2016 | Change % | | :-------------------------------- | :----- | :----- | :------- | | Operating Income | $1,567 | $8,430 | -81.4% | | Selling, General, & Administrative | $10,081 | $9,011 | +11.9% | | Depreciation and Amortization | $21,302 | $21,796 | -2.3% | | Provision for Income Tax | $(18,248) | $1,996 | N/A (from expense to benefit) | Adjusted Gross Margin Analysis 2018 vs. 2017 Adjusted Gross Margin - The overall adjusted gross margin percentage slightly decreased from 48.7% in 2017 to 48.5% in 2018, primarily due to a drop in rental revenue margins from 60.7% to 56.6% caused by unit deployment costs[206] - Sales margin increased from 19.4% to 22.8%, while service and maintenance margins slightly decreased from 74.3% to 73.3%[206] Adjusted Gross Margin by Product Line (in thousands) | Product Line | 2018 Adjusted Gross Margin | 2018 % | 2017 Adjusted Gross Margin | 2017 % | | :-------------------- | :------------------------- | :----- | :------------------------- | :----- | | Rental | $27,020 | 56.6% | $27,959 | 60.7% | | Sales | $3,705 | 22.8% | $3,922 | 19.4% | | Service & Maintenance | $1,058 | 73.3% | $1,069 | 74.3% | | Total | $31,783 | 48.5% | $32,950 | 48.7% | 2017 vs. 2016 Adjusted Gross Margin - The overall adjusted gross margin percentage dropped from 55.5% in 2016 to 48.7% in 2017, mainly due to a decrease in rental revenue margins from 64.1% to 60.7% caused by pricing pressures[210] - Sales margin increased from 18.3% to 19.4%, and service and maintenance margins increased from 69.8% to 74.3%[210] Adjusted Gross Margin by Product Line (in thousands) | Product Line | 2017 Adjusted Gross Margin | 2017 % | 2016 Adjusted Gross Margin | 2016 % | | :-------------------- | :------------------------- | :----- | :------------------------- | :----- | | Rental | $27,959 | 60.7% | $36,367 | 64.1% | | Sales | $3,922 | 19.4% | $2,497 | 18.3% | | Service & Maintenance | $1,069 | 74.3% | $918 | 69.8% | | Total | $32,950 | 48.7% | $39,782 | 55.5% | Liquidity and Capital Resources Working Capital and Funding Sources - Historically, operations have been funded through cash flows from operations and bank credit facilities In 2018, approximately $39.8 million was invested in rental fleet equipment, service vehicles, and land for the new corporate office, financed with cash on hand[212] Working Capital Positions (in thousands) | Metric | December 31, 2018 | December 31, 2017 | | :------------------------ | :------------------ | :------------------ | | Current Assets | $96,399 | $108,226 | | Current Liabilities | $10,946 | $7,453 | | Net Working Capital | $85,453 | $100,773 | Cash Flow Analysis - Cash and cash equivalents decreased in 2018 due to increased capital expenditures for new large horsepower compressor builds and the new corporate office construction[214] - Net cash flow from operating activities was approximately $23.4 million in 2018, primarily from net income and non-cash items like depreciation and stock-based compensation[214] - Inventory increased to $31.0 million at the end of 2018 from $26.2 million in 2017, mainly due to purchases for future jobs and timing of work-in-progress closing to finished goods[216] Cash and Debt Position (as of December 31) | Metric | 2018 (Millions) | 2017 (Millions) | | :-------------------- | :-------------- | :-------------- | | Cash and Cash Equivalents | $52.6 | $69.2 | | Working Capital | $85.5 | $100.8 | | Total Debt | $0.417 | $0.417 | Contractual Obligations - The company has a $4.3 million contractual obligation for the construction of a new corporate office, financed by cash on hand, expected to be completed in early 2019[217] Cash Contractual Obligations (in thousands) | Cash Contractual Obligations | 2019 | 2020 | 2021 | 2022 | 2023 | Thereafter | Total | | :------------------------- | :--- | :--- | :--- | :--- | :--- | :--------- | :---- | | Line of credit | $— | $417 | $— | $— | $— | $— | $417 | | Interest on line of credit | $17 | $17 | $— | $— | $— | $— | $34 | | Purchase obligations | $400 | $400 | $111 | $— | $— | $— | $911 | | Other long term liabilities | $— | $— | $— | $57 | $— | $— | $57 | | Facilities and office leases | $298 | $118 | $97 | $44 | $35 | $15 | $607 | | Total | $715 | $952 | $208 | $101 | $35 | $15 | $2,026 | Senior Bank Borrowings - The company has a senior secured revolving credit agreement with JP Morgan Chase Bank, N.A, with an aggregate commitment of $30 million, extendable up to $50 million[218] - The agreement was amended and renewed on August 31, 2017, extending the maturity date to December 31, 2020[218] - As of December 31, 2018, $417,000 was outstanding on the line of credit, with a borrowing base availability of $29.5 million[218][360] - Interest rates are variable, with options for LIBOR-based or CB Floating Rate, and the obligations are secured by inventory, accounts, lease receivables, and leased compressor equipment[220][222] - The agreement includes customary covenants and events of default; the company was in compliance with all covenants as of December 31, 2018[222][223][224] Capital Expenditures - The level of future expenditures will vary with energy market conditions, but current cash on hand, operating cash flow, and the available bank line of credit are believed to be adequate for 2019 and beyond[225] Capital Expenditures (in thousands) | Expenditure Category | 2018 | 2017 | 2016 | | :--------------------------------- | :----- | :----- | :----- | | Rental equipment and property and equipment | $39,790 | $13,489 | $3,321 | Off-Balance Sheet Arrangements - The company engages in off-balance sheet arrangements, including operating lease agreements and purchase agreements[226] - A purchase agreement from July 2008 for paint and coating requirements, with a $300,000 vendor fee recorded as a long-term liability, had a remaining liability of $57,000 as of December 31, 2018[227] - These arrangements are not expected to materially affect liquidity or capital resources[226] Recently Issued Accounting Pronouncements - The company will adopt ASU 2016-02, Leases (Topic 842), on January 1, 2019, which requires lessees to recognize assets and liabilities for finance and operating leases with terms over 12 months[347][348] - The adoption is anticipated to increase lease assets and liabilities on the consolidated balance sheet by approximately $700,000, but will not impact debt covenants on the existing line of credit[348] Environmental Regulations - The company's operations are affected by various federal, state, and local environmental laws and regulations concerning material discharge and protection of human safety and health[229] - Compliance costs increase the overall cost of business but have not had a material adverse effect on operations or financial condition, and no material expenditures are anticipated in the near future, though future changes are unpredictable[229] - The company could incur costs related to cleanup of sites or damages from regulated substance releases, including those from prior owners or leased facilities[229] Market Risk Disclosures The company is exposed to market risks primarily related to commodity prices and customer credit risk Commodity Risk - The company's commodity risk exposure is primarily linked to natural gas production and, to a lesser extent, oil production, with realized prices driven by prevailing worldwide crude oil and natural gas spot prices[230] - Fluctuations in oil and natural gas prices can lead exploration companies to cancel or curtail drilling programs, thereby reducing demand for the company's equipment and services[230] Financial Instruments and Debt - Financial instruments include cash and cash equivalents, trade receivables, accounts payable, and the line of credit[231] - The carrying amounts of these instruments approximate fair value due to their short-term nature or the use of prevailing market interest rates[231] Customer Credit Risk - The company is exposed to the risk of financial non-performance by its customers, with collectability dependent on customer liquidity[232] - Customer credit risk is managed by monitoring credit ratings, but a concentration of accounts receivable (one customer accounted for approximately 26% at December 31, 2018) poses a significant risk[232][234] Financial Statements and Supplementary Data The audited financial statements and supplementary financial data are included in this Annual Report on Form 10-K - The audited financial statements and supplementary financial data are included in this Annual Report on Form 10-K, beginning on page F-1[235] Changes in and Disagreements with Accountants There have been no changes in or disagreements with accountants on accounting and financial disclosure - There are no changes in or disagreements with accountants on accounting and financial disclosure[236] Controls and Procedures Management concluded disclosure controls were not effective due to a material weakness in internal control over financial reporting Disclosure Controls and Procedures Evaluation - Management, including the CEO and CFO, evaluated the effectiveness of disclosure controls and procedures as of December 31, 2018[237] - Based on the evaluation, disclosure controls and procedures were concluded to be not effective due to a material weakness in internal control over financial reporting[237] Internal Control Over Financial Reporting - Management is responsible for establishing and maintaining adequate internal control over financial reporting, designed to provide reasonable assurance regarding financial reporting reliability[238] - A material weakness was identified in Q4 2018 related to the preparation and review of the tax provision, specifically the failure to design and maintain effective controls to identify and account for nondeductible expenses[243] - This material weakness led management to conclude that internal control over financial reporting was not effective as of December 31, 2018[242][243] Remediation Plan - Management plans to address the material weakness in fiscal year 2019 through an in-depth review of tax controls, potentially involving external experts and internal audit[244] - The goal is to complete the review, implement new controls, and remediate the material weakness by the end of 2019[244] Changes in Internal Control - Except for the identified control deficiency, there were no other changes in internal control over financial reporting during the quarter ended December 31, 2018, that materially affected or are reasonably likely to materially affect it[246] Other Information There is no other information to report under this item - There is no other information to report under this item[247] Part III Directors, Executive Officers and Corporate Governance Information regarding directors, executive officers, and corporate governance is incorporated by reference from the proxy statement - Information required by this item is incorporated by reference to the company's definitive proxy statement for the annual meeting of shareholders to be held on June 20, 2019[5][259] - The company has adopted a Code of Business Conduct and Ethics, applicable to directors, officers, and employees, which is posted on its website[260] Executive Compensation Information regarding executive compensation is incorporated by reference from the company's definitive proxy statement - Information required by this item is incorporated by reference to the company's definitive proxy statement[5][261] Security Ownership and Related Stockholder Matters Information regarding security ownership is incorporated by reference from the company's definitive proxy statement - Information required by this item is incorporated by reference to the company's definitive proxy statement[5][262] Certain Relationships and Related Transactions, and Director Independence Information regarding related transactions and director independence is incorporated by reference from the proxy statement - Information required by this item is incorporated by reference to the company's definitive proxy statement[5][263] Principal Accounting Fees and Services Information regarding principal accounting fees and services is incorporated by reference from the proxy statement - Information required by this item is incorporated by reference to the company's definitive proxy statement[5][264] Part IV Exhibits and Consolidated Financial Statements This section lists the consolidated financial statements and exhibits filed as part of the Annual Report Consolidated Financial Statements - The consolidated financial statements are listed in the 'Index to Consolidated Financial Statements' and incorporated by reference[267] Exhibits List - A list of exhibits to this Annual Report on Form 10-K is provided, including corporate governance documents (Articles of Incorporation, Bylaws), credit agreements, equity compensation plans, employment agreements, and certifications[268][269][270][273] - The exhibits also include XBRL Instance Document and Taxonomy Extension documents for financial reporting[273] Form 10-K Summary There is no Form 10-K Summary provided in this report - No Form 10-K Summary is included in this report[272] Signatures The report is signed by executive officers and directors on behalf of Natural Gas Services Group, Inc - The report is signed on behalf of Natural Gas Services Group, Inc by Stephen C Taylor (Chairman of the Board, President and Chief Executive Officer) and G Larry Lawrence (Vice President and Chief Financial Officer), along with other directors, on March 18, 2019[275][276][277] Index to Consolidated Financial Statements This section provides an index to the consolidated financial statements included in the report Consolidated Financial Statements Index | Document | Page | | :---------------------------------------------------------------- | :--- | | Report of Independent Registered Public Accounting Firm | 1 | | Consolidated Balance Sheets as of December 31, 2018 and 2017 | 2 | | Consolidated Statements of Income for the Years Ended December 31, 2018, 2017 and 2016 | 3 | | Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2018, 2017 and 2016 | 4 | | Consolidated Statements of Cash Flows for the Years Ended December 31, 2018, 2017 and 2016 | 5 | | Notes to Consolidated Financial Statements | 6 | Report of Independent Registered Public Accounting Firm (Financial Statements) The independent auditor issued an unqualified opinion on financial statements but an adverse opinion on internal controls - BDO USA, LLP, the independent registered public accounting firm, issued an unqualified opinion on the consolidated financial statements for the years ended December 31, 2018, 2017, and 2016[282] - However, BDO USA, LLP also expressed an adverse opinion on the company's internal control over financial reporting as of December 31, 2018, based on COSO criteria[283] Consolidated Financial Statements Consolidated Balance Sheets The balance sheets detail the company's financial position, showing changes in assets, liabilities, and equity Consolidated Balance Sheets (in thousands) | ASSETS | December 31, 2018 | December 31, 2017 | | :---------------------------------------------------------------- | :------------------ | :------------------ | | Cash and cash equivalents | $52,628 | $69,208 | | Trade accounts receivable, net | $7,219 | $8,534 | | Inventory | $30,974 | $26,224 | | Prepaid income taxes | $3,148 | $3,443 | | Prepaid expenses and other | $2,430 | $817 | | Total current assets | $96,399 | $108,226 | | Long-Term Inventory, net | $3,980 | $2,829 | | Rental equipment, net | $175,886 | $167,099 | | Property and equipment, net | $16,587 | $7,652 | | Goodwill | $10,039 | $10,039 | | Intangibles, net | $1,401 | $1,526 | | Other assets | $1,109 | $939 | | Total assets | $305,401 | $298,310 | | LIABILITIES AND STOCKHOLDERS' EQUITY | | | | Accounts payable | $2,122 | $4,162 | | Accrued liabilities | $8,743 | $3,106 | | Deferred income | $81 | $185 | | Total current liabilities | $10,946 | $7,453 | | Line of credit | $417 | $417 | | Deferred income tax liability | $32,158 | $32,163 | | Other long-term liabilities | $1,699 | $958 | | Total liabilities | $45,220 | $40,991 | | Common stock | $130 | $129 | | Additional paid-in capital | $107,760 | $105,325 | | Retained earnings | $152,291 | $151,865 | | Total stockholders' equity | $260,181 | $257,319 | | Total liabilities and stockholders' equity | $305,401 | $298,310 | Consolidated Statements of Income The income statements show a decline in total revenue and a significant drop in net income in 2018 Consolidated Statements of Income (in thousands, except earnings per share) | Metric | 2018 | 2017 | 2016 | | :---------------------------------------------------------------- | :----- | :----- | :----- | | Rental income | $47,766 | $46,046 | $56,717 | | Sales | $16,269 | $20,208 | $13,621 | | Service and maintena