Natural Gas Services Group [NGS] Conference call transcript for 2022 q4
2023-04-03 13:38:06
Fiscal: 2022 q4
Operator: Good morning, and welcome to Natural Gas Services Group Inc.'s Fourth Quarter 2022 Earnings Conference Call. All participants are in a listen-only mode. After the speakers' presentation, we will conduct a question-and-answer session. As a reminder, this conference call is being recorded. I would now like to turn the call over to Alicia Dada, Investor Relations representative. Thank you. Please go ahead.
Alicia Dada: Thanks, Julia. Hello, everyone, and thank you for joining us to discuss our full year and fourth quarter fiscal 2022 financial results. Today's call is being webcast on our Investor Relations website at ndsgi.com. Also available on the site is our earnings press release, which was issued Friday, March 31. Before I hand the call over, I'd like to remind everyone that during today's call, including the Q&A, we may make forward-looking statements regarding expectations of the Company. These forward-looking statements involve known and unknown risks and uncertainties that may cause actual results to differ materially from those expressed or implied on this call. These risks are detailed in our most recent annual report on Form 10-K, and as such, may be amended or supplemented by subsequent quarterly reports filed with the Securities and Exchange Commission. The statements made during this call are based upon information known to Natural Gas Services Group as of the date and time of this call. NGS assumes no obligation to update the information presented in today's call. With that, I'd like to turn the call over to Steve Taylor, our Chairman of the Board, Interim CEO and President. Steve?
Steve Taylor: Thanks, Alicia and Julianne, and good morning, everyone. Welcome to our year-end 2022 earnings conference call. Thank you for joining us this morning. Before taking your questions, I'll highlight our full year results that were detailed in our earnings press release Friday afternoon, discuss the current business environment and provide comments on other aspects of our business. I also note that we filed our annual report on Form 10-K with the U.S. Securities and Exchange Commission on Friday. Before providing the financial highlights for the fourth quarter and full year of 2022, let me provide some context on the current operating environment. Like the broader markets, energy commodities have been increasingly volatile in recent weeks. This isn't terribly surprising, given the overall uncertainty in the broader economy. We anticipate that velocity to continue, at least in the near term until the broader financial markets experienced more stability and a clear picture regarding the banking system, Federal Reserve activity and the overall economy emerges. That said, while it's unlikely that we will see the same oil price acceleration experienced in the past year. We believe the capital discipline of exploration and production companies, the production restraint demonstrated by OPEC Plus members and the lack of near-term production growth is likely to protect the market from the oversupply of crude in the coming months. And if this weekend unexpected OPEC production cut as any indication, we may be witnessing a new chapter in global energy economics unfold on that provides further support for hydrocarbon prices. On the demand side, while we are cautious on demand growth and in fact, could see modest contraction from Western economies. That slowdown should be mitigated by a steady increase in petroleum demand from China as the economy reopens. In short, while we are less optimistic about price acceleration in the coming months, we are relatively confident that prices will settle in somewhere in the $80 range, which should provide excellent support for current production activity and the growth plans budgeted by our customers. Of course, we will visibly watch for signs of changes in supply and demand fundamentals and look to position the Company to take advantage of opportunities and identify challenges that would impact our operations and capital spending plans. While natural gas market has less impact on our business plan, it is fair to say we are somewhat confounded by the lack of support for gas prices. That said, a perfect storm of an incredibly mild winter, especially in Europe, what appears to be more moderate in industrial demand in North America and maintenance issues that reduced LNG export capacity from the United States all had an impact on gas prices. While all of those variables are likely to return to more normal levels over time is unlikely that natural gas prices will meaningfully accelerate in the near term. That said, regardless of the actual level of oil and natural gas prices, the dynamics of the production market provides significant opportunities for the compression business and natural gas services group in particular. As noted in previous quarters, as reservoir pressures decline, unconventional production increases and other production challenges arise, every barrel of oil produced in North America and around the world requires advanced techniques to reach the surface. One of the most important of which is compression. Absent some major economic or geopolitical surprise, which could include continued production straight from OPEC, that would have an impact on global energy demand, we believe commodity prices should remain firm, which should lead to steady growth in production spending. NGS with our past financial discipline is well positioned to take advantage of these opportunities beginning this year and beyond. As we have said on our last call, while we have been and we'll continue to be focused on operational efficiencies. Our line of sight to organic growth opportunities on the high horsepower market remains as strong as the industry has seen in a long time. We announced during the quarter that we expanded our credit facility with Texas Capital Bank to provide running room for future growth. At the end of 2022, we had approximately $25 million drawn on that facility. And at the end of the first quarter of this year, our bank debt is roughly $55 million. This leverage has allowed us to grow our fleet for key customers, the vast majority of which is pre-contracted work. While our largest customers are among the best capitalized and strongest companies in the exploration business, we are always seeking new clients as a way to expand and diversify our revenue base. While our position as a net borrower is a relatively new development for Natural Gas Services Group, we have a long track record of successfully managing our balance sheet and making calculated opportunistic investment decisions. Our borrowings are the result of the opportunities presently in front of us and our assessment of the future potential key customers, including our quest to maximize returns for our shareholders. In the past, we have been able to fund our capital equipment expansions with a combination of balance sheet cash and operating cash flow. But the present activity is so strong and the equipment is so expensive, they were only able to take advantage of the market with supplemental borrowing. I also want to emphasize that these are high-graded opportunities, ones with long-term contracts and market-leading rights. We are not chasing every job of oil to us. With that said, let's look at the results for the from the fourth quarter of 2022. Total revenue for the three months ended December 31, 2022, increased to $22.5 million from $22 million for the three months ended September 30, 2022, or a 2% increase. Total revenues increased year-over-year from $18 million for the three months ended December 31, 2021, for a 25% increase. Rental revenue increased 10.4% from $18.6 million in the three months ending September 30, 2022, compared to $20.6 million in the three months ending December 31, 2022. Rental revenue increased to $20.6 million in the fourth quarter of 2022 from $16.5 million in the fourth quarter of 2021 for a 25% gain. Both compared to period increases were primarily the result of the increased deployment of higher horsepower reeling units with the fourth quarter 2022 growth supplemented by rental price increases. Rental revenues have strengthened and are now running between 85% to 90% of our total revenues in all comparative periods. As of December 31, 2022, we had 1,221 utilized rental units, representing just over 318,000 horsepower compared to 1,254 rented units representing 298,000 horsepower as of December 31, 2021. We ended the fourth quarter with 65.3% utilization on a per unit basis and 74.8% utilization on a horsepower basis. Notably, all of our higher horsepower equipment is rented, meaning that everything from 400-horsepower and larger is 100% utilized. Utilized horsepower increased by 7% in the fourth quarter compared to the year ago period while revenue per horsepower increased 27.3% when compared to the same period, demonstrating the robust price increases we have been able to implement over the past year. Our total fleet as of December 31, 2022, consisted of units and just over 425,000 horsepower. Our large horsepower assets comprised approximately 14% of our utilized fleet by unit count but these units provide approximately 45% of our current rental revenue stream. Sales revenues for the sequential quarters declined from $1.8 million in the third quarter of 2022 to $1.3 million in the fourth quarter of 2022. But on a year-over-year quarterly basis, sales revenue increased from $1.1 million to $1.3 million. For the full year comparison, sales revenues increased from $6.9 million to $8.6 million or a 24.5% increase. As noted in our earnings release, adjusted gross rental margin increased sequentially from $8.6 million or 46% of revenue in Q3 2022 and to $11.3 million or 55% of revenue in the fourth quarter of 2022. This represents a rental gross margin increase of $2.7 million or approximately 30% in the sequential quarters. On a year-over-year basis, our adjusted rental gross margin of $11.3 million in the fourth quarter of 2022, more than doubled when compared to $4.9 million in the same period in 2021. Adjusted rental gross margin as a percent of rental revenues was 55% in the fourth quarter of 2022 and 30% in the same period of 2021. If anyone recalls in the first quarter call of 2022, I stated that we would achieve at least a 50% adjusted gross margin in our rental business by the fourth quarter of 2022. I'm happy to say we exceeded that with all the credit going to our service forces in the field. That is the primary financial metric and they did an excellent job. Sequentially, we reported an operating loss of $316,000 in the fourth quarter of last year compared to an operating loss of $294,000 in the third quarter of 2022. The slight increase in operating loss from the current period was primarily due to higher SG&A and approximately $280,000 in equipment and inventory retirements. This compares to an operating loss of $8.2 million for the three months ended December 31, 2021. Operating income improvement was primarily due to higher rental revenue, higher rental gross margins, and significantly lower write-downs from rental fleet equipment retirements and obsolete inventory. Our net loss in the fourth quarter of 2022 was $757,000 or $0.06 per diluted share. This compares to a net loss of $80,000 in the third quarter of the year or $0.01 per basic and diluted share. The higher net loss in the quarter was due to higher SG&A and a higher income tax rate. On a year-over-year quarterly basis, our net loss for the three months ended December 31, 2022, was $757,000 or $0.06 per basic diluted share compared to a net loss of $5.6 million or $0.42 per basic and diluted share for the three months ended December 31, 2021. Improved rental revenue and gross margins were the primary contributors to the lower net loss. For the comparative full years, net income improved dramatically from a loss of $9.2 million in 2021 to 570,000 loss in 2022. For Q4 2022, adjusted EBITDA was essentially flat at $7.8 million when compared to the prior quarter, but increased significantly from $2.3 million for the same period in 2021. I will note that SG&A expenses in the fourth quarter of 2022 were approximately $4.8 million, a $2 million increase from the year ago period and an increase of approximately $700,000 in the third quarter of 2022. These increases were primarily attributable to severance and retirement expenses as well as other costs related to our executive transition process. Many of these costs were extraordinary and short term in nature, and we expect them to significantly decrease by the end of this year. SG&A is likely to fluctuate over the next several quarters due to trailing transition costs and the overall growth in our business, but we are acutely focused on these expenses anticipate bringing them back into the 13% to 15% of revenue range that we have historically experienced. Our cash balance as of December 31, 2022, was approximately $3.4 million with $25 million outstanding under our revolving credit facility. In 2022, we realized cash flow from operations of $27.8 million and used $65.1 million for capital expenditures. $57 million of which was expended on our rental fleet. As a side note, for those of you keeping track of the saga of our elusive $11 million tax refund, there has been some progress. We've been lobbying the Advocates Office of the IRS and recently had a conversation with the service. There is movement, but there's a government speed movement. In refunds over $5 million have to go through an audit, which is estimated to take another year to complete. Mind you, this is on top of the almost three years, we've already been waiting. In spite of that, we are celebrating the fact that it appears a real person exists with IRS that acknowledges we have a valid claim. As indicated earlier, the compression market remains strong, and we continue to see demand for new compression units, largely in the high horsepower range. We are likely to continue to deliberately expand our fleet to meet demand as long as such expansion meets our return expectations. While subject to change, based on market conditions and variability and opportunities, we expect our annual capital budget this year to be $95 million. This may fluctuate due to the number of actual contracts we secured, our contract projections and our assessment of the spec builds we need to pursue, but we think this is a realistic figure at this time. Before I take your questions, a couple of closing thoughts. First, as noted in our 10-K file on Friday, our audit noted a weakness in controls related to our accounting for work in progress or WIP and how we categorize certain WIP and inventory versus long-term assets, as well as how and when we expense certain WIP inventory. This weakness essentially a balance sheet reclassification was a result of a lack of control policy that resulted in the MIS classification of certain WIP inventories. As a result, we've made adjusting journal entries to correct errors, and worked with our accounting staff and external auditors and consultants to address this issue, including developing appropriate controls to prevent this issue in the future. We also believe the recent changes in our accounting and finance team and oversight from our new external auditors will mitigate future errors. Overall, we are pleased with the progress made over the past 12 months. While the noise around executive transitions could have been a distraction, NGS was able to remain focused on the business of growing our company and serving our customers, which is reflected in solid growth in our financial and operating metrics. Because now we're five years ago, we'd be on a transition to a company focused on large horse by compression. That transition continues and as noted earlier, continues to grow in importance to our story. Already half of our rental revenue now comes from high horsepower compression and large horsepower equipment is a key component of our margin growth. As noted last year or last quarter, we're now fabricating 2,500 horsepower compression packages, the largest units in our fleet, and continue to gain traction with those units as well as other categories of large horsepower equipment. We currently have 15 contracts for these very large packages. This is significant as we continue to leverage our large horsepower offerings with a broad range of existing and new customers with an eye towards potential opportunities in midstream markets. We continue to sign rental contracts with both premium rate and term. Continued improvements in service and availability should allow that advantage to continue, and we believe it should extend to the 2,500 horsepower market. Also, in addition to our traditional compression business, we continue to see opportunities to provide compression related to methane reduction initiatives, which have received a boost from the Inflation Reduction Act. While still early in the game, our technology should not only reduce the carbon footprint of our compression equipment it should create operating and tax efficiencies for those engaged in that business. The balance of 2023 could be a pivotal year for this emerging business. On the governance and lease ship front, our Board of Directors continues to engage in the search for new Chief Executive and Chief Financial Officer. With that said, the team and I will continue to focus on the opportunities ahead of us. We are energized by daily activity and are excited about the future of our company. I'm grateful to J.D. Faircloth, and his willingness to step in as interim CFO and help balance our Finance and Accounting Group. And as always, I'm incredibly grateful and proud of the entire NGS team for their dedication and efforts in making this not only a great energy compression company, be a great place to come to work every day. Thank you and I look forward to your questions.
Operator: Our first question comes from Rob Brown from Lake Street Capital. Please go ahead. Your line is open.
Rob Brown: Just wondering, if you could give a little bit more color on the demand environment for high horsepower? I think you said you had 15 contracts in place. How is the new sales activity funnel? And how is the custom environment, I guess.
Steve Taylor: Now, the 15 contracts are just 2,500 horsepower units. So, that's a brand-new market penetration for us. The -- what we classify as larger horsepower, 400-horsepower and up. And the 400-horsepower is very robust. We're sold out of those and we're building some more. And more than likely, we expect those to be contracted as they roll off. If you move up into the 1,400 and 1,500 horsepower range equipment and same thing there. We're totally sold out in that respect, and we're building more of the 1,500 horsepower units. And again, most of -- whether it's 400 horse or 1,500 horse or 2,500 horse for that matter, the majority of that equipment, 85% to 90% of it is already contracted. So obviously, the market is very robust. At this point in time, we don't have anything in the yard. Everything is being built either on pre-contracts or in the 400-horsepower, a little -- some spec units being built in there because it's a pretty popular unit there. But the -- so the demand is great right now, and we anticipate it staying that way. Our projections -- internal projections see a fair amount of big horsepower needed in the second half of the year and into next year. The OPEC move this weekend would do nothing to hurt that and probably enhance that. So, I would expect that the big horsepower just continues on and telling unless we see some disruptive factor in it. But right now, we see it being pretty positive.
Rob Brown: Okay. Great. And then the CapEx expectations of $95 million is how much of that is from that 2,500 horsepower market?
Steve Taylor: That -- let me calculate in my head. That's probably -- that's 1/3 to 1/2 of it, just those units right there. They're pretty expensive. So in the 1/3 to 1/2, it's somewhat of a range, but it kind of depends on how the rest of the build schedule comes out to on our 1,500 horse or a bit towards 400 horse or something like that. But that give you a rough idea, say, 35% to 50% of it is going to be that bigger stuff.
Rob Brown: Okay. And then you talked about pretty nice growth in the rental in the fourth quarter from my price increases. Do you see opportunity for further price increases? Or will that just flow through in '23 and drive the growth in '23?
Steve Taylor: We had some additional increases in Q1 of this year, which we'll report on in the next call. But no, I think we're at a good point right now. Now any further price increases we see or choose to implement will probably just be as a result of cost of goods going up either the equipment itself or if we have continued inflation and supply chain issues, just inflationary impacts from those items. But from the point of market-driven or induced price increases that we may just choose to do, we feel like we're okay where we are right now. And again, anything further will be just due to cost of goods or cost of service.
Operator: Our next question comes from Tate Sullivan from Maxim Group. Please go ahead. Your line is open.
Tate Sullivan: Just looking at more change in rented compressors, do you -- I mean on net-net, do you still have any smaller horsepower units coming back to from the field? Or should it be given your recent CapEx and $95 million CapEx plan? Should it be a pretty consistent cadence of the increasing the total number of rented compressors in the field?
Steve Taylor: Any increase of -- well, an increase in the fleet is going to be obviously primarily driven by larger horsepower stuff. Any increase in rented compressors would just be dictated by utilization, which we expect the high horsepower utilization to stay high. The -- and I think the medium horsepower will probably stay fairly steady. The only risk to utilization will probably be in the smaller horsepower, which is primarily driven by gas markets. But we haven't seen -- even with the drawdown in gas price, we haven't seen a whole lot of return on that. We had some return last year due to price increases, which we expected. And obviously, operators don't like the lower gas price. But we haven't seen a a lot of equipment come back due to that. I think -- you have to remember, the gas price fell, but it didn't fall below where it's been for a decade. It went up mid to the end of last year and then it's come back down. But it kind of came back down to where it was. Just a low price we've all been used to for a long time. So -- if you look at it on just a point-to-point basis, it looks pretty bad. If you look at the trend in the last year or two, it's pretty much business as usual. Gas price just doesn't do much. There's just a lot of gas in this country. So, we don't see a whole lot right there. We have seen some weakness in pricing on it, but that's about it, but not a whole lot of returned equipment at this point anyway. And I'll kind of expand on that a little bit. I've had comments about, well, gosh, you get this -- go ahead and get this line of credit and you take on some debt you haven't had. And people don't remember, we used to have debt, but it's been 10, 12 years ago. You do this and now oil prices had gone down. Of course, they came back up today. Gas prices have gone down, interest rates are going up. Oh my gosh, what the heck's going on? And if you look at our overall fleet, about 25% of our revenue is driven by natural gas activity. So it's pretty small. It used to be 10 years ago, it was 100%. And with this large horsepower diversification, we start to -- started shifting our revenue towards oil commodity economics versus natural gas commodity economics. And so only roughly 25% of our revenue is driven by pure natural gas activity. And the other 75% is driven by oil, mainly due to the gas lift operations that a lot of producers have started doing based on -- with the shale production. So yes, if you look at gas price, it's something -- I'd love it to go to $5 or $10. I don't think it's going to anytime soon. But any variation in that gas price has a limited effect on what we're doing. It has no effect on our capital expense because we really don't reinvest in that smaller market, which is driven by natural gas primarily. All of our investment goes into the oil market. Now both commodities, both fluctuate oil is a better commodity from the standpoint that there's less -- it didn't stay low. Obviously, at fluctuates, you go high, you go low, but it comes back into a fairly normalized range at times. And then you look at what's happened on the macro aspect from the banking and interest rates and stuff like that, and they continue to go up and whatever the Fed you're going to do in inflation and everything else. I mean there's all kinds of countervailing wins on that. But the interest rates, we've got a good banking group behind us. TCB is in there. There's some big banks in there. They did a lot of due diligence on our projections and financials and they're comfortable with our plans. And we have some nominal leverage requirements. We don't ever in our projections see going above 3:1. In a downturn, we are typically protected by longer terms and the higher rates on that. So whether it's -- whether it's debt you're looking at or just the normal fluctuations in the business, those contracts help get you through those. And then if you ever have to do something on interest ratio. There are -- presently, there are interest rate swaps that are fairly attractive and things like that, you can go from variable to fixed and vice versa, if need be. So the interest rate thing, obviously, is something we watch. We haven't watched it in 10 years, haven't had to. But now with the CapEx we're spending, we'll generate a higher level of cash and EBITDA, and our projections look very good and strong and the banks agree with that. So, all those factors now, whether it's commodity pricing or interest rates, we pretty well got a good handle on it and feel like we're either naturally hedged or can get hedges in place if appears to be a problem. So long answer to a short question, I guess. But from the commodity prices and macro interest rate environment, we think we're in pretty good shape.
Tate Sullivan: And just one follow-up question on the compressors that you are retiring, and you retire maybe it's more of an accounting change when you choose to retire those units. But will there -- could there be any residual value in the retired units at all? Or do they just simply go to scrap with no potential proceeds long term for you?
Steve Taylor: Yes. The ones we retired in Q4 were all smaller units pretty close to the end of their depreciable life and actually a useful a lot because when we look at the retirement, it's not just book value we look at, but it's the cost of overhaul something, rebuilding something back up to usual potential and then what's your potential economic benefit from it, right? What's your rent going to be? And so that drives those decisions, too. We were talking about $200,000 worth, which was actually about 150 or 200 units. So, it wasn't much of a write-down for the number of units, but they're primarily smaller, we got out of the fleet. We typically will -- it's like taking a kid to a candy store. We have these units scattered around. We'll have the field guys strip off any parts they can reuse and then if we don't think we're going to use them to refurbish or reapply, we'll take them to scrap. But one example of reapplication is what we announced last year some electric motor conversion. We took some 250-horse class compressors took the engines of those. Actually, we built some of the industry reuse then put electric motors on them, and we're building up some electric drive packages. So we squeeze whatever juice we can out of that lemon before we just sum the rest to the scrap yard.
Operator: Our next question comes from Justin Jacobs from Mill Road Capital. Please go ahead. Your line is open.
Justin Jacobs: I appreciate you taking the time here. A couple of different categories of questions here. Let me start on CapEx. The CapEx numbers are surprisingly large, $30 million in the most recent quarter, sounds like you'd probably do something around another $30 million in the first quarter and $95 million for the coming year. Can you give me a description kind of as of year-end because when we have a detailed info, what -- how many units are in the process of getting built? And can you break that out by 2,500 horsepower, 1,200 to 1,300 horsepower, 400 horsepower. Just kind of trying to get a sense of what the fleet is going to come online in the coming year.
Steve Taylor: Yes. From a debt balance standpoint, so as I mentioned, we have $25 million at the end of '22 and $55 million at the end of essentially Q1 this year. So, we did spend $30 million in Q1. We had spent $25 million in Q4 because we had simply zero debt at the beginning of the fourth quarter last year. We're anticipating each quarter going forward, about $20 million to $25 million. So Q2, Q3, Q4, and they will end up at that $25 million plus $95 million or $120 million debt balance at the end of this year. Now what that's made up of in -- if you allow me, I'm going to be a little vague on the count of equipment. I mentioned the 15 2,500 horsepower units. I don't want to give too much away to the various ones listening in. But the balance -- the majority of the remaining and the remaining capital is 1,500 horse units, and that's going to be probably half of the budget of the total budget. So to use $120 million. And then the balance between that and the 2,500 horse units is going to be the 400-horse range. So it boils down to 400 horse, 1,500 horse and 2,500 horse. And the 400 is going to be roughly 10%. The 1,500 horse is roughly 50% and the balance is 2,500.
Justin Jacobs: Okay. So let me go a little bit different direction. All-in cost right now for a 2,500 horsepower. One of those compressors, -- not just the compressor, the overall piece of equipment to get it out in the field, what's the capital cost for that, approximately?
Steve Taylor: The package, it's going to run in the $2.75 million to $3 million range.
Justin Jacobs: Okay. And what is it for the 1,500 now?
Steve Taylor: Those are in the -- that's the same thing about $1 million cheaper. Well, let me say, $1.5 million to $1.75 million.
Justin Jacobs: Okay. So those have had -- those have gone up a little bit because my recollection from a year or two ago, probably two years ago. Those were more $1 million to $1.5 million. So, it's the inflation.
Justin Jacobs: When we started -- yes, when we started building those 1,500 horse probably almost four years ago, yes, they were $1.1 million roughly. They've gone up quite a bit.
Justin Jacobs: Okay. I can probably back into -- are any of the 2,500 horsepower as of year-end were any of those out in the field of -- I think it was said 14 that you had contracted?
Steve Taylor: No. No, they're being built.
Justin Jacobs: What's the expectation of timing when they go out in the field?
Steve Taylor: It's going to be a second half, I mean it's hard to nail it down because some of that stuff shifts around, but it's a Q3, Q4 sort of time frame.
Justin Jacobs: Okay. Yes. I guess in -- these are big CapEx numbers here. If we look at the earnings call a year ago, you told shareholders to expect $20 million to $25 million and sad to $20 million, $25 million, we did $65 million last year. We're doing $95 million this year. It's just trying to get -- I think it's important for shareholders to understand kind of what the plan is and where are we going here on capital outlay. And I appreciate some of the competitive concerns you have in terms of breaking out a number of units, but it's very difficult to project kind of what EBITDA is going to be generated out of this in the coming year and specifically the timing without some better detail of kind of on each of these units and what the fleet is going to look like.
Steve Taylor: Yes. And I understand what you're saying, and we've got, obviously, detailed schedules when things are anticipated to come out. Unfortunately, those schedules probably change every two weeks based on customer drive and demand. We've got them contracted, but the customers sometimes shift things around, move units in front and behind things like that. And I appreciate what you're saying. I just am hesitant to put out too much detail as mentioned just from a competitive standpoint as far as people know when and where. And obviously, they can guess, most of the stuff goes to the Permian. So, it's -- yes, I can try to think through and maybe come up with a better way to give a clearer picture. But I think I don't want to break down exactly when certain units are coming out, et cetera. And sometimes just the quarterly spend that I went through while ago -- that's probably the best detail I can give you with that going into this a year that many units and I understand it's hard to project EBITDA growth off that. But without getting in too much detail, I'm a little hesitant.
Justin Jacobs: Let me ask another question, which is as you look forward beyond that into 2024, what level of CapEx should we expect?
Steve Taylor: In 2024?
Justin Jacobs: Yes. I mean I'm just trying to understand if the building spree is going to continue, and that is kind of baked in.
Steve Taylor: Yes. That will put our -- well, I just went through puts our debt balance of $120 million at the end of the year, I'm assuming no interim paydown or anything. We've got $175 million commitment. Our borrowing base now is about $140 million. So presuming we get to the borrowing base goes up to $175 million. That leaves about $50 million not -- if nothing else changes as to what's led from that commitment. The 2024 CapEx budget is going to probably depend on really what happens in Q3 and Q4 as far as what other orders come in on large horsepower rental equipment. It's real hard it was real hard and almost impossible to say right now. I would -- I mean if nothing else, you could say, well, $5 million then we run out of commitment, right? But obviously, by that time, we'd have higher EBITDA flowing through and could get more if the market demanded more.
Justin Jacobs: Well, I mean that's just push back -- yes. But just to push back on that for a second. I mean, if you're saying that you've got these 2,500s that are coming on sometime in the second half, maybe the EBITDA is sitting at that point, but maybe it's not if there are delays, some issues getting out there. I mean Q4 a year ago you had significant issues and incremental costs in getting new equipment out in the field. So, that's my question here, is this kind of all plays into then capital structure, as you said, $120 million by year-end. That's slightly -- slightly below what your market cap is currently. That's a pretty material change. And you've got $125 million uncommitted accordion on top of that. I just don't know where you're going from a capital perspective. And I'm trying to get an understanding of thinking forward, not just one quarter or even three quarters, how much more that's going to be on this business?
Steve Taylor: Yes. Well, our projections show that our debt would peak and this is based on 2023 from what we see and then this equipment being set and EBITDA -- some EBITDA being generated in 2024, obviously, the full year of whatever is put in the second half. Our debt would peak in about the fourth quarter of this year. And all I can say is what we see from a static standpoint now based on our projections now what we see from the market and the borrowings. And then the EBITDA coming in starts paying that down and we would have the debt paid down in a couple of years after that. That's static. I know it and I know your question is, well, I want to now dynamics. I want to know what's going on next year. It's really hard to say what's going on next year. If the market stays strong, it could be. It could be another $95 million maybe. I don't know. That's -- I hesitate to fill that number out there because it could be $50 million or could be $25 million if everything -- if we have a big recession next year and things fall down. It's just hard to say. I'd have to really take a stab at something that really we don't have any basis and fact for right now as far as what next year is going to look like.
Justin Jacobs: Okay. All right. Let me go to a different topic here, which is the SG&A increase. If I look at 2022, it's $13.6 million, which is an increase of $2.9 million versus last year. All this increase is Q3 and Q4. In the fourth quarter, you're running at 4/8 of SG&A. Two questions for you. First is, what are the components of the $700,000 sequential increase from Q3 to Q4? And then second question is, what are the components of the $2 million increase from Q4 a year ago?
Steve Taylor: Okay. The primary differences in the year-over-year are the retirement and severance expenses and frankly, that it was my retirement agreement. And then John Chisholm's severance expenses, the interim there. So we had higher costs there over $1 million on that. There were double salaries in there from a CEO standpoint, certainly for about six months. We've had higher administrative salaries around $140,000 or $50,000 there. We had about $150,000 higher software expenses and about 300,000, well, about $0.5 million higher consulting and stock expense. So that's year-over-year. Now sequentially, the consulting and deferred comp, again, round about $500,000 higher. Health insurance is a little over $100,000 higher stock about $300,000 higher and administrative salaries also. So that's the majority of it. The majority of it is, as I mentioned, some of these transition costs of my retirement agreement coming back in, John being interim for six months in there and the associated expenses there and then higher administrative salaries and some higher software costs.
Justin Jacobs: What were the stock -- what were the nature of the consulting expenses?
Steve Taylor: We've had consultants like I mentioned on the accounting side. We've had some -- I don't know if the search expenses fell into any one of those. I have to check on that. That may be Q1 expense. And just some -- it's latest contract settlements and expenses we terminated.
Justin Jacobs: That's one of my follow-up questions is where are the search expenses? I know the Company has got multiple search expenses that was I was hoping at least that that's in Q4, but it sounds like that actually may be in Q1, so we've got incremental SG&A coming.
Steve Taylor: Yes. The -- it doesn't look like the search expenses are -- and I don't think the search expand. I had don't check for sure, but I don't think the search expenses are in -- up to Q4, I think they will show up in Q1. And so, that's why I mentioned we're still going to have some tailing off of some transition expenses over the rest of the year getting that the SG&A more in shape and down as we get other people in and other people out.
Justin Jacobs: Yes. Well, it sounds like it's actually going to go up a little bit because you're going to -- if you have your retirement agree of expenses that we're hitting in both Q3 and Q4, they're going to be there in Q1 still I assume.
Steve Taylor: Yes. That will -- but John Chisholm's expenses are all totally in Q or last year. And I think a fair amount of those consulting expenses are there too. And really, the RSU expenses all come down. So, there's going to be -- the search ones would kick in, but there are going to be some offsetting savings there, too.
Justin Jacobs: Yes. I mean it's kind of just big picture as I look at Q3 to Q4, your company adjusted EBITDA went up $20,000 on what were rental cost?
Steve Taylor: Yes.
Justin Jacobs: I'm sorry, the yes -- can you hear me again?
Steve Taylor: Yes.
Justin Jacobs: Okay. Yes, the Company adjusted EBITDA in Q3 to Q4, I mean, went up $20,000. So your rental profit increase, which is material, is getting completely eaten up by SG&A, and I'm trying to figure out what are the new units are coming in, when is that EBITDA rolling in? I've got SG&A volatility. Very difficult to see kind of what EBITDA looks like for the year?
Steve Taylor: Yes -- and no, you're right. That was disappointment in these results that the very good operating results got chewed up by some other transition severance retirement expenses. And it's -- I know we don't break those out publicly on the SG&A, but that's just looking forward and seeing what's coming off and what may be coming on, what's the only thing coming on would be that we see would be search expenses. Yes, we think we'll still be able to get down into that 13% to 15% historical range. We'll be approaching it towards the end of the year, but certainly into next year, I think we'll have that in a lot better shape because there are some trailing ones admittedly.
Justin Jacobs: Okay. Let me go just last question briefly. And this is kind of audit function questions around the Company. I know there's a material weakness in the K. Can you describe the issue a little bit?
Steve Taylor: Yes. It's primarily a balance sheet issue. There was some WIP that should have been classified as long-term assets versus inventory. And that was the biggest -- and there's some -- primarily, it was engine compressor build parts, stepping built that was classified wrong. There's also some vehicle and software expenses that round it out, but the majority were compressor components and costs that or just misclassified on the balance sheet.
Justin Jacobs: But you did -- I mean I think you mentioned another place you have brought in accounting consultants to -- is that partially to address at least partially to address these issues?
Steve Taylor: Yes, to help us. Well, the issues were addressed by our auditors and our own personnel. We did employ an accounting consultant to help us write up some -- clearly write up some findings we thought it was better for a third party to write the findings for the SEC and the K to put a little more detail succinctly in there. So that was the extent of the accounting consulting we used on that primarily to help us clearly define exactly what it was. But we, along with our auditors, have found it.
Justin Jacobs: I also note also your earnings were delayed. Your call was rescheduled to this morning. This is the second time this has happened in the last year. Can you talk to me about why the earnings were delayed?
Steve Taylor: It's primarily just the transitions going on. We've got an interim CFO. And then with the earnings and everything, we had to essentially have Moss Adams come back in and attest to the findings. Also anytime you switch auditors, which we did last year, the prior auditors had some review responsibility on that. So, that took a -- the whole process took a little longer than we had anticipated. And so, we held off the call. I think we announced it 10 days ago or so, we held off to make sure everything was done. And obviously, Friday was the deadline for the K, so we went ahead and put that out in the earnings and then have to call it a day. So it was a lot of transition and then just working through some of the issues that showed up in material weakness and plus two sets of auditors helping us.
Justin Jacobs: Yes. Okay. So basically, the resignation of Moss Adams was a factor in this delay.
Steve Taylor: Well, only from the point that they had to come back in and review and attest to what they had done because they were part of last year.
Justin Jacobs: Yes. Well I'm saying the fact that they weren't the auditor. You got a transition here, there was in. So going through all that transition plus not having a full-time CFO, that's an impact.
Steve Taylor: Yes, sir, definitely.
Operator: Our next question comes from Hale Hoak from Hoak & Co. Please go ahead. Your line is open.
Hale Hoak: I know this whole transition of your retirement kind of drive down longer than you wanted and been a little messier than you wanted. But appreciate you stepping back in and seeing it through. I'm curious, it seems like there's so much going on at the Company as the prior caller mentioned, you've spent almost your entire market cap in CapEx. And as it relates to that, if you're spending $150 million of CapEx between 2022 and 2023, and I'm using round numbers, and I know you're hesitant to give guidance, which I totally appreciate. But is there any kind of directional numbers that you want us to think about on paybacks? I know when John Chisholm was involved, I think he was talking about kind of five-year paybacks or 20% returns. I mean can we think of this $150 million of CapEx over two years, adding $30 million of incremental EBITDA once it's all up and running? Or is there any range you're willing to give us?
Steve Taylor: Yes. And the returns we are looking at, you're in the right ballpark. We're looking at five to six years, depending on the equipment, five- or six-year cash-on-cash paybacks. Some are a little higher but none of them are below the 15% to 20% range. Some of them are up into the 20% to 25% range. So the returns look good. From a EBITDA standpoint, again, we start to in the line of giving guidance or projections, but I think the -- you'll see EBITDA returns in line with what that -- the five- to six-year payout shows up, too. So if you can look at that CapEx, I think you'll be able to take that CapEx number and look at that five- to six-year payback and be pretty close to what we think EBITDA is going to be.
Hale Hoak: All right. And I guess, getting back to your transition, there's obviously a CEO search going on, but there's also some new directors being proposed. It seems probable -- possible to probable to me that you have a different looking board in the next three months. And it seems fair and reasonable to me that those potential new directors should have some input on who your new CEO is. Are you willing to stick around for three to six more months and let the board vote occur before a new CEO is committed by potentially a smaller and older board or the existing board?
Steve Taylor: Well, starting from the same perspective that I step back in when John needed to step down. I've got a -- as I remind people a couple of times, I've got a pretty good stake in the Company on over 5% myself. So, I'm intimately and intricately involved in how the Company operates and the returns given and certainly the value derived through share price. So, I serve at the pleasure of the Board, and I would serve longer at the pleasure of the Board if need be. I'm not going to my agreement ends June 30. And at that point, for the agreement, the CEO and President duties transition, they could transition earlier, too, depending on what the search finds, but that would be the -- the agreement shows that as the last date. But if the Company and the Board deemed it necessary, I'm not -- I'm not disconnecting my phone on July 1. This is -- obviously, I've been with the Company a long time. We feel like we built a pretty solid foundation of stuff and it looks like we're at pretty good jump-off point on some of the stuff. So no, I serve at the pleasure of the Board, either moving out or standing in whatever the circumstance may be that the Board determines its best.
Hale Hoak: Well, the Board serves at the pleasure of the shareholders, and you're an extremely large shareholder and our firm is your largest shareholder. And I would love to see you stick around and let the new board shake out. I mean it's quite possible or probable that there's two new directors at it. And I think that those people should have input on the CEO. So that's important to me. And if the current Board tries to ram through a new CEO before the annual meeting, I'd be extremely disappointed.
Steve Taylor: Yes. Well, and I appreciate your comments and your confidence, as you say, being a large shareholder myself, my duty would be addressed shareholder concerns and enhance shareholder value just like just like you're wanting as being the largest shareholder and certainly as Justin would like to. So again, whatever -- whoever ends up on the board and -- and I think the present Board has got nominations to come and whoever else might be added to it. Certainly, I'm all I'm all for whatever we need to do to enhance the value of the Company and contribute to the growth going forward.
Hale Hoak: Well, I appreciate your flexibility as always, and thanks for your hard work.
Steve Taylor: Okay, thanks Hale.
Operator: We have no further questions. I would like to turn the call back over to Steve Taylor for closing remarks.
Steve Taylor: Okay. Well, I appreciate everybody dialing in and the questions. As I just mentioned, I think we've got a good base to build from. We've got a lot of opportunity coming up. Obviously, some things are different going through transitions. We've got a bank line, we need to utilize and use, and certainly, we need to deliver the returns that that demands and entails. I think we'll have a good year going forward. And of course, I'll provide updates on our progress in the next first quarter call. So thanks again to everybody, and enjoy your day.
Operator: This concludes today's conference call. Thank you for your participation. You may now disconnect.
