Q3 2019 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the Interflex third quarter 2019 results conference call. At this time all participants are in listen only mode. After the speakers presentation. There will be acuity session to ask a question. During this session you will need to press star one on your telephone. Please be advised to today's conference is being recorded if you.

Acquire any further assistance. Please press star Zero I would now like to hand, the conference over to your Speaker today, Stephan Ali Director Investor Relations. Sir. Please go ahead.

Thanks, operator, good morning, everyone and thank you for joining US today here with me are Mark Rossiter, Interflex, President and Chief Executive Officer Soggy. Additionally, it reflects a senior Vice President and Chief Financial Officer, and then Park Vice President corporate controller.

During this call will be providing our financial results for the three months ended September Thirtyth 2019, a brief commentary on the performance of our business segments on a summary of our financial position.

Today's discussion will include forward looking statements regarding interflex as expectations for future performance in business prospects.

Forward looking information involves risks and uncertainties that could differ materially from those expressed in these statements. Please see our advisory columnist within our news release and other regulatory filings for more information on forward looking statements and associated risk factors.

Approximately one hour following the completion of this call recording will be available on our website under the Investor section.

During this call unless otherwise stated we'll be referring to the three months ended September Thirtyth 2019, compared to the same period of 2018 will proceed on the basis that you've all taking the opportunity to read yesterday's press release, I'll now turn the call over to Mark.

Thanks, Stephen Good morning, everyone.

Interflex delivered another quarter of strong results across each of its product lines driven by the continued growth of its recurring revenue business and operational excellence within engineered systems.

Revenues of $544 million, an EBIT of $88 million are indicative of the focus and commitment of our workforce, who everyday exemplify our values of integrity commitment creativity and success.

We entered 2019 with a record engineered systems backlog, which we've executed two exacting standards of quality.

Safety and profitability throughout the year.

This backlog included a small number of higher margin projects that were booked in 2018, and which are now progressing through the manufacturing and installation stages.

As these large projects are completed through 19 into 2020 , we expect that consolidated gross margins will normalize to the five year average of approximately 19%.

Offset positively by future contributions from our growing asset ownership platform.

Bookings in the quarter continued the trend that emerged during the first half of 29 team, bringing our backlog to $701 million. The current backlog consists of approximately 50 50 waiting between gas processing and gas compression projects.

And gives engineered systems revenue visibility to the first half of 2020.

While we believe our market share remains unchanged demand has suffered from a combination of restrain customer spending.

Global trade in political uncertainty and constrained access to capital for many industry participants.

As a business line that is invariably linked to our customers Capex, we expect engineered systems bookings to remain challenged into late 2020.

As in previous downturns, we have and will continue to aggressively manage costs and working capital well, we navigate this environment.

All that said, where we have not seen a slowdown is in our asset ownership platform.

Our strategic pivot towards asset ownership, which commenced in 2014.

Has provided a platform for growth within what we believed to be the largest opportunity set for the global natural gas.

Market today.

Our contract compression fleet in the USA has grown to a highly utilized 280000 horsepower.

Bringing our total global fleet to over 700000 horsepower.

This market continues to show strength and what we expect to continue deploying capital to these opportunities throughout 2019 and beyond.

We are starting to see some downward pressure on rates for small horsepower applications, particularly in challenged us patients, but by and large our rates and utilization have not just held their own but strengthened in the quarter.

Since the acquisition of Mason 2017, our U.S. rental platform has grown by 100%.

Having added approximately 60000 horsepower in 2019 alone across a combination of wellhead gas lift in midstream applications.

Well, our us rental platform has experienced significant growth. So too has the total us rental compression market, which remains constructive and which we expect to offer substantial opportunities for both organic and inorganic growth.

In our rest of World segment, we continue progressing the three previously announced boom projects from which we expect to combine annualized revenue contribution of approximately $30 million.

Commencing in the first half of 2020.

We're also in discussions for additional large scale boom projects within Latin America in the Middle East.

These opportunities are more complex and scale with longer contract durations, but also tend to have longer gestation periods before converting to executed contracts.

Our regional teams will continue pursuing these opportunities to further the company's goals.

With respect to our assets in Mexico. We previously stated that a portion of the contracts for the company's fleet will expire in December of 2019 and June of 2020.

And that we elected to not participate in the bid process to replace those contracts.

What's transpired instead is that the winning bidders were unable to deliver on their obligations. So we have seen a one year extension on some of our previously deployed units taking these out to December 2020.

We intend to continue aggressively pursuing opportunities with either P mix or independent producers in Mexico, and deploying idle units to global opportunities, where they can be utilized.

We're also seeing some asset ownership opportunities emerging in Canada, where customers are beginning to adopt electric power offerings on a rental basis.

Overall asset ownership represents the most significant growth prospect for the company and we intend to continue deploying capital to this higher margin less cyclical business.

As we explore these opportunities we are guided by our ambitions of bettering the quantity and quality of our earnings to provide stakeholders with a growing base of stable and predictable earnings.

While maintaining sector, leading returns on capital employed.

For the right opportunities, we are prepared to exceed our 2019 expectations of Capex, well conservatively utilizing the advantageous strength of our balance sheet.

Ultimately we are aiming for continued growth with at least 50% of revenues being derived from recurring sources in the future.

Going into year end and looking at 2020 and beyond global natural gas fundamentals remain constructive.

In the U.S. produced volumes of natural gas continue to grow and takeaway capacity is starting to increase although the growth stories in the us have moderated, particularly in the Permian basin, which is transitioning to a more mature development phase. The U.S. contains world class basins, whose long term development will demand interflex is products and services.

Yes.

And the rest of World segment several countries within Latin America in the Middle East are continuing efforts to displace the burning of coal and crude oil for domestic power generation and replacing it with cleaner burning natural gas.

The gas compression and processing infrastructure requirements to fulfill these initiatives are significant and form a large part of our international opportunity set for both engineered systems and asset ownership.

We remain cautious on the outlook for Canada, as eager as tissues and an uncertain political environment are limiting near term opportunities for growth. However opportunity still exists in relation to LNG development and electric power both of which our teams will preserve pursue in earnest.

I'd also like to address our increase in the dividend returning money to shareholders as had been a priority for the company since 2011 and will remain a priority going forward. Since 2011, we have increased our dividend by over 90% and we are proud to show our commitment to the sustainable and predictable return of cash to shareholders.

Lastly, I'd like to welcome Sanjay Additionally to enter Flexes executive management team as Chief Financial Officer, Sanjay brings a wealth of experienced interflex and will be instrumental to future growth I will now turn things over to Sanjay to review our financial results.

Thank you Mark.

Interflex delivered another strong quarter of operational and financial results record revenue of 544 million and adjusted EBITDA of 107 million represent 22% and 63% increases over the prior year period, respectively.

As Mark mentioned our performance this quarter was driven by a combination of improved gross margin percentage from engineered system projects in the backlog and contributions from both the organic expansion of the contract compression fleet in the us and increased aftermarket service activity.

Increased revenues and improved gross margin resulted in record EBIT for the quarter of $88 million net earnings of $63 million were 71 cents per share reflect the 66% increase over the prior year period.

As DNA totaled $45 million, a $5 million increase partially driven by compensation cost for a larger workforce and the effective cost recoveries recognized in the comparative period.

During the quarter Interflex invested $55 million in rental assets largely in the us continuing the organic expansion of the us contract compression fleet.

Excluding additions to PPD year to date growth Capex of $141 million has been deployed towards our global asset ownership platform.

In the absence of or inorganic opportunities our full year expectation for growth Capex remains consistent with previously indicated $160 million.

Turning to bookings.

Engineered systems across all regions saw $126 million of new orders in the quarter, reflecting decreased customer spending as Mark mentioned.

Certain growth engines, such as the Permian basin appear to be transitioning away from smaller producers towards major oil companies and large independents.

While our expectation during the first half of 2019 was that engineered systems bookings activity would improve into year end.

We now believe that bookings will be challenged in the near to mid term. While this transition unfolds. However, we believe that this shifts across all basins is a positive dynamic for interflex that will allow us to utilize our strengths of size scope and reputation to capitalize on for.

Unities.

Demand for Interflex. The service expertise continues to grow service revenues saw an increase across all regions due to higher activity levels and the company secured several new long term service agreements in the quarter.

Consolidated rental revenue grew by 13% over the comparative period as a result, the organic growth in the us contract compression fleet.

As Mark mentioned, we continue to assess opportunities to allocate capital to this initiative as we believe in its ability to provide a significant base of predictable sustainable profitability.

Turning to the balance sheet Aeroflex continues to invest in fleet expansion and has access to a significant portion of its bank facility for future drawings to meet its growth targets.

As of September Thirtyth 2019, the company held cash and cash equivalents of $220 million and had drawn $88 million against the bank facility, leaving it with access to $589 million for future drawings.

The company is net debt to EBITDA ratio currently stands at 0.6 to one.

We also continue to diligently manage working capital to maximize flexibility as we pursue addition.

Demand for natural gas is growing globally, which will drive demand for interflex as products and services.

Although we have seen in some near term challenges in the customers converting inquiries into bookings growth in our asset ownership and aftermarket services platforms is expected to add stability to future earnings.

Interflex continues to benefit from the strategic decisions to diversify both its product offerings and geographic footprint and we remain committed to this strategy.

This completes the formal component of the webcast additional details can be found in our December 7th press release.

We will now be happy to take any questions.

Thank you as a reminder to ask a question you will need to press star one on your telephone to withdraw your question. Please press the pound cake.

Our first question comes from the line of Great National Bank Finance. Your line is open. Please go ahead.

Hey, guys congrats on the strong quarter and thanks for taking my questions.

Thanks, Greg no problem I'd like to start by by taking a look at the margins here.

On the margin you mentioned in your prepared remarks.

I have a normalization of margins going forward I might've missed the timing on that can you give us an idea of what it should happen and if I just missed I'll go back and read the transcript, but is this like a Q4 thing where it's going to snap back or does the high margin project work keep those margins elevated going into year end and it's more of a 2020, when we start seeing normalized.

I think into into 2020, you'll see a normalize.

I'd say, probably Q2 onward.

Okay.

Useful.

On on the recurring revenue side and on the EBITDA margins and whatnot. We've a very good feel for what you are recurring revenue wise for the quarter. We got it at about 2020, 7% the rentals and service business, there, but how much of a 106 million in EBITDA was associated with those recurring revenue groups.

Well that's a good question, Greg we don't we don't disclose that in practice I think that we've mentioned before that we think roughly a third.

Of the EBITDA is from recurring revenue, but we don't give the exact number.

No problem it was worth a shot.

Hi, John .

Switching over to the backlog.

We are continuing to see a role obviously your common suggested the bookings are about to reignite in the near term I guess I have two questions. There one is.

Can you give us an idea of how far out the current backlog stretches you did mentioned it provides comfort for 2019 and into the early part of 2020, but at the risk of being too pedantic here is early 2020 Q1 for each one.

I'd say, it's more like H one Greg.

All right. So this will stretch out into the Q2 and then in the longer term when we start to see the backlog growth reignite.

Where geographically do you see the highest likelihood of that occurring.

The pipeline right now is a little bit more buoyant in the United States and it is in Canada.

The for opportunities. They just they look better they have a better feel to them and the lower 48 than they do in Canada.

And the rest of World segment, a lot of our business development activities are circulating around boom opportunities not necessarily engineered systems that you'd see in the backlog.

So that's that's a relative strength of each one.

Got it okay. So number one us.

Number two Canada I guess.

The industry would be rest of the world.

That's right on that rest of World segment.

Bookings in the quarter have been under $10 million for the law for through the last four quarters and now the backlogs under 20 million.

You did $90 million, an engineering systems revenue for that segment. This quarter is there risk that theres no contribution from rest of the world engineered systems moving into 2020.

I don't think Theres, a risk of that Greg I think the maybe the reduction and engineered systems revenue for rest of world is due to a couple of factors. The most significant of which is we're really directing or business development teams towards asset ownership opportunities as much as possible.

The second thing that is putting pressure downward pressure on the EPS bookings for rest of world is that we sort of change our risk appetite for integrated turnkey projects globally and those fall under engineered systems bookings and Thats, probably the last 12 to 18 months that we've done that so I'm not saying this is the new normal from restaurant.

So for engineered systems bookings by any stretch, we would should love to be higher we like that business, but that's that's why it's a little bit lower and it's a little bit too early to say, what we'd expect from 2020, we would love it to be much higher.

In that we'd love to find a lot more opportunities to sell equipment globally and to do the the appropriate.

And integrated turnkey projects as well.

Okay that makes sense.

And then lastly, this is it for me.

On the broader bid pipeline.

Bookings for the first nine months of averaged a 140 million, which is well below the Q2 like the pre Q2 18 average of $270 million just kind of something in the past you guys have pointed to is something that would normalize.

Based on your prepared remarks today is it fair to assume that you're not about to snap back way above that bookings level that to 70 bookings level in order to make the average around to 70 simply because things are a little bit softer right now.

I think if you look at the macro in areas, where we operate I think it's pretty reasonable to assume that getting back up to 270 in the immediate future is unlikely.

And I don't think Thats really a big surprise to anybody thats watching the space I think that to 70 was.

Benefit of a couple a real big.

Upturns.

Over the last five years.

Got it okay. That's it for me thanks for taking the questions.

Thank you and our next question comes from the line of Keith Mckey with RBC. Your line is open. Please go ahead.

Hi, good morning, and thanks for taking my question.

Just.

Just on the recurring revenue, particularly the service side, we did notice a decrease in service revenue quarter over quarter in I think all geographies.

I guess two parts to this what the what would you say is the cause of that and do you expect to material risk of that trend continuing.

I'm going to ask Ben Park to answer that question. So if you actually take a look it was it was a higher proportion of part sales were higher than expected portion of part sales in Q2, you actually take a look at Q1 versus Q3, you'll see the Q3 is higher than Q1, so that was just.

Something that we saw in Q2 that was.

Which was beneficial but it was a little bit unexpected in terms of the levels that we saw there and there are some fluctuations that will occur as we get particles within a quarter.

Got you so we shouldn't expect to see that that as a as a trend as a trend downward then it's just an anomaly that Q2 was was with higher.

Exactly.

Okay and.

How should we be thinking about service revenue next year, particularly in the context of all of the work and projects that you're delivering this year should we expect to see contracts put on some of that stuff to help kind of support that service line or or we're not seeing that yet.

Keith Thats, a very reasonable assumption, we do commission and provide service support right. After delivering thing. So we always see service always gets a beneficial uplift when we've had a good run of engineered systems bookings and delivering those things so thats a pretty reasonable assumption.

Okay. Thanks on the last one from me when we say booking is going to be challenged into late 2020 are you.

Not optimistic about them, improving from current levels or or or.

Are we thinking that it's going to be much lower than the then the historical that to 70 number.

So there's probably a couple of things I'm I'm thinking about Keith first of all.

2018 was a really busy year in the United States like really busy and so I think that.

There was a lot of people bought a lot of stuff and we're currently we're sort of suffering from an overhang from 18, but also the capital constraints. That's a dynamic that we just don't fully understand when it might ease off we understand.

Pressure on our business from commodity issues, that's what we've dealt with for a long time sort of a capital imposed restrictions on our customers is something that is difficult for us to predict when it's going to change meaningfully so thats were being somewhat pessimistic by saying into the latter half of 2020, because it's just tough to say.

Got you okay. Thanks, Thats it from me.

Thank you and as a reminder, if he would like to ask your question. Please press Star then one.

Our next question comes from the line of John Morrison with.

Hi, BC capital markets. Your line is open. Please go ahead.

Good morning, all.

Has there been has there been any change in the delivery schedule for the current backlog as we see producers pullback on Capex plans and temperature growth or should we think about the backlog having.

Fairly from high conversion rate as those engineered systems.

Orders naturally had fairly definitive delivery schedules.

The.

The orders had definitive delivery schedules and.

We haven't seen by enlarge the customers asking is to push those things out.

Okay. It's fair to assume that there was no major cancellations to talk about.

Either.

That's safe to assume yep okay.

125 million a bookings that you made in the quarter with the delivery schedule on those be fairly typical to what you've seen over the past year or faster or slower.

I think there'll be faster, let's say that in 2018, we were talking in terms of nine to 12 months was an average delivery and I'd say now we're probably talking in terms of.

Five to nine months, depending on the product.

Okay. So is it fair to assume that the delivery schedule over the last 12 to 18 month since it was such a robust market was more limited by your own delivery in your peers delivery ability more southern customer demands.

Yes, I think so and.

A lot of that nine to 12 month delivery that we are providing customers was based on how quickly we could get engines and compressors. There's a couple of Oems that have a big market share and their deliveries went out into the 40 week range, which pushed ours out into that nine to 12 months those deliveries have come in our shops is not are not as busy as they used to.

Then, but still there is a natural speed with which our customers can react if it's a midstream build project. They take some time to get the overall project done if we're talking about putting field compression in.

We'll be able to meaningfully deliver that faster like well inside of six months going forward and our customers will be able to install that stuff faster. So I think the backlog new bookings in Q4 in Q1, they will have a much shorter delivery time, especially if its directed towards compression and smaller projects.

It's in the lower 48, and Canada, Okay. So inline with like the data points that we're seeing where a high horsepower cat engine or a large from compressor maybe down to 15 16 weeks.

That means that should we see spending inflect in call. It mid 2020, your ability to convert that into revenue and cash flow. You believe is much shorter than has been the case over the last 18 24 ish months.

I agree completely yes, I think the bookings in Q4, Q1, Q2 will have a much higher likelihood of converting to billings for 2020, then would have been the case a year ago exactly.

Mark did the bookings number surprise you this quarter as I know that you would love to have it had to handle on it but I guess.

We weren't shocked by the number just given some of the spending pullback that you're seeing in the market is that fair and inline with your view.

Well I was I was disappointed but maybe I wasn't so surprised.

I was hoping for some things, but the end users just didnt have the capex to spend and they're really being quite cautious as much as are cautious on capex opex doesn't seem to be under the same sort of pressure, hence the recurring revenue in the service numbers really quite good but I was I was disappointed but not surprised okay.

You continued to see solid rental opportunities in the U.S. deploying another north of 50 million on equipment ads in the quarter is that at all slowing in the last two to three months or again since customers. Since your customers are under is much pressure on the Opex side, you might actually see those inquiries uptick.

Slightly in the coming period.

Yes. This is sanjay.

There's a couple of variables that are going into that definitely overall activities coming down a bit but then the desire to get things off balance sheet is going up so you've got a couple of things that are sort of working in opposite directions. There I think it's fair to say like 55 million in a quarter or was it was a pretty good clip.

So I think we would expect.

The foot to come off the gas pedal a bit, but we're still seeing a pretty robust investment in the rental fleet.

Okay. That's very helpful of the contract extensions that you did in Mexico did pricing on those largely hold at the previous rates or where are you in a position to perhaps push pricing since.

Some of the appears that couldn't deliver.

Let them needing those packages.

I think it's fair to say that they were they were pretty much at historical levels.

Okay.

Sungy or Mark I guess can you give any color around the conversations with the board on.

Calibrating the dividend increase that you did to a 10% and what underpin that was it largely payout based.

Or was there something else.

That underpin the denomination that was ultimately chosen.

I think it was yeah. It was really a commitment to return money to shareholders and I think that.

The management team in the board views the dividend is a very efficient way to do that.

It's not really placing any any undue strain on the balance sheet as you guys are probably aware.

So we felt like it made a lot of sense to a lot of our shareholder base to support the dividend and and return money in that fashion.

Is it fair to assume that that level of increases probably the Max that you'd want to push that is ultimately sustainability in long term durability of that commitment to shareholder cash returns really doesn't want to be questioned.

Yes, I think I mean, those are all the variables that we're looking at.

Right quarter to quarter as we're looking at the dividend. So absolutely. We don't we don't ever want to be in a position where the dividend is straining.

The free cash flow that's available.

So I wouldn't I wouldn't expect us to want to accelerate or do you or decelerate I think we feel pretty comfortable with the.

The rate of growth that we've shown historically and that we're showing today.

Maybe just one last one for me Mark is the level of bidding in Latam changed at all in the last six to 12 months as you referenced theres still a lot of whom problem projects out there or have you seen any major projects that either were cancelled or you want awarded that you thought you were well positioned to win.

I'll take that last question first we havent had any what I would call significant losses.

In the last 12 months in Latin America, I would say that the projects. We would have hoped to have converted by now were largely deferred due to.

Elections in Argentina.

A different things going on in Mexico, we like to Brazilian market and the projects in Brazil are big and Theres big industry players or look at them. So they never move as quickly as we wish they would that's more of the flavor of it than any meaningful losses or change in market share.

Okay I appreciate.

The colors good quarter ill turn it back.

Thank you and our next question comes from the line of Matthews with Industrial Alliance Securities. Your line is open. Please go ahead.

Good morning.

Good morning.

My first question just a clarification, sorry, I think I just missed this earlier when it comes to those build own operate maintain contracts.

You said, we'll be starting an H. 120 did you say that would be contributing 30 million in revenue annualized.

Yes.

Okay, great. Thanks.

And would that be sort of all kind of right once or would it be a bit more of a ramp up.

It gets pretty close isn't it Ben yes, it really I don't know the projects are slated to all hit at the same time.

So.

I don't think that we can say that it's going to be a huge ramp up but but they're not that far apart. We're talking only six month difference there when we're talking first half of the year.

Okay, Great and Im also just one question about the engineered systems revenue I was just wondering if you could quantify what sort of proportion of that would be sort of book in turn business. You know projects that are booked and.

Converted in the same quarter.

So let me let me try to understand your question Matthew the.

Are you talking with the bookings in the quarter. The that we had like how much of that is going to be turned or maybe if you can just ask question again to make sure I get it right.

Sorry, just I'm, just kind of wondering generally kind of it in any quarter.

What sort of proportion of engineered systems bookings would be converted within the same quarter as opposed to.

The work done later on.

Hardly any.

Hardly any of those would be.

Sometimes we have inventory that we can sell and deliver in the same quarter that hasn't been all that comment and I wouldn't say that thats a material part of our numbers. So the majority of our engineered systems bookings will be turning to billings at the earliest six months and they could stretch into 12 months from the data booking until they roll off into bill.

Thanks.

Okay. Thanks.

And just one last question switching to USA compression rental.

In terms of the demand you're seeing there.

Would you say that from the time that you invest in additional horsepower to the time that its utilized.

Pretty quick would you say does that happen right away.

It happens pretty quick if we have.

Hey, idle equipment. It can happen within weeks, if we have to build it from scratch, which we have had to do so far this year because our utilization is pretty high then it's really from the day, we get the assigned rental contract until it's making revenue could be four to six months just depends on the package.

Okay.

Would you be able to quantify sort of where your utilization is right now.

We Ben I'm looking to you to make sure that were I mean, I don't think than we've ever really disclose that but we are.

Yes, we are above 80% were well above 80% globally.

Yes.

Okay, great. Thank you that's it for me I'll turn the call back.

Thank you and I'm showing no further questions at this time and I would like to turn the conference back over to Mark roster for any further remarks.

Thank you operator since there are no further questions I would like to once again. Thank you for joining us on the call. We look forward to given your fourth quarter results of February have a good weekend.

Ladies and gentlemen. This concludes today's conference call. Thank you for participation you may now disconnect.