Q4 2019 Earnings Call
Ladies and gentlemen, thank you for standing by and welcome to the Interflex fourth quarter and year end 2019 results.
This time all participants are in listen only mode. After the speakers presentation. There will be a question and answer session to ask a question during that section you will need to press star one on your telephone. Please be advised that today's conference is being recorded if you require any further assistance. Please press star zero.
I'll now hand that conference over to Stefan Ali.
Good morning, everyone and thanks for joining US here with me are Mark Rossiter, Interflex as President and Chief Executive Officer Sundry. Additionally, it reflects the senior Vice President and Chief Financial Officer, and Ben Park enter.
As it in corporate controller.
During this call will be providing our financial results for the three months ended December 31st 2019, a brief commentary on the performance of our three business segments, and a summary of our financial position.
Today's discussion will include forward looking statements regarding interflex is expectations for future performance and business prospects are forward looking information involves risks and uncertainties and the stated expectations could differ materially from actual results or performance.
Please see the advisory comments within our news release and other regulatory filings for more information on forward looking statements and associated risk factors.
Proximately one hour following the completion of this call.
Gordon 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 December 30, Onest 2019, compared to the same period of 2080.
We'll 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 stuff and good morning, everyone Aeroflex as fourth quarter results conclude a strong year performance across all product lines. During the quarter. We continued to build out of our asset ownership platform, where we've added approximately 30000 horsepower tour U.S. contract compression fleet and continued progressing our three previous.
The in house boom projects in Latin America, and the Middle East, which we expect to begin contributing to our results at various times through to mid year 2020.
Although our quarterly results were impacted by a nonrecurring write off of specialized assets, which Sanjay will elaborate on.
We see continued strength within our asset ownership platform, both within the U.S. and internationally, having landed a small but important post corner five you're doing project in Brazil, which will strengthen our presence and reputation in that country.
Details as to timing and estimated revenue contribution from this particular project will be communicated in due course after final specifications are determined.
In 2020, we anticipate the continued build out of our rental fleet with the growth Capex spending plan similar to 2019.
However, we are prepared to allocate additional capital to our growth initiatives for accretive opportunities.
Putting utilizing the strength of our balance sheet, if it makes sense to do so.
We have been asked whether we're concerned about overbuilding in the rental space, we want to clarify that the majority of a rental assets under construction, whether within the U.S. or rest of world segment, having associated contract with a customer before we manufactured equipment.
Given that most units are underpinned by a binding customer contract before the relevant unit is constructed.
Asset ownership Buildout is less speculative then sunlight. Thanks.
For boom assets nothing is built on a speculative basis because it. This dynamic we have good visibility into where market demand for rental equipment is heading and whether or not to tap the brakes or accelerate our capital expenditures. Our fleet growth in 2019 is indicative of the health of the market as is the 87% utilization.
<unk> for U.S. contract compression fleet, which is comparable to the largest players in the space.
Turning to engineered systems, we continue to executing on our backlog and working through the higher margin projects that were booked at the end of 2018.
These projects were milestones for the company given their size and scope and were executed two exacting standards by or Calgary and Houston teams.
The margins earned on these projects were used to fund growth in our asset ownership platform, which assists in stabilizing future financial performance.
Well, we successfully executed projects within our shops customer disputes related to I.T.K. projects in our international segment negatively impacted our results. These I teekay projects have now been completed and are awaiting final payment.
The bookings during the quarter and through 2019 for that matter was less than desirable.
Bookings of 96 million on the quarter represent the fourth consecutive low bookings quarter and the lowest since Q1 2016.
Well, we're obviously dissatisfied with the pace of bookings through 2019, our bid pipeline for new engineered systems projects clearly indicates that producers are contemplating capital projects through 2020, and we believe we will capture our market share across all geographies.
The question that remains is when do those bids convert to bookings and while that cannot be answered with certainty the longer this bookings downturn persists, the stronger or expectations of a rebound that activity as it becomes a matter of time until at least sustaining investment returns.
As far as catalysts are concerned the Permian basin is still getting a lot of attention and we're hopeful that with continued resolution of eagerness issues 2020, we'll see a sizable addition of producing wells a particular interest as the international space, where we see significant opportunities for projects that will facilitate the displacement of other fuel sources for local electrical power Gen.
Ration in favour of natural gas.
In Canada activity across the industry is expected to be flat as eagerness issues remain unresolved that said there appears to be some opportunity within liquids recovery and electric power Gen, which our teams are chasing.
We're also encouraged by the strength of our aftermarket services business, which in the fourth quarter posted the second highest quarterly Amos revenue in the company's history.
Unlike previous commodity price driven downturns the challenges of today's market revolve primarily around our customer base exercising a disciplined approach to growth capital expenditures, while continuing to dedicate capital to maintenance expenditures.
Barring any significant declines in commodity prices or changes in customer mindset. We expect this strength to continue through 2020.
Overall 2019 was a tremendously successful year operationally for Interflex and I would like to thank our 2500 employees for their dedication and commitment to delivering quality products to our customers.
For 2020, so long as the weakness in engineered systems bookings persists, we expect a more challenging operating environment in which our focus will turn to controlling costs and disciplined management of working capital.
On a positive note the build out of our asset ownership platform will utilize shop space throughout the year well the insourcing of work facilitated by our Houston. This expansion will allow for better cost controls.
This is a differentiator that did not exist during the 2015 downturn and beneficial aspect of our vertically integrated platform.
I'll now turn things over to Sonji to review our financial results.
Thanks Mark.
Fourth quarter revenue was consistent with the prior year period, but decreased from the previous quarter due to lower engineered systems revenue on weaker bookings through 29 team and scope changes on major projects that slowed revenue recognition.
A decline in engineered systems revenue was partially offset by increased contributions from our aftermarket services segment and our growing contract compression fleet with recurring revenue increasing by 14.5% year over year.
Gross margins increased over the comparative quarter, driven primarily by higher margin engineered systems projects that were booked near the end of 2018 in which will be completed in Q1 of 2020.
On an annual basis consolidated 2019 gross margins of 21% represent the highest annual gross margins in the company's history.
However, fourth quarter gross margins were negatively impacted by three events.
Firstly, an increase in warranty expenses for Canadian project completed in 2019.
Secondly expenses related to customer disputes in our rest of world segment.
And thirdly, most significantly a write off of rental equipment totaling approximately $24 million.
The majority of this write off relates to specialize compression units, which were acquired as a part of our 2014 acquisition in which have never been utilized by Interflex nor generated revenue for Interflex.
The asset write offs is a nonrecurring event, but its impact on quarterly gross margins and ultimately EBIT is material.
We also took action to better align our cost structure with near term activity levels expected from the engineered systems business.
Selling general and administrative expenses increased over the comparative quarter due to the effects of cost recoveries recognized in the prior year as well as increased compensation on higher headcount, partially offset by mark to market impacts on share based compensation.
EBIT was consistent with the comparative periods. However, once adjusted for unique items and nonrecurring events. The fourth quarter of 2019 was a notably better than the same period a 22018.
Going forward, we reiterate our message that we anticipate gross margins reverting to their historical norms due to the slower activity in the engineered systems segment.
As Mark alluded to engineered systems bookings activity is anticipated to be sluggish to start 2020.
However, our bid pipeline is encouraging, particularly in international markets, giving us us some cautious optimism that bookings activity may pick up in the back end of 2020.
Growth of our asset ownership platform was strong in the quarter with $76 million deployed towards rental assets.
Rental results in the quarter were hampered by the asset write off.
Portion of this was a unique nonrecurring charge and added back for adjusted EBITDA purposes.
Notwithstanding this write off our rental product line is well positioned with a global feet fleet, consisting of 670000 horsepower 310000 of which is allocated to our us contract compression business.
For perspective, today's us contract compression market comprises over 13 million horsepower.
From a capital allocation perspective, our priorities in 2020 are threefold.
First deploying capital towards organic rental fleet additions.
Second growing the dividend at an affordable and sustainable rate.
And third seeking inorganic growth opportunities.
We do expect to deploy capital at a similar pace to that of 2019.
That said additional accretive opportunities may arise throughout the year.
Across our diverse geographies and with a net debt to EBITDA of one to one in access of up to 557 million of additional credit we're prepared to utilize our balance sheet strength to capture opportunities that move us closer towards our strategic goals.
With respect to inorganic growth, we continue to assess potential acquisition and purchase leaseback opportunities, but are exercising patience and discipline in our approach.
This completes the formal component of the webcast additional details can be found in our February 20 of press release, we will now be happy to take any questions.
Thank you and ladies and gentlemen, if you have a question at this time just press Star then one on your telephone to withdraw your question just based upon key please standby well, we compile that Ken a roster.
And we have a question from the line of Matthew weeks with Industrial Alliance. Please go ahead.
Good morning.
My first question was just a clarification.
So there was the 24 million an impairment charges and I was looking at the adjusted EBITDA on and I'm, sorry, if you've covered this already but it looked like 14 million was added back to arrive at that figure, but the other 10 million was not accounted for there.
Was it included.
In expenses when arriving at your adjusted EBITDA.
Yes, Thats correct Matthews's Sanjay so.
You're correct. The for the full impairment was 24 million those were all idle assets that were not generating any revenue for interflex.
And we did think a little bit about whether we should add back the full 24 into adjusted EBITDA, We took a little bit more of a conservative approach.
And we only added back the 14 million.
Which is associated with assets that were never never utilized under the ownership of Interflex.
And that's what came back into adjusted EBITDA, but you're correct that.
The full 24 does hit the expenses.
Okay. So if you had added it all back EBITDA could have been.
Could have been bigger than.
That's correct, yes, it would have been just around $100 million for the quarter. If we had added the full amount back.
Okay.
Okay that makes sense. Thanks. My next question was just around around bookings.
Was wondering I was kind of we were expecting bookings the Pete to be low, but this was particularly low quarter in the context of the year I was wondering if there were any large.
Project that maybe are bidding on that you didnt win or.
You weren't getting your share of.
Bookings in the market or kind of what happened there or if it was just in general.
Weak industry spending.
Oh. This is mark cross that are I would say in general weak industry spending.
Okay. So it wasn't due to a lack of.
Market share or anything like that or any or any big misses in particular.
No.
Okay.
And and the outlook for bookings.
Would you say as far as things look like right now is pretty similar at least in North America going forward, but you see more upside in the international market.
I would say that our level of bidding activity.
Over the last month and I have two months has been more promising than it was in Q3 in Q4 as 29 team.
And like we said in the prepared comments. The real question is when that bidding activity gets backed up with orders from clients, we feel better today than we did three four months ago, but we're still cautious that people have to pull the trigger in spend money on things and that's specific to north American engineered systems sales.
Oh Im.
Additionally.
We feel a much different and more exciting.
Sentiment in the Middle East in Latin America for new projects than we did throughout most of 2019.
So we're optimistic now in those regions, we spend a lot of time and effort on an asset ownership opportunities and the little bit less so on the sale of engineered systems. So if good things happen, you'll see it in a announcements of new boom contracts, new rental contracts et cetera throughout those regions, but I think that.
A lot of companies in our space. The narrative is North America slow international good I would agree with that sentiment in general, but theres been a slight pickup in the bidding activity in North America and will well kinda believe it when we see it if you know what I mean.
Yeah exactly so.
Well, just one last kind of follow up to that.
And you say there has been sort of a recent pickup at North America, and that's kind of.
Contrary to what I was expecting so you haven't seen kind of a decline in the customer conversations due to what we're seeing with the co bid 19 buyers.
No that hasn't actually come up.
At all in our North American bidding activity.
Okay.
That's it for me thanks.
Thank you.
Thank you and our next question comes from John Morrison, We see Ibcs capital markets. Please go ahead.
Good morning, all up Sanjit sorta get granular on the write downs, but can you just disaggregate those numbers a little bit more so the there was 9 million that effectively you elected to not add back in the adjusted number can you give anymore color on what the nature of those write downs were versus the 15 that was obviously very.
Three related to assets that hadn't been used for a period of time you thought it was just prudent so effectively I assume you wrote those down to zero, but what was what was the actual nature of the other night.
Yes. So the other nine were sort of other older assets that had been had been used but they were idle.
At this time and we just they did carry some book value to them, but they weren't generating any any revenue for interflex and we just felt that.
The the value of the assets wasn't wasn't really there they weren't really redeploy level with.
Miskin investment to the assets. So that's the general nature Theres a couple of different categories. A lot of it was was still in Latin America, but there was stuff in the United States as well.
And would there be some likelihood to those assets eventually being redeployed are you largely view those to be.
Going to the salvage yard at this point.
Yeah. There is so there is actually some likelihood that they do get put back to work in fact, we've had some commercial interest in them, but but nothing to the point that that we felt like we shouldnt be doing the prudent thing and taking the write off at this time.
The inventory number obviously built throughout the year end you ended about 100 million higher than you did Q4 18 was that entirely a function of ordering things for the strong engineered systems bookings that were coming in.
And basically being able to take advantage of the supply chain that was long at that point or should we be thinking about some of that higher inventory number eventually being converted into some of the contract compression fleet build out that you're doing right now.
Yeah, I think you know the driver I think you hit the nail and ahead with the driver John So it was very much tight supply chains things really active in all business lines really contract compression plus engineered surfaces and so we needed to order.
For a long lead items to kind of stay ahead of the orders at the time and you know as we all know the story orders fell off pretty pretty quickly and I think it's a pretty common effect, where are you still got your supply chain active and you still have assets coming at you.
So that's really what that's really what drove the increase in inventory.
I would say that all the the assets that can pose that inventory are all fungible assets. So they're all things that we're going to need.
Whether it's in the engineered systems business and it comes up as an order or whether its.
Assets that we roll into the U.S. contract compression fleet I think thats remains to be seen and we'll put them to work.
In the most logical place that that it makes sense to put them to work but.
We view them as perfectly fungible assets and eventually we'll use them.
Okay. So its caterpillar engines compressors things along those lines that maybe the inventory number comes down a little bit slower than you'd like but it will fall into one of those two buckets and there is no oddity to those assets that you wouldn't expect to use them in the coming years.
Yes, that's a good way to think about a John.
Okay International margins going forward, obviously, they were negative in the quarter.
Was that a function of just the low engineered systems number or was asset utilization in any particular country, maybe a drag to performance.
So that is directly related to the impairment John and the vast majority of the impairment was taken in the international segment and so if you add back that $24 million to the gross margin line you'd see that it was a pretty in line quarter.
Relative to Eathree. So that's really what's driving that I don't I don't think that there's too much beyond that that.
Would be material.
Okay, and Mexico, obviously, theres been some choppiness in that market and the rest of world segment any update on.
Whether the line of sight for 2020 would be stronger than maybe what we saw on 2019.
I think we're kind of expecting a fairly flat outlook for for that geography in particular, but again as you say, it's a geography, that's kind of prone to surprises both on the positive side and the negative side.
<unk>.
Just in terms of the order inquiry in the Middle East being strong is that specific to boom projects is it's specific to engineered systems and any idea around gestation period, just because the sales cycles nationally or longer outside of North America is that something that you would think hitting from a 2020 per.
Active or.
Is it longer term in nature than that.
John This is mark the we have our sales teams pointed in the middle east preferentially towards asset ownership opportunities, but they look at engineered systems opportunities as they come in the stuff. We have in front of this right now that we're working the hardest on our asset ownership opportunities and.
There are several that would have a closing date in 2020, if the customers proceed on that sort of pace that they've told us they will and we've got an experienced is sometimes customers don't proceed at the same pace that they initially tell us they will so we'll see but I'm quite optimistic that we'll have.
We will be driving toward some boom opportunities in 2020.
Okay.
Mark I understand that the contract compression business is positive and that you're not effectively building. It on anything on spec everything's largely contracted when it goes into the shopping gets built out and that would largely hole to be true for most of your peers, but contracts are also constantly rolling off and kind of the broader installed base in the field.
And sometimes those renewals don't always come as expected so.
What gives you confidence that we couldn't end up in a minor oversupply situation if activity doesn't inflect or said another way what would be the orange light that you'd be looking forward to maybe pull back on some of those new build opportunities.
Well, we monitor net additions and and units going into service out of service on a weekly basis.
Our sales team talk to our customers a lot and we spend a lot of time, making sure we understand the underlying resource where the equipment is so lot of our equipments in the Permian Basin, we have a view as to that resource we know what our equipments being used to do in the basin.
We we look at weekly sets and removals to confirm our assumptions that we sort of go from there. So there's nothing saying that we won't ever get surprised that it will for sure happen from time to time, but we keep a really close weekly eye on it.
One of the benefits, we believe in having a rental company and the manufacturing company under one roof is that the supply chain is tightly controllable. So we can buy engines, a compressors sit on them and only released those two main components for manufacturing when we have good.
Indications on a weekly basis. So we can really control that and not overspending. So we may have approved the manufacturer of a number of units for the fleet, but the team in Houston will only build individually units when they see the need arrive. So it's a tightly controlled thing because we definitely don't want to overbuild, we want to have utilization.
It is as high as possible and we don't really want to flood the overall market with idle equipment that would be put a downward pressure on prices.
Okay, maybe just one last one from me.
Continuing on the theme of building out the asset ownership model are there are there more deal. The are there more deals like may be found out in the market and how are you thinking about valuation thresholds on buying something in the field either through a sale leaseback opportunity or an outright purchase of another competitor.
Considering that you could internally build those units for effectively new assets for replacement cost.
How are you thinking about the buy versus build argument right now.
Well were and our priorities.
We've got organic growth capital is what we really like so the multiples are all in the neighborhood. If you buy company or if you build new they're all kind of in the same neighborhood ish.
But we'd like new stuff and we'd like new stuff that we build for sure. So that's our preference is organic growth. There's no doubt that there are rental fleets in the United States that for the right multiple we could buy.
And we're looking at those all the time.
But as of today, we're quite happy with building their own stuff and we'll go from there.
Okay. Appreciate the color I'll turn it back.
Okay.
Thank you. Our next question comes from Keith Mccain with RBC.
Hi, good morning, Thanks for taking my questions. The first one here and May have touched on it briefly in your prepared remarks, but just wondering about the potential of risk that if you.
Right sizing the engineered systems business over the next few months assuming bookings stay low.
And then we do see a pickup in the second half the year.
Will you still be able to respond to those new opportunities in similar level of execution that you'd expected that your customers would expect or or would there be a lag or a drop in efficiency should that scenario app in which would almost be a good problem to have but something we're we're monitoring.
Keith that question strikes at the heart of what our engineering systems leaders have been thinking about for nine months in Canada in the United States and it's every downturn do you have to trim costs in accordance with revenue, but you want to keep the people that will really drive growth.
In the company. So I would say that's a person by person analysis that we do whenever we think about reducing our workforce and it's something we trust our managers to do but it's it's a challenge for certain.
Okay understood.
Next question is.
So we we original are we got new disclosures on revenue by our gross margin My business line and we saw a.
As kind of what we would have expected at higher margins and the growing compression rentals business.
Now in the comments in your prepared remarks, so we kind of see.
Are we heard that you expect gross margins to revert to historical norms. So should we take that to me that you're just talking about the engineered systems gross margins or corporate gross margins implying that.
Engineered systems margins could be much worse than historical norms, but offset by the new growing higher compression rental margins and netting out at around the same.
Well.
I think it behooves people to think about Interflex and those different product lines when it comes to the margin.
There's no doubt that are engineered systems margins.
Our at a high point today due to stuff, we booked when things were busy and that there will be under pressure going forward.
What the overall mix for the all enterprise looks like going forward is not something that we.
Provide guidance on but I think you'll see are engineered systems margins come under pressure for the balance of the year.
We've got this growing.
The amount of revenue from asset ownership, that's a higher margin and that's kind of the whole point of our strategy is to keep the overall enterprise margin as high as possible.
Got you okay.
That's it for me I'll turn it back thanks.
Thank you.
Our next question comes from Arrow Mcneill with TD Securities.
Morning.
Alright. Thanks.
Do you guys view the weakness in engineered systems and the pickup in spending on the rental side as a change in the way that you're engaging with your north American customers customers and I guess Im wondering even relative to last quarter. If your customers are increasingly asking you to put the assets on your balance sheet instead of.
Errors as they kind of move towards this self funding return focused business model.
Aaron Good question I would say that the.
The customers we've had for engineered systems traditionally are different than our rental customers. So people have asked US do you have customer ex that used to buy that's now renting because you offer that that's not as common having their rental fleet, especially United States has introduced us to a whole new group of customers that have always been true.
Additional rental companies.
Bigger midstream companies can swing back and forth from buying to renting depending on their own capital situation that would be the only exception to that rule, but most of our rental customers our upstream oil and gas producers that we didnt sell equipment to before anyways, because they were mainly rental guys.
Okay and then.
Obviously growing that the rentals business has been.
Very long term focus for interflex, but it does seem as though the rate at which you're deploying capital and plan to do so in the features increase so I guess I'm wondering what level of leverage you'd be comfortable with assuming that.
The increase leverage but also come with contracted cash flow or maybe asked differently. What do you see is like an optimal capital structure.
Yeah, it's its a good question.
Aaron and I think the way that we generally think about it is is we view two times leverage ratio is being kind of a soft ceiling.
Having said that.
We're always gauging the market in terms of the opportunity to deploy capital to to grow our recurring revenue business line faster so.
We're we're flexible I guess in terms of the amount of Capex that we're putting out the door and but but I would say that we're we're always viewing two times as kind of a ceiling on that saw ceiling on that.
With the only exception being again, if we find an opportunity to do a larger deal that sort of moves the needle more in the recurring towards the recurring revenue side of the business that might change our philosophy on leverage but it will come with.
A pretty pretty healthy move towards a more recurring business if that makes sense yet.
You'd mentioned as one of your capital priorities.
You know potentially increasing the dividend.
I guess two questions for me would that be kind of married to your.
Contracted cash flow and then second.
Can we assume that the timing of a dividend increase would probably be consistent with prior years and along with Q3 results.
Yeah, I mean, I'd say on the dividend those are board level decision. So we don't we don't want to speculate too much in terms of what the overall board thinks is appropriate, but I guess, what I would say on the dividend as I wouldn't expect any major changes we've been pretty predictable in terms of how we've grown the dividend and what we've done and I don't.
We anticipate any broad.
Changes in direction there.
Okay. Thanks.
Thats all for me.
Thank you. Thank you.
Thank you.
Sorry, Minder, ladies and gentlemen to ask a question just press Star then one.
And our next question is from Anthony Linton with National Bank. Please go ahead.
Good morning, guys.
We're not just just a question on the rental fleet. We just saw that Capex jumped in Q4 over Q3 on the rental fleet. I was just wondering is that a result of seeing more opportunities or what drove that.
The it's important to note that capex for.
Asset ownership, we've got four regions. So don't assume that all that money went directly to the U.S. rental fleet. We've got boom projects that were executing in the middle East in Latin America. So I just want to make sure that thats, but you can't just say that whole 74 million Bucks was the U.S. rental fleet theres other things going on.
So.
That being said.
The number doesn't surprise us too much is underpinned by demand. It's it's underpinned by boom contracts that we've had we've been executing for nine to 12 months and it's it's done in a really measured controlled way, even though it was a lot for the quarter, we understand that we're comfortable with it and.
We definitely have a plan going forward about the cash spend in accordance with demand from customers.
Okay. So moving into 2020, you guys talked about spending at a similar level to 2019 does that mean, you're looking to spend kind of around 200 million in capex.
I mean, we were vague in the comments for reason, we're seeing so far this year, we're seeing demand from our U.S. fleet.
Very similar to them and we had last year for the fleet. We're also seeing increased levels of activity for new boom projects in rentals globally. So based on what we know today. It feels very similar to last year, if not maybe a little bit better.
In some of our international markets. So we could see our ability to deploy the same amount of capital, but it's going to be tightly controlled.
Okay.
And then just thinking about the growth rate on the on the rentals business I think in your prepared comments you said.
Around 15% is that kind of what you're thinking moving into 2020.
Yes, I mean, I think the best way to get your head around that is if you look at it historically, our recurring revenue business lines have grown.
13% year over year in 2018 in 14 and half percent year over year in 2019.
So sitting here today, given that our expectation is the to deploy capital at a similar rate I would say the historical trend is a pretty good indicator of what we would expect going forward.
Okay, great. That's it for me thanks.
Thank you, thank you and theirs.
Thank you and there's no more questions in the queue I would like to turn the call back to Mark Rossiter for his final remarks.
Since there are no further questions I would like to once again. Thank you for joining us in the call. We look forward to give you our first quarter results in may have a great weekend.
And with that ladies and gentlemen, we thank you for participating in today's conference you may now disconnect have a keybanc.
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