Q1 2022 Enerflex Ltd Earnings Call

Operator: - during the conference call please press star then zero on your touchstone telephone. As a reminder, this conference call is being recorded. I would now like to turn a conference over to your host, Stefan Ali, Vice President Strategy and Investor Relations. Please go ahead.

Stefan Ali: Thank you operator, and good morning everyone. Here with me Marc Rossiter, Enerflex's President and Chief Executive Officer, Sanjay Bishnoi, Enerflex's Senior Vice President and Chief Financial Officer and Ben Park, Enerflex's Vice President and Corporate Controller. During this call, we'll be providing our financial results for the three months ended March 31st, 2022. A brief commentary on the performance of our three business segments and a summary of our financial position.

Stefan Ali: Today's discussion will include forward-looking statements regarding Enerflex's expectations for future performance and business prospects. Forward-looking information involves risks and uncertainties, and the stated expectations could differ materially from actual results or performance. For more information, please see the advisory comments within our news release, MDNA and other regulatory filings.

Stefan Ali: Approximately one hour following the completion of this call, a recording will be available on our website under the Investors section. During this call, unless otherwise stated, we'll be referring to the three months ended March 31st, 2022, compared to the same period of 2021. We'll proceed on the basis that you've all taken the opportunity to read yesterday's press release. I'll now turn the call over to Marc.

Marc Edward Rossiter: Thanks, Stephen, and good morning everyone. We are pleased to report a successful first quarter and continued positive momentum across our business.

Marc Edward Rossiter: Our ability to secure higher volumes of work in recent months is a function of robust supply and demand fundamentals in the oil and gas industry, where ongoing strength in commodity prices improve balance sheets of our customers and a renewed focus on energy security, led to quarterly engineered systems bookings over of over $230 million and grew our backlog for a fifth consecutive quarter. Increased industry activity is a first step towards normalizing engineered systems gross margins and, as a result of recent bookings activity, we've generated a quarter-over-quarter gross margin improvement of 200 basis points in our manufacturing business, despite increased supply chain pressures. While we're cautiously optimistic about the trajectory of the recovery, we continue seeing many of our customers maintain their commitment toward capital discipline and there remains some uncertainty in predicting the impact of geopolitical events on the global energy landscape and pace of energy development across our regions.

Speaker 4: where ongoing strength in commodity prices, improved balance sheets of our customers and a renewed focus on energy security led to quarterly engineered systems bookings over of over $230 million and grew our backlog for a fifth consecutive quarter. Increased industry activity is a first step towards normalizing Engineered systems gross margins and, as a result of recent bookings activity, we've generated a quarter-over-quarter gross margin improvement of 200 basis points in our manufacturing business, despite increased supply chain pressures. While we're cautiously optimistic about the trajectory of the recovery, we continue seeing many of our customers maintain their commitment toward capital discipline and there remains some uncertainty in predicting the impact of geopolitical events on the global energy landscape and pace of energy development across our regions.

Marc Edward Rossiter: Our recurring revenue businesses delivered stable, predictable contributions to our overall performance. After market service business continues to recover from the downturn and is expected to do so throughout the year, though will be contending with broad-based OEM supply chain challenges on the timely delivery of spare parts, along with inflationary operating cost pressures.

Marc Edward Rossiter: Our energy infrastructure business continued its strong performance. Improved activity within key U.S. basins drove demand for a U.S. contract compression fleet, which grew to 405 thousand horsepower during the quarter and maintained an average utilization 91%.

Marc Edward Rossiter: In our rest of world segment, our assets continued to perform as expected. We commenced operations for a 10 year natural gas infrastructure asset in early January and progressed another 10 year infrastructure contract that was awarded to Enerflex during the fourth quarter of 2021.

Marc Edward Rossiter: Collectively, these assets reinforce our strategic goal of generating long-term stable cash flows. Overall, I'm proud of our team's efforts to keep our assets performing to the benefit of our customers and stakeholders.

Marc Edward Rossiter: In our energy transition business, we continue progressing several opportunities across the carbon capture, renewable natural gas and hydrogen spaces. We are also seeing continued demand for electrified solutions across multiple regions which are helping our customers eliminate scope point emissions from their operations.

Marc Edward Rossiter: Constructive public policy support will assist in promoting investment in this emerging market, which should benefit Enerflex in the coming years.

Marc Edward Rossiter: Lastly, we continue to progress all necessary matters to close our all share acquisition of Exterran that was announced in January of 2022.

Marc Edward Rossiter: A number of regulatory approvals have already been obtained, and we are currently not aware of any reason that would prevent us from obtaining the remaining approvals.

Marc Edward Rossiter: As we progress our preintegration planning work, we are increasingly excited about the strategic fit of the two companies, the support of macroeconomic fundamentals for global natural gas production growth and the support received by the market.

Marc Edward Rossiter: Upon closing, this transactional created through energy infrastructure company. Enerflex remains focused on delivering on the strategic rationale of the acquisition including: increasing recurring pro forma gross margin to approximately 70% of total, striving for a sustainable cost structure through synergy realization and providing better capabilities to our global client base.

Speaker 4: including: increasing recurring pro forma gross margin to approximately 70% of total, striving for a sustainable cost structure through synergy realization and providing better capabilities to our global client base.

Speaker 4: Striving for a sustainable cost structure through synergy realization.

Speaker 4: and providing better capabilities to our global client base.

Marc Edward Rossiter: I will now turn the call over to Sanjay Bishnoi to review our financial results.

Sanjay Bishnoi: Thanks, Mark. First quarter revenue of $323 million, increased significantly versus the prior year period, from a combination of higher engineered systems revenue, on stronger bookings in recent periods, revenue recognition on a previously announced 10 year natural gas infrastructure project, higher utilizations on our energy infrastructure and the increased volume work across all segments.

Sanjay Bishnoi: Bookings momentum continued in the quarter, totalling $237 million, up significantly from $99 million in the same period last year. Our engineered systems backlog exited the quarter at $620 million, which is over 3x higher than the backlog at March 31st, 2021, and provides a healthy backdrop for 2022.

Sanjay Bishnoi: During the quarter, management completed its continuous review of how expenses are classified. Following this review, certain expenditures were reclassified between cost of goods sold and SG&A. Although the reclassification has no impact on net earnings in periods- prior periods, this change provides more relevant information to uses of the financial statements and better reflects the costs that are directly attributable to the production of goods and the supply of services.

Sanjay Bishnoi: The resulting gross margin was $54 million, or 16.6%, for the first quarter of 2022, compared to $45.5 million, or 22.4%, for the comparable period.

Sanjay Bishnoi: The lower gross margin percent in the current quarter is primarily due to a shift in the product mix, less government got grants received and competitive pricing pressures on material and labor.

Sanjay Bishnoi: SG&A costs of $46.8 million in the first quarter of 2022 were up from $38.5 million in the same period last year.

Sanjay Bishnoi: The increase is primarily due to the transaction costs associated with the pending Exterran transaction and the reduced cost recoveries from government subsidies.

Sanjay Bishnoi: These increases are partially set offset by lower share-based compensation.

Sanjay Bishnoi: During the quarter, we invested $29.2 million towards construction of a natural gas infrastructure asset that was awarded in the fourth quarter of 2021 and which will be accounted for as a finance <unk>.

Sanjay Bishnoi: We also invested $2.5 million of capital, primary- primarily towards units in our USA contract compression fleet, which has grown to approximately 405 thousand horse power.

Sanjay Bishnoi: From a capital allocation perspective, 2022 gross CapEx will continue to be limited to the funding of inflight projects and those opportunities satisfying stringent investment criteria. With respect to liquidity, Enerflex has $133 million of cash on hand and access to $672 million on our bank facility, giving us ample liquidity to fund our required investments in working capital and capital assets.

Sanjay Bishnoi: We continue to maintain balance sheet strength, exiting the quarter at a bank-adjusted net debt to EBITDA ratio of 1.43x.

Sanjay Bishnoi: Lastly, Enerflex's board will continue to evaluate dividend payments on a quarterly basis, based on the availability of cash flow and anticipated market conditions.

Sanjay Bishnoi: Yesterday declaring a dividend of two point five cents per share to be paid on July 7th, 2022.

Sanjay Bishnoi: This completes the formal component of the webcast. Additional details can be found in our May 4th press release. We will now be happy to take any questions.

Operator: Ladies and gentlemen, if you have a question at this time please press star and then the number one key on your touch tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Your first question comes from the line of a Michael Robertson with National Bank Financial. Your line's open.

Michael Storry-Robertson: Good morning all and thanks to taking my questions. Given the noted increase in volatility of raw material pricing and availability, are there any initiatives you've implemented in order to try and firm up pricing or delivery date and suppliers to help solidify your- your targeted timing and margins? And I guess, are there differences in your approach to whether it's parts for the service segment or components for larger scale projects?

Marc Edward Rossiter: Yeah, Michael, this is Mark Rossiter. Thanks for the question, I'll take that. Dealing with supply chain is probably issues number one and three for the professionals in our engineered systems business and the aftermarket service business, and there are different strategies in both those businesses. But, by and large, it's mostly about being extremely nimble and fast acting when we hear news in the supply chain and also having relationships with the customers that allow us to pass on those unforeseen cost increases as effectively as possible to those clients. In engineered systems, frequently when we close a job we get the opportunity to update all the prices in the major equipment before we accept the order and that can lock in 80% or more of the overall cost base and so that mitigates some of those issues. In the service business, you know, spare parts that go with projects, they're frequently quoted right at the moment - we know exactly what we can buy them for. Some of the downward pressure in our AMS business margins in the quarter was due to some other things like fuel costs, a little bit of Omicron wave that had our people at home and the biggest issue in AMS is just waiting for parts. So if we have technicians ready to go to do- to go perform- perform a service job and they don't have the parts, then they sort of have to sit around to the show up and that leads to some inefficiency.

Speaker 4: fuel costs, a little bit of Omicron wave that had our people at home and the biggest issue in AMS is just waiting for parts. So if we have technicians ready to go to do- to go perform- perform a service job and they don't have the parts, then they sort of have to sit around to the show up and that leads to some inefficiency.

Michael Storry-Robertson: Got it. Got it. That's a really helpful color, Marc. I appreciate it. Just another one for me. I was wondering if you've seen an impact in terms of inbounds or sentiment in Canada on potential CCUS related opportunities following the CCUS investment tax credit in the federal budget?

Marc Edward Rossiter: I don't think we've seen- we have a lot of inbounds on CCUS prior to the announcement. There's a lot of oil and gas customers, especially that have been looking at how to decarbonize themselves for over a year now and so that the investment tax credit, I don't think, sped up those conversations significantly.

Multiple speakers: That's my takes on- Jay do you have a different take on that? Yes, I think, maybe, echoing Marc's comment- we already felt like we had a pretty healthy set of dialogue going with those customers and I think that the investment tax credit, certainly from a finance guy's perspective, it's going to be very helpful to get these projects closer to actuality, but we think that we were already having some pretty high-quality dialogues before the budget.

Multiple speakers: Alright. That's great stuff. Encouraging to hear. I will jump back in the queue. Thanks for taking my questions. Alright, your next question comes from the line of Aaron MacNeal with GD Securities. Your line's open.

Multiple speakers: Hey. Morning, all. Thanks for taking my question. I'm wondering if you could provide any details or anecdotes on your preliminary steps on integration with the Exterran? I appreciate there's not probably a whole lot you can say, but maybe you can give us a sense of what you've done to to date, what's still outstanding and if you're more or less confident in your synergy target in 2023 guidance? Andrew- Aaron, sorry. Aaron, thanks for the question. After we made the announcement, we had integration teams establish at Exterran and Enerflex and, to the degree that we're allowed to do pre-integration planning. We've been doing it along a lot of you strategic and also functional lines. I'm- I'm quite pleased with the progress the teams have made to date. We're still competing in the market. We're two independent companies and we're competing against one another in all the reasons within we- within which we operate. So, there's- there's some limit on how much integration planning we can do, but within those limits, I'm quite satisfied and quite happy with the progress that's been made.  Okay. With respect to- this one’s probably for Sanjay- with respect to the high yield offering that you intend to pursue at the close, were the ratings you received from S&P and Fitch in line with your expectations and are you at all concerned with your ability to obtain high yield debt at a reasonable coupon given the rising interest rate environment? So, I’ll take them one by one, Aaron. The ratings were very much in line with where we thought things would shake out. No surprises there. I would say, in terms of the high yield market, it’s something that we’re monitoring quite closely. I would say that interest rates, as everybody knows, are going up and that’s a bit of a headwind but I would say that the tailwind that we’re getting is the macro-fundamentals around energy and oil and gas in particular.

Sanjay Bishnoi: And so you've actually seen some strength in oil and gas related issuances in the high yield market. And so, we still think that it's a very constructive market for the offering that we are going to bring to market, and we're really waiting to get through some of these regulatory approvals and other conditions and then ready to go to the market once the time is right.

Aaron MacNeil: Understood. Maybe, since your prepared remarks are so quick, I'll sneak another question in. Just wondering if you can speak to your involvement with the Meadowbrook CCUS. I know it's early days, but can you give us a sense of timeline, what your involvement might be, both from an operational and capital perspective?

Multiple speakers: Yeah. No, we're delighted to be working with the Bison team and with our- with our partners on that project. Our involvement is really primarily because we want to- we want to be doing as stewards of of the industry and proponents of the carbon capture here in the province of Alberta. We want to be doing everything that we can to be supportive to the industry and we just- we thought it was a neat project. We like the management team. We like the partners and we're happy to be part of a solution that's moving to the next phase, which is going to be really an evaluation phase, but delighted to be part of that story. So you're in an evaluation stage, but you know, what might a commercial timeline look like? You know-. Actually be involved.

Multiple speakers: Yes. No. We'll be a part of the consortium. I mean that's- that's- that's how we are participating in that project. We're not the operator of that project, we have a non-operating minority investment in it, but we continue to expect to be involved in that capacity. And yeah, I think you know part, part of the evaluation phase which is really- when I say evaluation, it's really that's how the, that's how Alberta energy has sort of couched the next phase that we have to do some evaluation work and some test wells to evaluate the formation and- and the safety of the formation as well. And so, beyond that phase- you know we'll- during- during this phase of it, we'll be generating a more, you know, detailed sort of idea of how the capital, the project, will unfold. So probably early for us at this point to be commenting on the capital commitment to the project, but we'll certainly keep the market appraised as that develops. Understood. Thanks, for taking my questions. Turn it over.

Operator: All right. Again, ladies and gentlemen, if you have question at this time, please press star and the number one key on your touch tone telephone. If your question has been answered and you wish to remove yourself from the queue, please press the pound key. Your next question comes from the line of Cole Pereira from Stifel. Your line's open.

Multiple speakers: Hi. Good morning, everyone. Wanted to start on the U.S. engineered systems margins. I think we're all aware of the margin pressures and obviously work mix is a consideration as well. But, I mean, from your commentary I do get the sense that you should see an improvement in that metric over the next few quarters. Is that fair? Acknowledging there is some uncertainty, obviously. That's fair, Cole.

Cole J. Pereira: Okay, perfect. And, you know, on the supply chain front, as you think about potential impacts from the COVID-19 shutdowns in China, do you think the worse has passed? Do you think it could get worse or do you think there's still not enough visibility? And you commented on the U.S. ES side- You can pass through a lot of the costs. So is it more- the risk is in terms of timing and logistics of inputs, et cetera?

Marc Edward Rossiter: Cole, in February 2020, I predicted COVID-19 was not going to be a big deal, so I'm not going to predict anything about COVID-19, hopefully ever again. It's difficult for me to really- really consider how the shutdowns in China will impact our supply chain. In almost every one of our projects that goes out the door has control system on it that's got a computer chip in it. And so, that's one sort of commodity that's been- that's been challenging over the last couple of months. How the Chinese shutdown specifically impact going our supply chain going forward is difficult to predict.

Speaker 4: really consider how the shutdowns in China will impact our supply chain. In almost every one of our projects that goes out the door has control system on it that's got a computer chip in it. And so, that's one sort of commodity that's been- that's been challenging over the last couple of months. How the Chinese shutdown specifically impact going our supply chain going forward is difficult to predict.

Cole J. Pereira: Okay got it. Yes, that's totally fair. Just quickly, on the Mexican Exterran lawsuit, I'm wondering if there's any additional details you can provide just on how exactly it occurred? I mean, I acknowledge it's a complicated jurisdiction, but I'm just surprised that you- any termination lawsuit would have $120 million payout, which obviously helps a support that it was made in error.

Sanjay Bishnoi: Yes, Cole. This is Sunjay. I think- I think we would point you to Exterran's 10Q. This is an issue that the Exterran management team has been managing and I think they've articulated some of the things that you said, which is they believe there's a calculation error and they believe that it's- it's not material.

Cole J. Pereira: Okay, got it. Thanks. And just quickly, on the closing of the acquisition, any additional guide post you can add? I mean, do you think it could be late Q2, early Q3, late Q3, or is there just still not enough visibility at this point?

Multiple speakers: Yes. So we- we were optimistic that we can- we can get there in Q2. We don't believe that we can in Q2 anymore. You know, what we can tell you is that we're- we're very happy with the way the teams are working together. We feel like we've got really good dialogue with- with the Exterran team at all levels, like from the C suite down to the working level. And you know- so, we're working diligently and as fast as we can. We're hopeful that we can get to close in Q3 but that's that really- I guess we'll have to wait and see how things unfold on- on the regulatory side of things and the other conditions that we're trying to satisfy. Ok, great. That's super helpful. I'll turn it back. Thanks. Your next question comes from the line of Tim Monachello with a APB Capital Markets. Your line's open. Hey. Good morning, everyone. Just a follow question to Cole's on the labor dispute in Mexico. I'm just know, regardless of how unlikely this is to be material and think it probably is unlikely. Is there- is that a hurdle that you need to get over before you can close the transaction? You know, I guess what I would say is that, on the issue itself, really we are operating as two separate companies right now because we have to. And- and so, I would, I would point you to Exterran's disclosures on the subject. And from a, you know, from a deal timing perspective, it's really- we're very focused on clearing the regulatory hurdles that we've got in front of us. We did get some, some comments back from the SEC. They're down the fairway comments. They are going to take a little bit of time, just the process them, but, you know, we think there's really nothing that- of concern in those, in those comments. So we're really focused on clearing those regulatory hurdles, lining up a shareholder vote and getting the close, we believe, hopefully in Q3, but in the second half of 2022. Okay, So you don't need to see a formal resolution to this matter before you can close the deal- when you'd be comfortable closing a deal with this still, sort of in limo?. Yes, we're currently monitoring the situation Tim, and I think that's where we would leave it here today.

Speaker 10: the labor dispute in Mexico. I'm just know, regardless of how unlikely this is to be material and think it probably is unlikely. Is there- is that a hurdle that you need to get over before you can close the transaction? You know, I guess what I would say is that, on the issue itself, really we are operating as two separate companies right now because we have to. And- and so, I would, I would point you to Exterran's disclosures on the subject. And from a, you know, from a deal timing perspective, it's really- we're very focused on clearing the regulatory hurdles that we've got in front of us. We did get some, some comments back from the SEC. They're down the fairway comments. They are going to take a little bit of time, just the process them, but, you know, we think there's really nothing that- of concern in those, in those comments. So we're really focused on clearing those regulatory hurdles, lining up a shareholder vote

Speaker 6: and getting the close, we believe, hopefully in Q3, but in the second half of 2022. Okay, So you don't need to see a formal resolution to this matter before you can close the deal- when you'd be comfortable closing a deal with this still, sort of in limo?. Yes, we're currently monitoring the situation Tim, and I think that's where we would leave it here today.

Multiple speakers: Okay and then second question: we saw lookings come down in Canada and there's a little bit of a cautionary statement just around slowness in demand related to egress capacity constraints. Can you talk a little bit about the Canadian market- What you're seeing for demand on the increment there? Hey, Tim. This is Mark. We're seeing customers in Canada that want to do work and they're getting out in front of a lot of the CapEx, spend with engineering work, with detailed pricing, with sort of lining up supply chains with us in a really collaborative manner. We're optimistic that Q2 forward in Canada will be a more positive story in the bookings front. That's what we're hoping for and, based on the conversations we've been having with customers, we believe the addition of infrastructure to the western Canadian sedimentary basin should be more significant in the coming quarters than it was in the last few. Okay, and then last one for me- just on service margins.

Multiple speakers: Obviously those came down in the quarter. But you guys have been dealing with supply chain issues for the better part of the last year, maybe the full year. So what changed in Q1 that brought those margins down and what's the outlook for service margin to <unk>? In Q1, there was kind of an acute part issue from a number of our suppliers from a delivery point of view. So we had been managing supply chain like everybody has been for a year but in the quarter for one or two of our key suppliers they had a particular challenge getting parts to us on time and that impacted our AMS business globally. I would say a little bit more locally. We had Omicron issues in our North American businesses in January that had a lot of our technicians in the sidelines, which was too bad. But, we think that's behind us and I'll reiterate that margin we turned into AMS for the quarter is not what we're looking for. We really expect it to return to upper team numbers, which is traditional in short order.

Speaker 4: and that impacted our AMS business globally. I would say a little bit more locally. We had Omicron issues in our North American businesses in January that had a lot of our technicians in the sidelines, which was too bad. But, we think that's behind us and I'll reiterate that margin we turned into AMS for the quarter is not what we're looking for. We really expect it to return to upper team numbers, which is traditional in short order.

Multiple speakers: Okay, that's very helpful. I'll turn it back. Thanks, guys. Alright, I'm showing no further questions at this time. I would like to turn to conference back to Mark Rossiter.

Marc Edward Rossiter: Thank you, Operator. Since there are no further questions, I'd like to once again thank you for joining us on the call. We look forward to giving you our second quarter results in August .

Operator: Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.