Enerflex Ltd (EFXT) 2013 Q3 法說會逐字稿

Ladies and gentlemen thank you for standing by. And welcome to the Enerflex third quarter 2013 financial results conference call.

(Operator Instructions)

As a reminder, this conference is being recorded today Friday, November 8, 2013. It is now my pleasure to introduce Blair Goertzen, President and Chief Executive Officer. Please begin, sir.

Thank you and good morning. Thanks for joining us to everyone that's on the call. Here with me today is James Harbilas, the Enerflex Vice President and Chief Financial Officer.

During this call we will be providing our financial results for the three months ending September 30, 2013, a brief commentary on the performance of our three business segments, and a summary of our financial position at the end of the third quarter 2013. Approximately one hour following the completion of this call a recording will be available on our website under the investors section.

During the presentation, unless stated otherwise, we will be referring to the three months ended September 30, 2013 compared the same period of 2012. I will proceed on the basis that you have all taken the opportunity to read yesterday's press release.

Enerflex reported net earnings from continuing operation of CAD13 million or CAD0.16 a share for the third quarter of 2013 representing an CAD8 million decrease compared to the third quarter of 2012. The decrease in net earnings for the quarter was a result of lower gross margin and higher SG&A expenses compared to the prior year.

In the third quarter of 2013 the company experienced cost increases on three international projects due to scope and design variations, and to a lesser degree, due to the project execution challenges. The cost increases resulted in the deterioration in gross margin of approximately CAD11 million in the quarter.

Variation claims, where appropriate, have been submitted for certain projects or are in the process of being submitted. For projects still in progress there could be additional cost increases resulting in further variation claims that will be assessed at that point. To the extent that these cost increases are subsequently recovered through variation claims from customers, revenue will be recognized in the corresponding period.

Variation claims are typically approved at the completion of the project. This results in volatility in gross margins for the international segment as costs are recognized as incurred on these projects while revenue resulting from variation claims is recognized in the period that these claims are approved.

During the third quarter, Enerflex continued to make progress towards achieving or exceeding a number of its strategic objectives. Recurring revenues from the service and rentals product line has increased for the third consecutive quarter from 21% at the end of 2012 to 24% at the end of the third quarter 2013. The Company is also progressing towards its goal of 30% to 40% recurring revenue.

In terms of safety management objectives, Enerflex surpassed its strategic objective by reducing its company wide total recordable injury rate by 13%. Enerflex has become increasingly active in the Alberta oil sands with bookings of CAD20 million in the first nine months of 2013 and CAD29 million subsequent to the third quarter. We see continued opportunities for additional bookings for the fourth quarter of 2013.

In the third quarter as a part of the annual capital expenditure program, the company purchased an additional 31 acres of land adjacent to the existing manufacturing facility in Houston to accommodate future growth. Further, the company continues to work towards its strategic objective of 10% EBIT margin. EBIT as a percentage of revenue for the trailing 12 months was 7.3%, which was comparable to the period ended September 30, 2012.

Finally, subsequent to the third quarter Enerflex announced an increase to its annual dividend, which is the company's second dividend increase since re-emerging as a public company in June of 2011. The dividend has been increased by CAD0.02 per share annually to CAD0.30 per share, which represents a 7% increase.

I will now turn it over to James Harbilas, our Vice President and Chief Financial Officer, to review our financial results.

Thank you Blair. Bookings for the third quarter of 2013 totaled CAD248 million, which is an increase of CAD104 million or 73% compared to the same period of 2012. These increases were primarily due to increased booking activity in the Canada and northern United States, and southern United States and Latin America segments, partially offset by lower activity in the international segment.

Backlog of CAD652 million was 16% lower at September 30, 2013 compared to the end of the third quarter of 2012. Sequentially, backlog has decreased by CAD45 million from June 30, 2013 and by CAD31 million or 5% from December 31, 2012.

Consolidated revenue for the third quarter was CAD391 million compared to CAD370 million in the third quarter of 2012. The increase of CAD21 million was due to higher revenue in the Canada, northern US, and southern US and Latin America segments partially offset by lower revenue for the international segment.

Continuing with a view of our product breakdown -- a review of our product break down, engineered systems revenue was CAD293 million for the quarter, which was 1% higher than the prior year. The increase in revenue for the quarter was due to higher revenue in the southern United States and Latin America segment, partially offset by decreases in engineered systems revenue for the Canada and northern United States and international segments when compared to 2012.

Service revenue for the quarter ended September 30, 2013 was CAD87 million compared to CAD70 million for the same period of 2012. The increase in service revenue was a result of the company continuing to benefit from increased activity levels in Canada, the United States and Austral-Asia regions. Rental revenue was slightly higher in the third quarter 2013, coming in at CAD11 million compared to $10 million in 2012. Higher rental unit sales contributed to an increase in North American utilization rates which improved to 70% during the third quarter compared to 61% during the same period of 2012.

Consolidated gross margin for the quarter was CAD61 million compared to CAD67 million for the same period of 2012. The decrease in gross margin was driven primarily by the cost increases on three international projects, partially offset by higher margin in the southern United States and Latin America segments. When expressed as a percentage of revenue gross margin decreased from 18.2% in 2012 to 15.7% in 2013.

Selling, general and administrative expenses for the quarter were CAD42 million compared to CAD39 million for the same period of 2012. The increase in SG&A was due to higher compensation and incentive costs and higher depreciation and amortization expense, partially offset by favorable foreign exchange movements.

Moving on to our regional results. In Canada and the northern United States revenue increased by CAD5 million to CAD135 million during the third quarter when compared, the third quarter of 2013 compared to 2012. The increase in revenue as a result of higher service revenue from increased parts and engine sales and from after market services, and higher rental revenue due to an increase in rental unit sales.

Operating income for the third quarter of 2013 decreased to CAD8 million from CAD9 million during the same period of 2012 due to increased SG&A expenses attributable to higher compensation and incentive costs. And severance costs associated with the reduction in the workforce in the production and processing business.

In the southern US and Latin America segment, revenue for the third quarter was CAD164 million, which was CAD22 million higher when compared to the same period in 2012. The increase in revenue was due to higher engineered systems and higher service revenue as a result of increased service calls and parts sales.

Engineered systems revenue and increased due to the additional capacity at the Houston manufacturing facility, partially offset by the impact of lower opening backlog to start 2013. Operating income for the third quarter of 2013 increased from CAD13 million to CAD18 million due to higher gross margin, partially offset by higher SG&A expenses. Gross margin was higher in the quarter due to the impact of higher revenues as well as improved gross margin performance. SG&A expenses were higher compared to 2012 as a result of higher compensation and incentive costs.

Revenue for the international region was CAD6 million lower at CAD92 million in the third quarter of 2013. Engineered systems revenue was lower in 2013 as a result of lower opening backlog levels, which was partially offset by higher service revenue in the Austral-Asian and MENA regions. Operating income decreased by CAD14 million to an operating loss of CAD7 million during the third quarter of 2013 due to lower gross margin and higher SG&A expenses. The lower gross margin was driven primarily by cost increases on three international projects due to scope and design variations, and to a lesser degree, due to project execution challenges.

The cost increases negatively impacted gross margin by CAD11 million in the period. Variation claims, where appropriate, have either submitted or in the process of being submitted. There could be additional cost increases on these projects in future quarters in which case further variation claims will be assessed at that point. SG&A increased during the third quarter of 2013 due to higher compensation and incentive costs.

Turning our focus to Enerflex's financial position, the company continues to maintain a strong balance sheet. At the end of the third quarter of 2013 the company held CAD102 million in cash and had CAD326 million of available credit facilities. With a debt balance of CAD89 million Enerflex ended the quarter in a net cash position. Accordingly, the company exited the quarter was net cash-to-EBITDA ratio of 0.11 to 1. Enerflex had a net cash to EBITDA ratio of 0.03 to 1 at the end of September 2012.

Return on capital employed for the trailing 12 months ended September 13, 2013 was 11.9% compared to 12% in the same period of 2012, primarily due to higher capital employed in 2013. I would now like to turn the call back over to Blair for to provide an outlook for each of our regional segments.

Thanks James. The Canada and northern US segment expressed a downturn in activity during 2012 really as a result of weak natural gas prices which began to recover in the second half of 2012 and continued through to April 2013. Since then gas prices have trended downwards, currently sitting at around CAD3.60 per MCF. This continues to create uncertainty for producers and typically negatively impacts bookings for Enerflex's engineered systems business and challenges revenues for the service and rental business here in Canada.

Enerflex has recently seen increased activity in demand for equipment destined for the oil sands and in equipment related to natural gas liquids opportunities, such as the Montney gas play. Medium to long-term growth of this region will be tied to oil sands and LNG development in Western Canada, as well as continued development of the Duvernay and other unconventional gas resources.

Canada and the northern US segment recorded bookings of CAD75 million for the third quarter of 2013 compared to $48 million in 2012. As a result, backlog levels compared to the start of 2013 have increased by CAD61 million to CAD220 million at the end of third quarter of 2013.

Activity in the liquid rich US gas basins has remained steady through 2013 despite continued weakness in NGL prices resulting in increased orders for compression and processing equipment for the southern US and Latin American segment. Therefore, Enerflex continues to be optimistic with respect to this region.

For the third quarter, 2013 bookings increased by CAD98 million to CAD151 million. Bookings were also higher compared to 2012 as a result of the increase in engineered systems products destined for international markets. Backlog for the southern US and Latin American segment has increased by CAD52 million from CAD228 million at the start of 2013 to CAD280 million at the end of the third quarter.

The international segment continues to hold long-term opportunities despite low bookings activity for the third quarter of 2013. It is an important to note that the Canada and northern US and southern US and Latin American segments recorded bookings totaling CAD19 million in the third quarter which are destined for international markets but not presented in the international segment. This compared to CAD8 million in bookings recorded in the third quarter of 2012 that were destined for international markets.

Bookings recorded in the international segment for the third quarter 2013 were CAD21 million lower when compared to the same period of 2012. The decrease was due to lower coal seam gas exploration and gas storage project activity in Australia and lower activity in the Middle East. Backlog was CAD152 million at the end of the third quarter of 2013, which is CAD145 million decrease from the 2013 opening backlog of CAD297 million.

In summary, higher revenue levels for the third quarter 2013 did not translate into improved gross margin as a result of the cost increases that we faced in the international segment during the quarter. Management has determined and is executing on a plan to address the challenges identified and is pursuing those variation claims where appropriate.

On the other hand, bookings were significantly improved in the third quarter and recurring revenue as a percentage of the total revenue continues to increase. As a result, the Enerflex Management Team remains cautiously optimistic giving the improved bookings for the quarter and a strong backlog coupled with growth in our service revenue. This positions us well for the remainder of 2013 and on into 2014 as we remain diligent and focused on improving project performance in the international segment. Our strong balance sheet positions the company to continue to grow its business and deal with any challenges over the remainder of 2013 and early 2014.

This completes the formal component of the webcast. Additional details can be found in our November 7th press release and we would now be happy to take any questions. Operator?

(Operator Instructions)

Scott Treadwell with TD Securities.

Maybe I could ask about these variation claims. I understand that the engineering change process and how that all plays out, but are those typically approved or negotiated with the client as they happen? Or are they, at the end of the project they are all put together and you have one big sit down? Just thinking about the timing of I guess how far these projects are along and where those variation claims might show up down the road.

So Scott, it's James. They typically -- those negotiations typically take place at the end of the project. We have had situations even in previous quarters where we've basically concluded those negotiations and booked the revenue associated with those variation claims in the quarter. So if you go back to Q1 of 2011 we had a CAD9.5 million pick up that we recorded where the expenses were recorded in the previous period in 2010.

In Q2 2011 we had a further CAD7 million that had been approved on a project that we were executing at that time, and even as early as Q2 2013, we also were successful in getting about CAD5.8 million in variations approved at that time and those are obviously expenses that had been recorded in previous periods. With respect to the projects in question here, they are pretty far along. Some of them are 70% complete. We expect that these negotiations will most likely be concluded at some point in 2014, probably first half.

Perfect. You referenced a dollar amount on the gross margin side. Is that typically the amount that you would advance as the variation claim or would there be some margin on top of that?

Well, we have already incurred the cost on these projects in this period and previous periods, right? So we would be looking to get variation that would help to reverse part of the hit that we took. So whatever we get approved in future quarters, that will be recorded as revenue with no cost or gains and it would drop to the bottom line.

Okay. But it is not always that you will get full cost recovery, in some cases you may get more than your costs?

It could be, Scott. You can have less than your costs or more than your costs as you go through the negotiations. But certainly we don't try to go for less than the costs and in most cases we are looking to get the cost plus a margin.

That is correct.

Okay. Perfect. That was the only question I had guys, thanks very much.

You're welcome.

Dana Benner with Altacorp Capital.

I wanted to follow on Scott's question, and I know that these have happened for as long as projects like this have occurred. But, I guess the question really is, is there anything unique about these three projects that would lead you to believe that full cost recovery, plus or minus a little bit isn't possible? Or is this just one of those things that you have to deal with in this type of business?

There is nothing unique about these three projects.

Okay. Nothing like a good terse answer. Let me move to the cryo plants that you are building, a couple I believe, and I noticed in the disclosure you talk about they are partially built and that the market has been a little slower to emerge than you would have thought. I wonder if you can give us some more color around that?

Certainly. So, we have had committed costs to the cryo plants of less than a CAD2 million. When we put that group together for the US we expected to have those actually move by the end of this year. That is not going to happen now.

We still have had a level of interest in the US, but the bigger positive in this is that when we put that group together we didn't realize how beneficial it would be for other gas treating and processing opportunities in the US. And the swing in mix between compression and treating and processing that we have seen in the US in terms of our own revenue has been very significant, and it's been basically on the back of creating that engineering group and sales group to focus on cryogenic and it has spawned all of this other opportunity.

While we still continue to actively market the two cryo plants, we have also had a significant gain on the other side of the business as well in terms of other treating and processing sales for the US. So, that is really the long and the short of it now, Dana.

What should we take from the inability to move these plants? I know that you say the market there is still not too bad despite lower liquids pricing, but is it just softness in the market, is it that you don't have the resume in this particular area that you would need to have to move those more quickly? What you think?

It is actually, the market has softened, there is product that is available on the fence, at least that is what we are being told. We believe that. I think to a smaller or lesser degree would be the resume of serial number of 001 in the market. So it's soft market, standard product available, and then of course, we are looking to enter that market as a new player.

Right. Okay, that is great color. Moving back -- or moving to Canada, with respect to the LNG opportunity that is emerging, there are a variety of companies out there that have already been engaged for work that is clearly linked to the potential development of these projects. Others a little bit further down the value chain are being asked for budgetary bids on things and I wonder if you can give an update as to how you are looking at these projects, referencing any particular bids that could be out there or things that you could be looking at?

I don't think we could point to any particular bid that has been released and says here, this is for LNG exploration. I think it is more a case of the field development that is occurring today that we are seeing the opportunities on that I would have to say is related to LNG, because it really is the only opportunity for incremental demand within Western Canada at this juncture. Certainly with the exports of eastern United States into Eastern Canada, and the export opportunities to the rest of the United States that have started to certainly wane over the past two or three years.

So, the exploration that we see, although not specifically cited to LNG, certainly we would believe that it is, and that, I think has been the renewal of some of the bookings that we are seeing now and some of the project opportunities for product in Western Canada that is in front of us today. So it seems to be picking up some momentum on the heels of some of the other, what would be called the drilling contracts and the fracking contracts that have already been let, and I think that on the equipment side for more of the midstream potential is starting to percolate as well.

Is it safe to say that the more material P&L impact would be 2015, 2016?

It is hard to say because there are quite a few inquiries today that are looking more like 2014. But again, that can change at this point. But we see some pretty firm interest that would have an impact again on 2014 versus 2015, 2016, which I think is going to be better than 2014. But 2014 isn't certainly going to be at the bottom of the trough either.

One final question as it relates to M&A, you have got an excellent balance sheet, allowed you to raise the dividend again, do you start to look at M&A a little more carefully now, not that you weren't before, but the sheer strength of the balance sheet may open up opportunities that maybe you didn't feel you had say a year ago?

I think we have been saying all the way along, that once we structurally have the business lined up here in Canada, post 2010, which we have been well along the way of that over a year ago, that we would entertain opportunities for growth both greenfield, and if it made sense, by M&A. That is really where we are today and nothing has changed over the past three quarters that we have been looking at what do we do with respect to growth and geography and product.

I will turn it back. Thank you.

Thanks a lot Dana.

(Operator Instructions)

Jon Morrison from CIBC World Markets.

Are you able to provide any color on Houston facility utilization in the quarter and what the shift structure looks like at the facility? Are you running two 8 hour shifts, 5 days a week now? The throughput of the facility was pretty impressive in the quarter and I am trying to wrap my head around idle capacity there right now.

So, basically, we have got good utilization in the Houston facility. We are running two shifts in the facility at this juncture, and again, it is a different model than elsewhere in the world that we actually produce product because there is the availability of very high-quality outsourced product. So we still would say there is capacity in Houston but certainly we are enjoying a fairly robust time there at the moment.

So how much is the revenue in the quarter would have been outsourced? Outside of your facility?

Yes, that is not something we would break down actually. I can tell you that it is, basically baffles and some carbon steel welding, but as a percentage of the overall, we would not break that down.

Okay. Sorry to go back to the same question that has been asked twice. Hopefully I am direct here. Are all of the international scope and design variations that came through in the quarter based on customer requests post the award of the work, or is there any discrepancies between engineering spec based on you and customer understanding based on the original award of the work.

There is always discrepancy between the customer spec and on the pre-feed, the feed, and then the ongoing project management. That just is a reality or a fact of business in this type of an environment. Some are very clear and some will be obviously challenged, and that is the job of the EPC or the customer.

Okay. But it's fairly typical versus anything you have seen?

Yes.

In the past. Am I right assuming that it is one customer for all three projects?

Three different projects.

Three different customers.

From a geographic perspective, were there any meaningful bookings internationally into new territories where you haven't traditionally sold product? Are you interested in sharing that.

Yes, Southeast Asia is gaining some traction for us out of our Singapore office. I would say that, that has been a good news story in terms of some bookings that we wouldn't have traditionally had prior to our Singapore operation opening in July of last year.

Okay. Just one last one for me. Was there any meaningful change in either the number of service trucks you have on the road or the number of technicians you had on the payroll in Canada quarter-over-quarter in Q3?

No there isn't, John.

That's all I had. Thank you for the color. I'll turn it back.

Thank you.

(Operator Instructions)

Jeff Fetterly, Peters and Company.

Blair, did I hear correctly in your dialogue there were some workforce reductions on the P&P side?

Yes that is correct.

Is this out of Nisku or is that somewhere else?

Yes that is out of Nisku.

Can you provide any context around that and how the demand components of that business looks?

We had a bit of a slowdown there to begin the third quarter and decided to take steps to right size the workforce and we did that at the beginning of the quarter. Throughout the back half of Q3 we saw some increased activity now in the oil sands space for a product that we are providing there and we are going to be executing that through the Nisku facility and we see additional opportunities for Q4 for additional bookings.

It was a step that we took to address costs and overhead that wasn't being charged to labor at the time and we are going to basically ramp up the workforce in the shop now to be able to do with the increased activity we are seeing in Q4 2013.

Okay. So the oil sands awards year-to-date, those will be done out of Nisku?

A large chunk of them will be done out of Nisku, that is correct.

Okay. The CAD29 million booked post Q3, is that all one project or one customer?

Yes.

Okay. Last question on the dividend. The year-over-year increase is obviously much smaller than you put through last year. How should we interpret that in the context of your outlook, especially relative to how strong the balance sheet is and is becoming?

We still have a strong outlook I guess. From our standpoint we have increased the dividend by 25% since we reemerged as a publicly traded company on June 1, 2011. So yes, this increase is a smaller one than last year, but it isn't because we don't have a positive outlook or a strong outlook for 2014. We just felt that we want to establish a track record of being able to increase the dividend on a regular basis, and for this year we decided that the 7% increase was an appropriate increase.

Thanks guys. I appreciate it.

Thanks.

Gentlemen, we have no further questions at this time. I will be turning the call back to you for your closing remarks.

Thank you operator. And since there are no further questions I would like to again thank everyone for joining us on the call today. We do look forward to giving you our fourth-quarter results in February of 2014. Thank you.

Ladies and gentlemen, this does conclude the conference call for today. We thank you all for your participation. Have a great weekend, everyone.