Enerflex Ltd (EFXT) 2013 Q4 法說會逐字稿

Welcome to the Enerflex fourth quarter and year-end 2013 results conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session.

(Operator Instructions)

As a reminder, this conference is being recorded today, Friday, February 28, 2014. It is now my pleasure to introduce Blair Goertzen, President and CEO. Please go ahead, sir.

Thank you and good morning, everyone. Thank you for joining us this morning. Here with me today is James Harbilas, Enerflex' Vice President and Chief Financial Officer. During this call, we will be providing our financial results for the three months ended December 31, 2013, a brief commentary on the performance of the three business segments, and a summary of our financial position at the end of 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 December 31, 2013 compared to the same period of 2012. I will proceed on the basis that you have all taken the opportunity to read yesterday's Press Release.

During the fourth quarter, we have seen positive market developments in North America which has resulted in increased demand for compression and process equipment related to natural gas liquids opportunities in Canada and the United States. This has translated into bookings of CAD386 million for the fourth quarter of 2013. Enerflex has also made progress towards our stated objectives of increasing our market share for traditional processing equipment destined for the Alberta oil sands and industrial power generation solutions for our customers. This has resulted in fourth-quarter bookings totaling CAD55 million for Oil Sands and CAD14 million for power generation in 2013. Enerflex has recorded bookings totaling CAD75 million for Alberta oil Sands and CAD46 million for power generation equipment for the full 2013 year.

The Company has maintained a strong balance sheet throughout the year. We are well-positioned to capitalize on opportunities that should benefit results in the near-term. Notwithstanding these positive developments, our 2013 financial results were disappointing as we continued to experience cost increases on projects in the International Region which had an adverse impact on margin performance. The cost increases resulted in deterioration of gross margin, and of approximately CAD9 million during the quarter. The majority of the cost increases during the quarter were directly related to customer-driven changes to design and schedule related to a project in Oman. We have taken steps to address the scope changes to this project and have filed a variation claims with the customer that are being vigorously pursued.

During the first quarter of 2014, this project has continued to experience substantial customer-driven scope and schedule challenges which is expected to result in further cost increases of approximately CAD14 million to CAD17 million and a corresponding impact on gross margin in the first half of 2014. The Company intends to pursue further variation claims for such increases, but does not expect resolution of these matters before the second half of 2014. Variation claims are filed once forecast costs on a fixed-price project exceeds budgeted costs as a result of increased scope, design, or schedule changes to the project. These changes are not unusual for engineering procurement construction, or EPC contracts. However, these customer-driven changes have resulted in volatility in gross margins for the International segment as costs are recognized as incurred on these projects while revenue results from variation claims not recognized until the period that these claims are approved.

In early 2014, two International projects in Australia, which had experienced margin erosion in 2013, were substantially completed, and accordingly, Management does not expect any additional material cost increases. We have taken steps in this region to improve our project execution and profitability. Effective February 1, 2014, Enerflex made a leadership change with the appointment of Mr. James Rodgers as Managing Director for AustralAsia. Mr. Rodgers brings extensive EPC and construction experience to his executive and leadership roles with International engineering companies. He is addressing the challenges faced in the region with respect to customer contracts and project timing issues and will take the lead in returning the region to acceptable profitability.

The Canada and northern United States and southern United States and Latin American segments performed well in the fourth quarter of 2013. These regions have shown positive trends in bookings and are entering 2014 with strong backlog levels. As we move forward in 2014, Enerflex is committed to addressing challenges in Australia for project execution, completing the Oman project during 2014, and recovering costs incurred for customer-driven project cost increases. I will now turn it over to James Harbilas, Enerflex' Vice President and Chief Financial Officer to review the financial results.

Thank you, Blair. Enerflex reported net earnings from continuing Operations of CAD11 million, or CAD0.14 per share for the fourth quarter of 2013, representing a CAD16 million decrease compared to the fourth 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. Consolidated revenue for the fourth quarter was CAD350 million compared to CAD422 million in the fourth quarter of 2012. The decrease of CAD72 million was due to lower revenue from southern US and Latin America and the International segments, which was partially offset by higher revenues in the Canada and northern US segments.

Bookings for the fourth quarter of 2013 totaled CAD386 million, which is an increase of CAD144 million or 59% compared to the same period of 2012. This was 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 CAD794 million was 16% higher at December 31, 2013 compared to the end of the fourth quarter of 2012 and 22% higher when compared to our backlog at September 30, 2013.

Continuing with a review of our product breakdown, engineered systems revenue was CAD245 million for the quarter which was 27% lower than the prior year. The decreases in revenue for the quarter was due to lower revenue in the southern United States and Latin America and International segments. Service revenue for the fourth quarter was CAD92 million compared to CAD77 million for the same period of 2012. The 20% increase in service revenue was as a result of higher engine sales and additional branches being opened in the southern United States and Latin America region. Rental revenue was slightly higher in the fourth quarter of 2013, coming in at CAD13 million compared to CAD10 million in 2012. Higher rental unit sales in 2013 contributed to an increase in North American utilization rates which improved to 70% during the fourth quarter of 2013 compared to 61% during the same period of 2012.

Consolidated gross margin for the quarter was CAD59 million compared to CAD78 million for 2012. The decrease in gross margin was primarily driven by cost increases on certain International projects and lower sales volume. Selling, general, and administrative expenses for the quarter were CAD45 million compared to CAD41 million for the same period in 2012. The increase in SG&A was due to higher compensation and stock-based costs, severance costs, higher third-party services, and higher depreciation and amortization expense.

Moving on to our regional results when comparing the fourth quarter of 2013 to the same quarter of 2012. In Canada and the northern United States, revenue increased by CAD13 million to CAD148 million in the fourth quarter of 2013 as a result of higher service revenue due to increased parts and engine sales and higher rental revenue resulting from an increase in rental unit sales. Operating income for the fourth quarter decreased to CAD5 million from CAD10 million during the same period of 2012 due to increased SG&A expenses attributable to higher compensation, stock-based compensation costs, severance costs, and third-party services. In the southern United States and Latin America segment, revenue for the fourth quarter was CAD125 million which was CAD29 million lower than the same period of 2012. The decrease in revenue was due to lower engineered systems, revenue partially offset by higher service revenue as a result of increased service calls and parts sales.

Operating income for the fourth quarter of 2013 decreased by CAD3 million to CAD17 million due to lower gross margin resulting from lower sales volumes and slightly weaker plant utilization. Revenue for the International Region for the fourth quarter was CAD55 million lower when compared to 2012 as a result of lower engineered systems revenue due to lower opening backlog levels. The region recorded an operating loss of CAD8 million in the fourth quarter due to lower gross margin partially offset by lower SG&A expenses due to lower compensation costs. The lower gross margin for the fourth quarter of 2013 was driven primarily by significant customer-driven cost increases on a project in Oman, and to a lesser degree, due to project execution challenges in Australia. The cost increases negatively impacted gross margin by CAD9 million in the period. Variation claims for customer-driven cost increases have been submitted and are currently being discussed with the client.

Turning our focus to Enerflex' financial position, the Company continues to maintain a strong balance sheet. At the end of the fourth quarter of 2013, the Company held CAD182 million in cash and had CAD298 million of available credit facilities. With a debt balance of CAD93 million, Enerflex ended the quarter in a net cash position. The quarterly -- the Company exited the quarter with a net cash to EBITDA ratio of 0.85 to 1. I would now like to turn the call back over to Blair to provide an outlook for each of our regional segments.

Thank you, James. The Canada northern US segment experienced a downturn in activity levels during the first half of 2013 due to weak natural gas prices. However, as a result of declining storage levels, natural gas prices have increased to approximately $5 an Mcf. This increase, coupled with the development of liquid-rich plays such as Alberta deep basin, Duvernay, and Montney formations has increased the inquiries and awards for compression and processing equipment. In addition, we have made strong progress towards increasing our presence in the market for traditional processing equipment destined for Alberta oil Sands as evidenced by contract awards totaling CAD55 million in Q4 of 2013.

Canada and the northern US segment recorded bookings of CAD167 million for the fourth quarter of 2013 compared to CAD85 million in 2012 driven by an increase in domestic activity, and to a lesser extent, equipment destined for International markets. As a result, backlog levels compared to the start of 2013 have increased by CAD86 million to CAD307 million at the end of the fourth quarter of 2013. The strong bookings trend is expected to continue in the first quarter of 2014.

Activity in the liquid-rich US gas basins has remained steady through 2013 despite improving but weak NGL prices which has resulted in new orders for compression and processing equipment for the region. Therefore, Enerflex continues to be optimistic with respect to this region. For the fourth quarter of 2013, bookings increased by CAD68 million over Q4 2012 to CAD186 million, primarily due to increased and engineered systems products destined for International markets.

Backlog for the southern US and Latin America has increased by CAD131 million from CAD228 million at the end of 2012 to CAD359 million at the end of 2013. The International segment continues to hold long-term opportunity despite low bookings activity within the region for the fourth quarter of 2013. Bookings that we recorded in the International segment for the fourth quarter of 2013 were CAD6 million lower when compared to the same period of 2012. The decrease was due to lower coal seam gas exploration and gas storage project activities in Australia and fewer opportunities in the MENA region. Backlog was CAD129 million at the end of the fourth quarter of 2013, which is a CAD168 million decrease from 2013 opening backlog of CAD297 million.

It is important to note that the Canada and northern United States and southern US and Latin American segments recorded bookings totaling CAD114 million in the fourth quarter of 2013, which are destined for International markets but not presented in the International segment. This compared to order CAD47 million in bookings recorded in the fourth quarter of 2012 that were destined for International markets. In summary, bookings activity was significantly improved over the fourth quarter of 2012, leaving the Company well-positioned to deliver improved results in 2014. Our strong balance sheet positions the Company to continue to grow its business and deal with any challenges in the coming year.

The Company's fourth-quarter financial results were significantly impacted by these cost increases that we've based in the International segment. However, Management has begun to address the internal challenges identified with new leadership in the region, and we remain diligent and focused on improving project performance in the segment. As previously stated, where cost increases on customer projects were customer-driven, the Company intends to vigorously pursue variation claims for such increases but does not expect resolution before the second half of 2014. This completes the formal component of the webcast. Additional details can be found in our February 27 Press Release, and we would now be happy to take any questions. Operator?

(Operator Instructions)

Dana Benner, AltaCorp Capital.

Morning.

Morning, Dana.

I wanted to start with the cost overages, I guess, related to the Oman project. So, if we add up the CAD11 million from Q3 that you disclosed, the CAD9 million approximately in Q4, and let's call it CAD15 million -- you've given a CAD14 million to CAD17 million range. Let's call it CAD15 million for the first half of 2014. That gets us to CAD35 million in terms of scope change. Scope and design change. Presumably, the goal would be to get CAD35 million-plus of margin on top of that in terms of a revenue pull-in in the second half of 2014. Is my math approximately correct?

Yes, it is.

Okay.

And, yes, you are also correct in the assumption that you have made that this is the type of -- the quantum that the variation orders are directed at.

Okay. So, acknowledging that every project is different. Every client is different, et cetera. What has been the historical conversion rate on getting scope changes approved and paid as requested? Or, can these often be very long and difficult negotiations? Or, just any historical color to help us understand would be appreciated?

Every client is different as you elaborated on -- or at least alluded to. The variation order process is quite similar with each customer as the variations are submitted, and then there is a very exhaustive and complete backup that is required to those changes as well and that's part of the process. And then, sort of the negotiations start around what is acceptable and what is not, and so that process can take weeks to months.

However, I think in both the customer and in Enerflex' best interest to come to some sort of conclusion prior to commissioning the plant. And so, that's kind of the process that we go on. And, the conversion rate, we certainly feel comfortable at this point that there is variation claims that are due to Enerflex, but the quantum won't be discussed and certainly then the timing is really accurately uncertain that this will happen probably after the first half of the year.

And then, the only thing I will add to that is that on the Q3 call, we pointed to examples in the past where we've been successful in recording approved variation claims in the quarter. So, in Q1 of 2011 and Q2 of 2011, we recorded some significant amounts that were approved during those quarters for projects that had been -- where we had taken the cost increases in 2010. So, it typically is towards the end of the project as the plant starts to get commissioned that those negotiations take place and are discussed with the client.

Okay, well that's great. I wanted to move to your backlog. The backlog has grown substantially two out of three regions and certainly very nicely corporately. I wonder if you could maybe give us a bit more color by region on the backlog? In any way that you want to define that, however you want to take the question?

Yes, sure. So, in Canada northern US, we booked CAD167 million for the quarter. The lion's share of that was definitely destined for the Canadian market at about CAD136 million. Within that CAD136 million, there was some significant bookings in there for Oil Sands work and power generation work in the quarter because we have started to get some great traction in both of those product lines.

We also had about CAD30 million that was destined for the International markets that was booked in the Canada and northern US segment. And then, in the southern US and Latin America segment, we had about CAD185 million of bookings during the quarter. About CAD83 million of that was headed for the International markets, primarily Asia and MENA. And then, the CAD103 million was obviously destined for the southern US market with a good chunk of that being gas processing. Gas processing work in that region.

Great. That's great. And then, two more questions. Maybe just additional color on how you feel you're doing on the gas processing side. I know it's a major growth imperative and growth area for you given what you've just told us on the composition of the backlog in southern US Latin America. Presumably, you'd be pleased with the general direction. But, any additional color on processing would be great?

Yes, Dana, we're extremely pleased at the progress made with the Houston facility on gas processing and treating. Putting that concerted effort into it throughout 2013 has really and still continues to be sort of a very bright star for the Company and the region. We don't see that changing at all in 2014 certainly with what we see in the first two months and what we see kind of in the queue of opportunity going forward.

Okay, and then just one final question. Is there anything as part of your Global ops that makes you want to change the rate at which you capitalize your rental fleet? Meaning, are market preferences changing in any particular market where you'd maybe want to put more money into a rental fleet? Or, is it moving more toward sales and you'd put less? What color can you give us?

Are you talking about allocating capital to certain regions, Dana? Is that the question?

Okay, well in that case then, certainly we have given a lot of consideration about the recurring revenue, and one of the strategic goals that we've got is to deploy some of this capital into rental fleet. Certainly, we've made traction in the northern US, and we continue to, I guess, quietly make inroads in the northern US with our rental fleet.

There are International opportunities as well that have presented themselves, and now that our Global footprint for servicing the structure has grown quite significantly over the past couple of years in the Middle East with about 70 technicians in the Middle East now as a result of Bahrain and Oman. And then, this well in Southeast Asia and Indonesia, we've also grown the technicians there. So, it gives us a much better opportunity to look at some of the rental contracts for compression that we gave a miss to in the past because of the lack of footprint. So, that is something that is very much front and center of the growth opportunity and deploying some capital into those areas.

Okay. Well that's great. I'll turn it back. Thank you.

Thanks, Dana.

(Operator Instructions)

Jon Morrison, CIBC World Markets.

Morning.

Morning.

Just to follow on Dana's question. Relative to your messaging on the Q3 call, has there been any change in your view on the likelihood of recovering change order fees of the stuff that was announced in Australia in Q3? Like are you more or less positive on recovering those costs? Is there really no structural change at this point?

There's no structural change and still positive on recovering costs.

Okay. In the US, can you give any sense of how much of your business is weighted towards gas processing and treating relative to your historical business, i.e., in the last 12 months, is 15% or 20% of your business in these new growth initiatives that you otherwise weren't strongly pursuing a year or two years ago?

Probably a little bit stronger than that, John, that the gas treating and processing increase in -- I would say, revenue and profitability would be better than 15% growth.

15% growth? Okay. Is the margin difference meaningful between those two businesses?

Yes.

Compression versus processing?

Yes.

In a basis point manner is it -- how much of the strong US margins is a function of mix versus the traditional compression business?

So, Jon, we don't want to -- it is a contributing factor, and it's a meaningful contributing factor. We don't want to express it in terms of basis points because we just don't want to disclose gross margin information.

Okay. In the bookings in the Canadian business, I realize that margins were a little bit lower than normal in Q4, and there is some one-time issues in there. If you look at what you've booked and what you expect profitability to be, is it fair to assume that it's in the range of traditional Canadian engineered system margins, somewhere in the 5% to 7% range?

Yes. I think that we would feel comfortable with it returning to that range. I mean, 2013 -- the front half of 2013 was impacted by weaker plant utilization in our Canadian Northern US markets just because of weaker bookings. In the back half of the year, we saw an increase in bookings, and the plants became -- started to ramp up and get a little busier.

But, we haven't gone to the point yet where we're fully absorbed. Equipment is starting to move into those plants, and we're starting to put production hours in there. And, we're going to get better absorption of those plants heading into 2014 because of higher backlog levels, so we would expect improved EBIT margins as a result of that as well.

Okay, last one for me. James just from an accounting perspective, I'm assuming that you're not planning to get any of the gross margin recoveries -- or potential gross margin recoveries on the Oman stuff until Q3, Q4, or beyond of 2014?

We think that that's probably the latest that that will happen, but there's always a chance that those negotiations move up from the timeframe, and if we get anything approved in Q1 or Q2, people will see it in that quarter. But, right now, the latest we expect it to be resolved is in the back half of 2014.

Perfect. As always appreciate the color.

Thanks a lot, Jon.

Mr. Goertzen, it appears we have no other questions. At this time, I'll turn the call back to you, sir.

All right, Operator, thanks for your help. And, since there are no further questions, I would like once again to thank everyone for the call. We're certainly available post- the call for any further questions. And I do look forward to giving you our first quarter results in the May 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.