Enerflex Ltd (EFXT) 2014 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Enerflex first-quarter results conference call. (Operator Instructions) As a reminder, this conference is being recorded today, Tuesday, May 13, 2014.

I would now like to turn the conference over to Blair Goertzen, President and Chief Executive Officer. Please go ahead, Mr. Goertzen.

All right, thank you. Good morning, everyone, and thank you for joining us. Here with me today is James Harbilas, Enerflex's Executive Vice President and Chief Financial Officer.

During this call, we will be providing our financial results for the three months ended March 31, 2014, a brief commentary on the performance of our three business segments, and a summary of our financial position at the end of the first quarter of 2014. Approximately one hour following the completion of this call, a recording will be available on our website under the investor relations section.

During this presentation, unless stated otherwise, we will be referring to the three months ended March 31, 2014, compared to the same period of 2013. I will proceed on the basis that you of all taken the opportunity to read yesterday's press release.

During the first quarter, we have been continuing to see positive market development in liquid rich plays in Canada and the United States in the Alberta oil sands and the electric power opportunities. We've also seen encouraging signs relative to liquefied natural gas projects in Canada, the US, and AustralAsia, which materialized into bookings for the first quarter and an end backlog of almost CAD200 million higher than the first quarter of 2013.

Bookings for the first quarter of 2014 were CAD238 million, an increase of CAD49 million. However, overall financial results for the Company were below expectations. We had additional cost increases on a large project in the international segment that were within the range previously communicated, which had a related impact on gross margin for the first quarter of 2014. Where the cost increases have been customer driven, variation claims have been submitted, and are being vigorously pursued.

The Canada and the Northern United States, and the Southern United States and Latin American segments performed well in the first quarter of 2014. These regions have shown positive trends in bookings and are answering the second quarter of 2014 with strong backlog levels.

International segment revenue decreased in the first quarter of 2014 due to lower engineered systems revenue driven by lower opening backlog and large projects that are nearing completion in the Middle East and AustralAsia regions and due to the impact on revenue of cost increases on the Oman project. This was partially offset by higher service revenue and increased activity in AustralAsia and the Middle East.

Effective June 1, 2014, Enerflex has made a leadership change with the appointment of Mr. Phil Pyle as President, International. Enerflex has a strong regional business model and the location of this role is essential to the Company's continued international growth.

Based in Abu Dhabi, Mr. Pyle will be responsible for overseeing and providing strategic and operational leadership for the international business. He brings over 25 years of extensive international operations experience to his leadership roles of multinational companies.

To support Enerflex's global growth strategy, Mr. William Moore has accepted the position of Senior Vice President, Business Development and Strategy and will be responsible for the development and execution of global growth objectives.

Improving market dynamics, coupled with our strong balance sheet, positions the Company to -- well, to capitalize on opportunities that may arise. After first-quarter results that were adversely affected by project cost increases previously anticipated and communicated, we would expect to deliver stronger results through 2014 as higher opening backlog is converted to revenue and as we continue to deliver improved recurring revenue from our service business.

In addition, we are looking forward to leveraging the recent senior leadership changes in the international business and with respect to business development.

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

Thank you, Blair. Enerflex generated net earnings from continuing operations of CAD4 million or CAD0.05 per share for the first quarter of 2014, representing a decrease of CAD11 million. The decrease in net earnings for the quarter was primarily due to lower gross margin and higher SG&A expenses, partially offset by higher equity earnings and lower income tax expense.

As previously reported, work on an international project in Oman continued to experience substantial customer-driven scope and design variations during the first quarter of 2014, which increased project costs by a further CAD16 million.

This resulted in a corresponding decrease in gross margins of CAD13 million. These cost increases were within the range previously disclosed. With the project 80% complete at the end of March 2014, the risk of further margin deterioration is significantly reduced. The Company has submitted and continues to pursue variation claims for cost increases on the project, but does not expect resolution before the second half of 2014.

During the first quarter of 2014, the Company recorded bookings of CAD238 million, which were CAD49 million, or 26% higher, than the comparable period in 2013. Bookings increased by CAD30 million for the Canada and Northern US segment as a result of improving market fundamentals.

In the international segment, increased activity in the AustralAsia region resulted in the CAD34 million increase in bookings for the segment. In the southern US and Latin America segment, the decline in bookings destined for international markets more than offset the increase in domestic bookings, resulting from strong activity in liquid rich US gas basis.

Backlog at March 31 was CAD802 million, which represented an increase of close to CAD200 million or 33%. Sequentially, backlog has increased by CAD8 million compared to CAD794 million at December 31, 2013.

Consolidated revenue for the first quarter was CAD332 million compared to CAD353 million. The decrease of CAD21 million was due to lower revenue in the international segment, which was partially offset by higher revenue in the Canada and Northern US, and Southern US and Latin America segments.

Continuing with the review of our product breakdown, engineered systems revenue was CAD230 million for the first quarter of 2014, which was 15% lower than the prior year. The lower revenue was primarily a result of lower backlog in the international region.

Service revenue for the first quarter of 2013 was CAD88 million compared to CAD68 million for the same period of 2013, an increase of 30%. Service activity levels in 2014 improved in all segments, with the Company continuing to benefit from increased activity in the Canada, US, and AustralAsia regions.

Rental revenue in the first quarter of 2013 was slightly lower, coming in at CAD14 million compared to CAD16 million. North American utilization levels improved to 73% during the first quarter of 2014 compared to 67% in the comparable quarter of last year. The increase in utilization over 2013 was largely due to the result of sales of idle rental units from the fleet.

Consolidated gross margin for the first quarter of 2014 was CAD51 million, or 50% of revenue, compared to CAD61 million or 17% in 2013. The decrease in gross margin was attributable to lower margin in the international segment, partially offset by higher margins in the Canada Northern US, and Southern US and Latin America segments.

In the international segment, further cost increases of CAD16 million were identified during the first quarter of 2013 -- 2014, which negatively impacted gross margin by CAD13 million in the period.

Selling, general, and administrative expenses for the quarter ended March 31, 2014 were CAD44 million compared to CAD39 million for the same period of 2013. The increase was a result of higher compensation expense, share base costs, and office and occupancy costs, partially offset by favorable foreign exchange movements.

The increase in compensation expense was attributable to salary increases effective at the beginning of 2014, approximating 3% overall and an increase in the number of indirect employees.

Mark-to-market adjustments also led to an increase in share-based compensation expense, driven by the increase in the share price during the first quarter of 2014. These increases were partially offset by reduced incentive costs.

Moving on to our regional results, in Canada and the Northern United States, revenue increased by CAD22 million to CAD142 million as a result of higher engineered systems revenue due to higher opening backlog and higher service revenue from increased parts and engine sales. These increases were partially offset by lower rental revenue as a result of a decrease in rental unit sales.

Operating income of CAD3 million for the first quarter of 2014 was slightly lower than the same period of 2013 due to higher SG&A expenses, partially offset by higher gross margin. Gross margin was positively impacted by higher revenue, lower warranty expense, and stronger plant utilization, partially offset by less favorable project performance.

The increase in SG&A was due to higher compensation expense and third-party services. The increase in compensation expense reflected the previously mentioned salary adjustments, an increase in indirect employees, and mark-to-market adjustments to share-based payment expenses, partially offset by reduced incentive costs.

In the Southern United States and Latin America segment, revenue for the first quarter was CAD118 million, which was CAD3 million higher. The increase in revenue was attributable to higher service revenue on increased service calls and parts sales compared to the same period last year.

This was partially offset by lower engineered systems revenue due to the timing of backlog conversion to revenue, as deliveries have been pushed out as a result of customer requirements. The associated revenue of these projects will be recognized in future quarters during 2014.

Operating income for the first quarter of 2014 held steady at CAD13 million due to higher gross margin offset by higher SG&A expenses. Gross margin was higher in the first quarter, resulting from improved gross margin performance and reduced warranty expense. SG&A expenses were higher due to higher office and occupancy costs and share-based compensation, partially offset by lower incentive costs.

Revenue in the international region for the first quarter of 2014 was CAD46 million lower due to lower engineered systems revenue, driven by lower opening backlog. This was partially offset by higher service revenue on increased activity in the AustralAsia and MENA regions.

The region recorded an operating loss of CAD8 million in the first quarter of 2014, which was CAD14 million lower due to lower gross margin and higher SG&A expenses. The lower gross margin for the first quarter was driven primarily by cost increases on the Oman project due to scope, design variations, and schedule delays, which impacted gross margin by CAD13 million in the period.

SG&A expenses were higher in 2014 compared to 2013 as a result of higher office and occupancy costs, mark-to-market adjustments to share-based payments, which was partially offset by lower incentive costs.

Turning our focus to Enerflex's financial position, the Company continues to maintain a strong balance sheet. At the end of the first quarter of 2014, the Company held CAD219 million in cash and had CAD319 million of available credit facilities.

With a debt balance of CAD88 million, Enerflex entered the quarter in a net cash position. Accordingly, the Company has a net cash to EBITDA ratio of 1.64 to 1 at the end of the first quarter. This compares to a net cash to EBITDA ratio of 0.3 to 1 at the end of the first quarter of 2013.

I would now like to turn the call back over to Blair to provide an outlet for each of our regional segments.

Thank you, James. The Canadian Northern US segment did experience a downturn in the activity during the first half of 2013 due to weak natural gas prices. Since then, gas prices have been trending upwards. North American storage levels are down year over year and are trending considerably below the five-year average range and as a result, natural gas prices have been increased approximately to CAD4.5 per mcf.

Prices in May are trending at about the same level for June deliveries. Natural gas fundamentals appear to be improving into 2014, a trend the Company expects to continue through the remainder of 2014.

Fundamentals will further improve as LNG projects in Western Canada progress and as the development of the Duvernay shale play expands, we have recently seen increased activity in traditional processing equipment destined for the Alberta oil sands as well and in compression and process equipment related to natural gas liquids opportunities, such as in the Alberta Deep Basin, Duvernay, and Montney reserves.

The Canada and the Northern US segment reported bookings of CAD100 million for the first quarter of 2014 compared to CAD70 million in 2013, driven by improved market dynamics in the region, the expansion into Alberta oil sands, and the electric power market. As a result, backlog levels compared to the start of 2014 have increased by CAD18 million to CAD324 million.

Market fundamentals in the Southern US have remained steady, despite weak NGL prices, which has resulted in new domestic orders for compression and processing equipment for the Southern US and Latin American segment. Therefore, the Company continues to be optimistic yet conscious with respect to the region.

Bookings for the region in the first quarter of 2014 were CAD103 million compared to CAD119 million, as increased domestic bookings were more than offset by lower orders destined for international markets. At the end of the first quarter of 2014, backlog increased by CAD3 million from the start of the year to CAD362 million.

The international segment continues to hold long-term opportunity, as evidenced by increased activity in the AustralAsia region, which is led to stronger bookings in the first quarter of 2014 compared to the same period in 2013. Bookings recorded in the international segment for the first quarter of 2014 were CAD33 million higher than when compared to same period of 2013.

Backlog was at CAD116 million at the end of the first quarter, which is a CAD13 million decrease from 2014 and 2014's opening backlog of CAD129 million. The decrease was primarily due to booking levels being lower than the conversion of backlogs to revenue in the first quarter of 2014.

In summary, continuing positive market developments in the first quarter of 2014, particularly in Canada, the US, and AustralAsia, have materialized into bookings when compared to the first quarter of 2013. The Company entered 2014 with strong backlog levels and exited the quarter with a closing backlog almost CAD200 million higher than the first quarter of 2013. Improving market dynamics, coupled with our strong balance sheet, position the Company well to capitalize on opportunities that arise.

After first-quarter results that were adversely affected by cost increases previously anticipated and communicated, we would expect to deliver stronger results through 2014 as the higher opening backlog is converted to revenue. And as the Company continues to deliver improved recurring revenue from a service business.

In addition, we're looking forward to leveraging the recent senior leadership changes in the international business and with respect to business development.

This does complete the formal component of the webcast. Additional details can be found in our May 12 press release. And we will now be happy to take any questions. Operator?

(Operator Instructions) Brody Woods, BMO Capital.

So just got a couple of quick questions just on the scope increases there. So obviously, as you noted, that was something that you telegraphed earlier and that you were kind of seeing second half of the year when you could expect to recoup some of those variation claims.

Would it be possible to put a number on what that might look like sort of on the top line and maybe -- I know on a margin basis, you get a little bit of a premium margin on it as well. Is there any way to kind of quantify that?

I wouldn't want to put an absolute number due to the negotiations. Certainly, what we've been saying is that we expect to collect it in the back half. The quantum is uncertain.

You know what the cost increases are, because we've disclosed those and those are certainly the type of dollars that we're going after in these variation claims that would essentially be taken as revenue and gross margin in the period that they are approved.

So again, I don't want to sound ambiguous, however, you know the quantum of the variations to date and those are the types of numbers that are being negotiated.

Okay. That's helpful. And then looking ahead, do you see any potential variations in scope on any projects you are working on currently or is that kind of the one that stands out? Obviously, you're over 80% done now, so that's probably the last of the ones to the Oman project, but any of the projects you're working do you see something similar?

Nothing to this magnitude at all.

Okay. I think that's helpful. That's all I had. Thank you very much.

Jon Morrison, CIBC World Markets.

On the international side, it's fair to say that your view on cost recoveries or the likelihood of cost recoveries hasn't changed since the last call?

That is correct, Jon, they have not changed at all.

Okay, perfect. Blair, can you just comment on the international side, geographically, where you guys are seeing the strongest bidding activity currently take place?

I would say the Middle East and product sales into northern Iraq for standard product. And then on the installation side, in Australia. Those are the two areas right now that have got the greatest visibility for the future.

What's the nature of the work in Australia currently?

So there are product sales for compression applications and there's also engineering and construction activities as well for the installation and pipeline looping -- increasing pipeline capacity on the East Coast.

On the Canadian Northern US, I was a little bit surprised by the margins in the quarter. James, can you just highlight whether there was anything one-time specific in nature in the quarter that we should be thinking about.

And if you assume that product support was much more profitable than the engineered systems, fabrication work, what is the actual profitability of that segment in the last quarter and expectations for go-forward margins?

Yes, you know, Jon, the lower operating income and EBIT margins were a function of three things primarily. There was some low-margin work that was making its way through the plant in the first quarter. We had some start-up costs on some of the new oil sands bookings that we announced in the back half of 2013.

And then there was handful of jobs -- probably half a dozen -- that had some bidding and engineering issues that impacted the gross margins on those jobs as they made their way through the shop floor in the first quarter. So if I normalize for all of those, we would see operating margins back up in that close to 6% range -- EBIT margins up close to that 6% range.

So it's fair to assume that you believe that 6%-ish -- call it 5% to 7% margins -- are achievable for the back half of the year or inclusive of Q2?

They are achievable.

The sequential decline in the Southern US and Latin America -- was that a function of throughput or was it a mix issue that kind of had the sequential slide in operating margins? They were still healthy, but obviously down from Q4 levels.

Yes, so, you know, typically what we see is the Q4 -- is typically our strongest quarter in the Southern US, Latin America. We get a lot of activity and deliveries that take place in Q4.

Q1 was a little weaker than we expected it, but as a result of some of these deliveries that we had in backlog being pushed to Q2, Q3, and even Q4 of 2014, so that impacted throughput of the facility and it impacted utilization and absorption of our overhead costs, which had a corresponding impact to gross margin and operating margins.

Last one from me. Just given the improving market conditions, is the likelihood of rentals acquisition starting to dissipate in that sellers' asks are elevating in the current market?

No, I would say that's not the case, that there's still -- I think the visibility that we have, that there still looks to be a lot of opportunity in that market.

Appreciate the color.

Mr. Goertzen, with no further questions, I'll turn it back to you for your closing remarks.

All right, thank you, operator. And since there are no further questions, I would once again like to thank you for joining us on the call and we look forward to giving you our second-quarter results in August 2014. Thanks.

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