Enerflex Ltd (EFXT) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Enerflex second-quarter 2014 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, August 8, 2014. It is now my pleasure to introduce Blair Goertzen, President and Chief Executive Officer with Enerflex. Please go ahead, sir.

Thank you. Good morning, everyone, and thank you for joining us. And here today with me 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 June 30, 2014, a brief commentary on the performance of our three business segments, and a summary of our financial position at the end of the second quarter of 2014. Approximately one hour following the completion of the 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 June 30, 2014, compared to the same period of 2013. I will proceed on the basis that you have all taken the opportunity to read yesterday's press release.

In the first half of 2014, we saw continuing positive market developments in liquid-rich plays here in Canada and in the United States and electric power opportunities. We have also seen encouraging signs relative to liquefied natural gas projects in Canada, the US, and AustralAsia, which have materialized into increased bookings in all regions for the first half of the year and an increased backlog of CAD868 million at the end of June 30, 2014. Bookings in the second quarter were CAD414 million, an increase of CAD97 million compared to the same period of 2013 and a sequential increase of CAD176 million from the first quarter of 2014.

On June 30, 2014, Enerflex completed the acquisition of the international contract compression and processing business as well as the aftermarket services business of Axip Energy Services, LP for $430 million. Axip's international contract compression processing and aftermarket service business is a leading provider of global energy services. It's headquartered in Houston, Texas; and Axip brings 173 employees with operations in Argentina, Brazil, Colombia, Mexico, Peru, Bahrain, Indonesia, Malaysia, and Thailand. Axip's energy infrastructure outfits include a 448-unit compression fleet totaling approximately 285,000 horsepower; and gas treatment facilities in Mexico, Argentina, and Peru.

With the completion of the acquisition, Ms. Patricia Martinez also joins Enerflex's executive management team as President, Latin America, and is responsible for the expansion and growth of the contract operations business and Enerflex's product sales for the entire Latin American region. Since the transaction closed, we have already been successful in capitalizing on rental opportunities in Latin America and the Middle East/North African region, which are expected to continue through 2014. We are excited to work with Axip employees to continue to grow and build on the Company's past successes.

In July 2014 Enerflex was provided with a letter of intent for one new project in the MENA region and one in the Latin American region. The project in the Middle East is for the rental of compression trains and the provision of on-site operations maintenance and services for a period of 48 months.

The project in Latin America for the rental of compressor units and the associated operations and maintenance services for a period of 48 months, as well. Coupled with a rental contract won earlier in the year in the Middle East region for the rental of compressors and associated operations and maintenance that was for a period of 24 months, the total awarded horsepower that will be deployed to these three projects is approximately 60,000 horsepower.

Lastly, Enerflex was successful in renewing a large service contract in the AustralAsia region for the initial contract term of between 36 to 48 months providing parts, service, and technical support. Recurring revenue is expected to increase significantly over the remainder of 2014, with the acquisition of Axip's rental and service business, which will bring Enerflex closer to achieving its strategic objective of generating recurring revenue of between 35% and 40% of total revenue.

The Canada and Northern US and Southern US and Latin American segments performed well in the second quarter of the year. These regions have shown positive trends in bookings and are entering the third quarter of 2014 with strong backlog levels. Increased activity in the AustralAsia region has led to an increase in bookings for the international segment in the first and second quarters of 2014 when compared to the same periods of 2013.

Since the second half of 2013 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 increased to approximately CAD4 dollars an MCF. Prices in August are trending into the CAD4.50 per MCF range for our September deliveries.

Natural gas fundamentals appear to be moving and improving in the back half of the 2014 period. Fundamentals should further improve as LNG projects in Western Canada progress and as development of the Duvernay shale play expands. We have recently seen increased activity in compression and the process equipment related to natural gas liquid opportunities such as the Alberta Deep Basin, Bakken, Duvernay, and Montney reservoirs.

The Canada and Northern US segment recorded bookings of CAD111 million for the second quarter of 2014, driven primarily by improving natural gas market dynamics in the region and the expansion by Enerflex into the Alberta oilsands and electric power market. As a result, backlog levels increased to CAD309 million at the end of the first six months of 2014 compared to CAD307 million at the end of December 31, 2013.

Market fundamentals in the Southern US have remained steady despite weak NGL prices, which have 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 with respect to this region.

Bookings for the region in the second quarter of 2014 were CAD227 million, an increase of CAD108 million over 2013. The increased domestic bookings were partially offset by lower orders destined for international markets. At the end of the second quarter of 2014, backlog increased by CAD76 million from the start of the year to CAD435 million.

The international segment continues to hold the long-term opportunity, as evidenced by increased activity in the region, which has led to stronger results than the first half of 2014. Bookings reported in the international segment for the second quarter were CAD77 million. Backlog was CAD125 million at the end of the second quarter, which is a CAD4 million decrease from the 2014 opening backlog. The decrease was primarily due to booking levels being lower and the conversion of backlog to revenue in the first half of 2014.

Improving market dynamics coupled with our strong balance sheet positions the Company well to capitalize on opportunities that may arise. We expect to deliver strong results through the remainder of 2014 as higher opening backlog is converted into revenue and as we continue to deliver improved recurring revenue from our services business.

In addition, we are looking forward to leveraging the recent executive leadership change 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. For the second quarter of 2014, Enerflex generated normalized net earnings of CAD25 million or CAD0.33 per share, which reflects one-time transaction costs expensed as part of the acquisition and the related tax effects. The normalized net earnings for the quarter were CAD7 million higher due to higher gross margin, partially offset by higher SG&A and income tax expenses.

Consolidated revenue for the second quarter was CAD446 million, representing an increase of CAD135 million, as revenue was higher in all three regional segments. Consolidated gross margin for the second quarter of 2014 was CAD86 million or 19% of revenue, an increase of CAD22 million. The increase was due to higher gross margin in the Canada/Northern US and Southern US and Latin America segments due to the positive impact of higher revenue, improved project margins, and improve plant utilization. The increases were partially offset by lower gross margin in the international segment.

Work on an international project in Oman continued during the quarter and is close to mechanical completion, which is expected during the third order of 2014. The Company has submitted and continues to pursue variation claims for cost increases that have been incurred on the project resulting from customer-driven scope and design variations. Enerflex expects resolution of these claims during the second half of 2014.

Selling, general, and administrative expenses for the quarter were CAD58 million or 13% of revenue. The increase was result of higher compensation expenses, legal and advisory fees associated with Axip acquisition. The increase in compensation expense was attributable to salary increases in line with market, an increase in staffing, and share-based expense due to the increase in share price at the end of the quarter.

Income tax expense for the second quarter of 2014 totaled CAD18 million or 61% of earnings before tax. The income tax expense and effective tax rate were high as result of one-time, nondeductible transaction expenses associated with the acquisition; and the tax impact of repatriating cash to Canada to partially finance the acquisition. If we normalize for these two items, our tax rate would drop to roughly 34%.

Continuing with the review of our product breakdown, engineered systems revenue increased to CAD348 million for the second quarter of 2014, which was 56% higher than the prior year. The higher revenue was primarily the result of higher backlog into Canada/Northern US and Southern US and Latin American regions. This was partially offset by lower backlog in the international segment.

Service revenue for the second quarter was CAD91 million, an increase of 15%. Service activity levels in 2014 improved over 2013 in all segments, with the Company continuing to benefit from increased activity in Canada, the United States, AustralAsia, and the Middle East.

Rental revenue for the second quarter of 2014 was CAD7 million, which was 22% lower than 2013. North American rental utilization levels improved to 70% during second quarter of 2013 and had reached 71% in June 2014. The increase in utilization over 2013 was largely the result of the sale of idle units from the fleet.

Moving on to our regional results, in Canada and Northern US, revenue increased by CAD61 million during the second quarter of 2014 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 result of the decrease in the total horsepower under rental contracts.

Operating income of CAD7 million for the second quarter of 2014 was a result of higher gross margin, partially offset by higher SG&A expenses. Gross margin was positively impacted by higher revenue, lower warranty expense, and strong plant utilization, partially offset by lower project margins.

The increase in SG&A was due to higher compensation expense and third-party services related to the Axip acquisition. The increase in compensation expense reflected the previously mentioned salary adjustments, an increase in staffing, and higher share-based payment expense due to the increase in share price at the end of the second quarter.

In the Southern US and Latin America segment, revenue for the second quarter of 2014 was CAD171 million. The increase in revenue of CAD72 million was attributable to higher engineered systems revenue due to higher opening backlog and higher service revenue on increased service calls and parts sales.

Operating income for the second quarter of 2014 increased by CAD5 million to CAD17 million. The increase was due to higher gross margin, partially offset by higher SG&A expenses. The increase in gross margin was attributable to higher revenues, improved project margins, and significantly better plant utilization. SG&A expenses were higher in 2014 due to higher office and occupancy costs, higher compensation expense, and increased third-party services.

Revenue in the international region for the second quarter of 2014 was CAD92 million. The increase of CAD2 million was the result of higher service revenue, partially offset by lower engineered systems and rental revenues. The region recorded operating income of CAD4.2 million for the second quarter of 2014.

The lower operating income was attributable to lower gross margin and higher SG&A expenses. SG&A expenses were higher in 2014 as a result of higher compensation expense and higher third-party services related to the Axip acquisition.

Turning our focus to Enerflex's financial position, the Company continues to maintain a strong balance sheet. Cash totaled CAD130 million at the end of the second quarter of 2014. The Company drew proceeds of CAD331 million from its credit facility and exited the quarter with a net debt to normalized EBITDA ratio of 2.06 to 1. The increase in debt was due to drawings on the Company's credit facilities, which were used to fund the Axip acquisition.

In summary, continuing positive market developments in the first half of 2014, particularly in Canada, the United States, and AustralAsia, materialized into the increased bookings when compared to the second quarter of 2013. The Company entered 2014 with strong backlog levels and exited the quarter with a closing backlog of CAD868 million, which is almost CAD74 million higher.

Enerflex's recent acquisition is consistent with the Company's strategy of increasing recurring revenue streams and expanding geographic markets. Improving market dynamics, coupled with our strong balance sheet and our recent acquisition, position the Company well to capitalize on opportunities, as evidenced by the recent long-term service treatment in Australia and rental projects in MENA and Latin America.

This completes the formal component of the webcast. Additional details can be found in our August 7 press release. We will now be happy to take any questions. Operator?

(Operator Instructions) Dana Benner, AltaCorp Capital.

I wanted to start with -- I know it's a subject that you consider a tired one now, and I'm sure it's something that will turn for the better here soon. But going back to Oman, with respect to the Q2 impact, our quick math put the margin impact at around CAD4 million. Does that sound like a reasonable estimate for Q2?

Yes. It was actually about CAD4.7 million, if you look at the year-to-date impact on gross margin versus Q1. So it was about CAD4.7 million and resulted from the continuing revenue recognition on a percentage-of-completion basis of some of the increases that have incurred on the project in the past, and some minor increases that we also experienced in the second quarter.

Right. So then, given that, it sounds like there may be a residual in the Q3. So even if -- let's just say, for the sake of argument, you were able to gain recompense from the Omanis in Q3, I guess there could still be a Q3 negative margin impact due to the final installation. Is that possible?

Assuming no other increases, Dana, we would just continue to recognize revenue on this project on a percentage-of-completion basis, as we incur the final costs as we get ready for mechanical completion in Q3. So it would just be recognizing the last cost increases that we announced in the first two quarters of this year into Q3 through revenue.

Okay. But probably not likely to be a material amount?

No, I don't anticipate it would be.

Right. I guess moving to better news, with respect to the follow-on contract compression wins that you have announced post the close of Axip, could you give us an update on the capital required for those projects, and maybe just a larger update on CapEx for the year?

We don't want to talk about the CapEx associated with these projects for competitive reasons, obviously, on the call. These were competitively bid. What I can say is that if you look at it from a horsepower standpoint, it's roughly a 21% increase to the 285,000 horsepower that we acquired from Axip.

So it's a meaningful increase in horsepower deployed and will have a meaningful increase to EBITDA. In terms of the CapEx, though, it will straddle the last two quarters of this year and probably the first quarter of next year. And what we can say is that our net CapEx spend this year would go up by roughly CAD30 million to CAD40 million from where it is right now at the end of the second quarter. Year to date our net capital spend was about CAD11 million year-to-date. So we expect that to jump by about CAD30 million to CAD40 million towards the end of the year.

Right. And then when would you expect this to begin contributing to your financials? Not until Q1 2015?

No. So there is -- obviously, there's three projects here, and the projects vary in size. The two smaller projects, in terms of total horsepower deployed, will start to contribute EBITDA to late Q3 and Q4. And then the bigger project will start to contribute to EBITDA at the end of Q1 of 2015.

Great. I guess moving up a level on Axip, I think you went out of your way to make sure to manage expectations upon the purchase of Axip, knowing that they had had a pretty good growth for a while and that the prior ownership group maybe hadn't put the amount of capital in that had been put in place in prior -- or maybe the run rate just slowed down a little bit, and you felt like it might take a little while to re-tune the engine to get it back up. Is that still your sense for how the back half of this year unfolds, now that you can sort of really talk about Axip?

We want to be careful here not to provide any guidance; but, look, you hit the nail on the head. When you look at the business that we bought, they had a tremendous period of growth from 2007 to 2012. 2013 -- CapEx wasn't that big in this business, and they didn't really deploy meaningful capital to it and horsepower.

The contracts that are in play, though, will still generate EBITDA levels that were comparable to what we discussed when we announced the acquisition. But this is definitely a step in the right direction, where we have had the opportunity to now grow the fleet by 21% by deploying additional capital. And we expect the business to grow as a result of this going forward.

And, Dana, the pipeline of activity that we have visibility on is pretty significant in Latin America for both contract ops and for product cash sales as well is in the Middle East. And with that comes a fairly, I would say, good strike rate. So as James said, we do expect that pipeline to materialize into further projects over the course of the next 12 months.

Great. Wow, it's become very newsy very quickly. Just finally, with respect to your two mostly North American segments, Canada/Northern US and then Southern US/Latin America -- I mean, I think it's safe to say you really killed it on the engineering systems side.

I guess -- any additional color that you could give us? You have given us a bit, but any other ways for us to assess whether this is something that more reflects a strong blip in activity? Or is there something larger going on here that has some momentum that continues well into 2015, you think?

In Canada, there still is some positive rhetoric around LNG in the secondary market. And then there are some pundits that are talking about -- can this happen, with the fact that the US seems to be charging ahead? And where will Canada fit?

We are still positive here at Enerflex. And certainly, I would say that in talking to our customers and having discussions with those customers; and, obviously, watching what they are buying and what the opportunities are, still leads us to believe that this isn't sort of an aberration -- at the end of the day that there are some real legs underneath it for Canada.

And every quarter and every month that goes by gives us some more visibility on that. So we're still optimistic that Canada has a secondary market opportunity.

Now, the US is really a pretty good story at this point in time. And where last year there was a lot of treating and processing, this year it seems to be more wellhead compression and gas gathering. And, again, a pretty strong visibility out over the next nine months of activity in the US in both treating and in compression. So it just, again, seems to have a lot more -- the fundamentals are different than I think we would have seen a year ago.

Okay. Well, that's great clarification. I'll turn it back.

Scott Treadwell, TD Securities.

I'm going to ask this, but given one of your last answers, I'm not sure how much color you are comfortable giving. But at the end of the quarter -- obviously, a great quarter for bookings, and the backlog grew. Could you break out, even just as a starting point, maybe how much backlog Axip brought to the acquisition -- i.e., how much you got on closing? Or just some level to see maybe an apples-to-apples comparison of the business before and after the acquisition?

Yes, that's a good question, Scott. I just want to be clear: the business that we bought with Axip is primarily a contract compression business and aftermarket service business, so there isn't any meaningful backlog. We don't treat rental revenue and service revenue as bookings and backlog.

But what they did have and what they did bring from a backlog standpoint was one project where they are responsible for doing the construction and installation in Latin America. That was roughly a CAD28 million increase to the backlog to open the year. What we will report going forward, though, is any meaningful -- or any third-party sales that we make into Latin America as part of our ongoing bookings and backlog.

Okay. And fair to admit that, then, some of the bookings and backlog was related to the contracts that were awarded, where you are going to be building the equipment?

No. We don't put our own equipment into bookings and backlog.

Okay.

These are going to be opportunities -- the equipment will be built in our shop, but it's going to be deployed as a rental asset, and it will generate revenue, gross margin, and EBITDA as a rental asset and will be reported as part of our rental revenue stream.

Okay. And the other question for me, really, is looking at Canada. I know, having spoken to you guys a couple of months ago, the temperature was obviously increasing; and it was getting busier. And obviously, the Q2 results are a reflection of that.

Just looking out today, if you're a producer looking for some sort of infrastructure build, be it a gas gathering, or field compression, or something like that, is the dance card getting pretty full? Does that have any implications in terms of either pricing that you are able to get or trade input costs and things like that?

Well, we are never full. So that's the first part of the answer. It is busier; there is no question about it.

Activity that we're seeing now -- as lead times start to get longer, that comes with some better pricing opportunities as deliveries become more and more specific, just because in Canada, your deliveries typically happen over the winter months or in times where you can move heavier loads. So that tends to have some pricing favorability to it, as well.

So, again, we are not full. I don't think anyone would claim to be in that situation in Canada, but it's a better environment than we certainly had a year ago.

Okay. Great. I guess maybe to follow that up is as it gets busier, and you think about better absorption of fixed costs in your plants, is there still meaningful margins to be gained just from getting busier? Or is more of it just fine-tuning the process of how you price things, and how you buy, and all that sort of stuff?

Well, there's two areas, and you have touched on them both: higher activity typically garners better margin; and then, of course, your input costs are also -- sometimes they are under-challenged, but we've done a lot of work here in terms of automation at Enerflex.

Also, we have Lean manufacturing. And Jerry Fraelic's influence here over the past couple of years has been very instrumental. So we think we've got a pretty well-operating machine at this point in time, as well, to take advantage of what we would expect to be higher utilization in the facilities going forward.

Okay. Great. That's all I've got, guys. Thanks for the color.

(Operator Instructions) Jon Morrison, CIBC World Markets.

On the AustralAsia service contract renewal, do you expect service work for that customer to increase on the back of the award or remain in line with what you've seen over the past year with that specific customer?

It will remain in line with what we have seen in the past, although the installed base is growing, so that will be advantageous for us.

Okay. Has the view towards international cost recoveries changed at all over the last three months in terms of what you had hoped to recover in the back half of this year?

Not whatsoever.

On the contract awards, are you going to be building all of this internally yourself in Houston? If you are, is that going to displace any opportunities in terms of throughput for other engineered systems? Or do you believe that you have more than enough capacity?

To answer your question, yes. This equipment will be built in Houston. And no, we have enough capacity that this would not displace opportunities that we are pursuing in the US, or even other international equipment orders that we're pursuing in the Middle East or even into Latin America. We have enough capacity to deal with these rental opportunities, any future rental opportunities that are coming forward, and any third-party sales that we see in the pipeline.

Yes. We have redesigned the facility there as well to take advantage of 10 more bays, that were utilized for other parts of the fabrication process. So our ability to assemble has increased by 10 bays, and that's been helpful as well.

Were either of the awards new customers to Enerflex from an historical standpoint?

No. No, we've done business with these customers in the past.

Okay. In the US, can you give any sense of geographic weighting of the bookings that you took in the quarter in the Southern US? I'm guessing it's heavily weighted towards the Eagle Ford, but I'm just trying to get a sense of -- broadly, is that spread across various basins, or is it very basin-specific?

It would be spread across Eagle Ford and a lot of equipment going into the Marcellus. Those would be the two most active basins for us right now.

And is it all largely compression-based? Or is there continued growth in the processing side of the business?

As I said earlier, there has been a bit of a mix change in 2014, where compression has grown significantly over last year, and treating and processing is less than it was last year. So again, there's no real answer for it, other than there is just a lot of gas that's being moved right now. So a lot of standard packages for rental compression and that is being purchased in the US right now.

Just to follow on Dana's earlier question: from a CapEx perspective, is or anything that we should be thinking of other than building in what our assumptions for the rental cost buildout would be -- i.e., has your budget increased outside of the rental awards at this point?

No, it hasn't. We had some significant CapEx spend in previous years in implementing our ERP system -- SAP -- as we move the business towards SAP. I think that's going to be wrapping up here in 2014, so we don't see that being a material spend going forward. But the biggest change will be us allocating capital to these rental opportunities and deploying that horsepower.

Last one just for me: can you give an update on what your appetite is for more acquisitions, call that rental platforms or rental assets? Given that you have completed a large acquisition, would you still be looking at domestic rental acquisition opportunities? Or you put that on the back burner now?

I think it's a matter of timing. Certainly the prudent thing to do is to ensure that our arms are around our most recent acquisition in terms of culture and productivity. We intend to do that through the course of 2014 and 2015.

You are always looking at various things in an organization, but I reiterate -- the prudent thing for us to do right now is to ensure that we maximize our efforts, because -- and there are substantial opportunities within this acquisition. And that's the first place to focus our CapEx right now.

Appreciate the color. Great quarter, guys.

Mr. Goertzen, we have no further questions at this time. I'll return to call back to you for your closing remarks.

All right. Thanks, operator. Since there are no further questions, I would like to once again thank everyone for joining us on the call. And we really look forward to giving you are third-quarter results in November of 2014. Have a good weekend.

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