Enerflex Ltd (EFXT) 2015 Q1 法說會逐字稿

Welcome to the Enerflex first-quarter 2015 results conference call. (Operator Instructions). As a reminder, this conference is being recorded Thursday, May 7, 2015.

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

Thank you, operator, and good morning, everyone. Thank you for joining us this morning. 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, 2015, 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 2015.

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 March 31, 2015, compared to the same period of 2014. I will proceed on the basis that you have all taken the opportunity to read yesterday's press release.

As a result of the continuing commodity price challenges in North America during the first quarter of 2015, our bookings were CAD97 million or 41% lower than the same period of 2014. The movement in exchange rates during the quarter had a favorable impact on the US dollar denominated bookings.

We completed the first quarter of 2015 with a backlog of CAD715 million, which was CAD87 million lower. Sequentially, backlog had decreased by CAD201 million since December 31, 2014. With customers reducing their capital budgets in 2015, we have experienced some minor project cancellations.

We expect further capital reductions as the weak commodity prices continue and as customers seek to preserve financial flexibility. This in turn will reduce demand for our products and services over the remainder of 2015.

These market conditions create a significant uncertainty for bookings and activity levels for the remainder of the year and, therefore, uncertainty in the backlog and the engineered systems revenue over the remainder of 2015 and into 2016. Notwithstanding the weaker markets, our financial performance will benefit from strong backlog levels entering 2015, several long-term rental and service contracts and through our geographical diversified businesses.

With the acquisition of the Axip business, Enerflex has successfully positioned itself to deliver growth from market opportunities in Latin America and to increase recurring revenues globally. As discussed in our previous webcast, we have been proactive in implementing cost-saving initiatives to streamline our business, control costs, and move forward towards our EBIT goal of 10%.

Despite the addition of a full-year of results for the Axip business and inflationary pressures, we are targeting SG&A levels consistent with those in 2014. During the quarter, we made headcount reductions of over 200 employees. Even with the resulting severance costs of CAD2 million, SG&A as a percentage of revenue decreased from 14% to 11%.

We are regularly reviewing these cost reduction initiatives, and will adjust as the market evolves and as management continues to evaluate the impact low commodity prices will have on its business.

Now turning to the outlook for each of the segments. Effective January 1, 2015, Enerflex realigned its reporting segments into Canada, USA and the rest-of-world segments. The USA segment now includes the Northern United States service business and the retrofit and rentals operations based out of Casper, Wyoming, both of which were previously reported in the Canada and Northern United States segment.

The rest-of-the-world segment includes what was previously the Latin American engineered systems, aftermarket service and rentals businesses, combined with the former international segment.

In Canada, bookings activity slowed significantly in the first quarter of 2015, reflecting the weak commodity price environment and deferral of capital investment by our customers. Bookings were CAD30 million in the first quarter of 2015, compared to CAD96 million in 2014. Since the beginning of the year, backlog has decreased from CAD332 million to CAD228 million.

Customers are expected to continue to defer projects until there is greater certainty around the commodity price environment, which results in significant uncertainty to the extent and duration of the slowdown.

The unfavorable market conditions in the United States is driven by the significant decrease in oil prices, the impact on production levels and, therefore, associated gas levels and the impact on NGL prices, which resulted in bookings of CAD89 million for the first quarter of 2015, compared to CAD108 million in 2014. At the end of the first quarter, backlog decreased by CAD87 million from the start of the year to CAD325 million.

The commodity price slowdown is expected in at least the first half of 2015. There is significant uncertainty as to the extent and duration of the slowdown.

In the rest-of-the-world segment, bookings were CAD21 million for the first quarter of 2015, compared to CAD34 million in the first quarter of 2014. Leveraging the acquisition of the Axip business, Enerflex secured and continues to pursue a number of rental and service opportunities in the rest-of-the-world segment.

In the EMEA region, three large projects totaling approximately 70,000 horsepower are in progress and will contribute to results through the remainder of 2015 and beyond. Additionally, a number of other engineering systems and recurring revenue opportunities are being pursued across the region. We remain adequately positioned in this segment with backlog of CAD162 million at March 31, 2015.

Enerflex continues to be optimistic about the outlook in Latin America despite the global context, having secure bookings in equipment sales and contract services in the region. The energy reform in Mexico and the development of the Vaca Muerta shale play in Argentina could generate unprecedented opportunities for Enerflex products and services.

In Brazil, the Company is seeing an increased demand for natural gas fueled projects as a means to reduce the dependency on hydroelectric power. This demand coupled with the associated gas expected from pre-salt oil production presents interesting opportunities for surface facilities. Additionally, infrastructure developments in Colombia, Peru and Bolivia are expected to result over time in an increased Enerflex presence in these countries.

Our strong first-quarter financial results were attributable to momentum we achieved before the sharp decline in oil prices during the fourth quarter of 2014, together with the strong contribution from the Axip business.

However, the decline in our bookings, a key leading indicator, confirms our expectation of challenges ahead. With an innovative approach to product sales, increased recurring revenues, a geographically diversified business and considerable backlog, Enerflex is still well-positioned to weather these challenges. The Company's early implementation of ongoing cost-cutting initiatives provide additional financial flexibility to successfully navigate these uncertain economic environments.

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 first quarter of 2015, Enerflex generated net earnings of CAD23 million or CAD0.29 per share, compared to net earnings of CAD4 million or CAD0.05 per share. Consolidated revenues for the first quarter was CAD475 million. This increase of CAD143 million was due to higher activity in all three segments.

Consolidated gross margin for the same period was CAD84 million or 18% of revenue, an increase of CAD31 million. This increase was due to higher gross margin in all three segments, due to the positive impact of higher revenue, partially offset by lower project margins.

Selling, general and administrative expenses for the first quarter were CAD51 million or 11% of revenue. The increases were a result of higher compensation expenses due to the increase of employees to support the Company's growth during 2014, and as a result of the Axip acquisition.

Continuing with a review of our product breakdown. Engineered systems revenue increase to CAD342 million for the first quarter, or 49% higher. The higher revenue was primarily a result of higher opening backlog in all three segments.

Service revenue for the first quarter 2015 was CAD96 million compared to CAD88 million for the same period of 2014, an increase of 9%. Service activity levels improved in 2015, as a result of the contribution of the Axip business, which was partially offset by lower service revenues in Canada and the US segments due to lower parts and engine sales.

Rental revenue for the first quarter was CAD38 million, which was an increase of 161%. This was largely a result of rental contracts acquired with the Axip business in Latin America, the Middle East, and Asia. In Canada rental revenue was lower, resulting from fewer unit sales in 2015 compared to 2014.

Moving on to our regional results. In Canada, revenue increased by CAD54 million during the first quarter as a result of higher engineered systems revenue due to higher opening backlog, offset by lower part sales and rental unit sales.

Operating income for the first quarter of 2015 increased to CAD9 million as a result of higher gross margin and lower SG&A expenses in the quarter. The higher gross margin resulted from the positive impact of higher revenue, partially offset by lower project margins.

Lower SG&A was due to lower depreciation and amortization expense and favorable foreign exchange movements. In the USA segment, revenue for the first quarter of 2015 was CAD207 million. The increase of CAD65 million was attributable to higher engineered systems revenue as a result of higher opening backlog, partially offset by lower service revenue on reduced part sales.

Operating income for the first quarter of 2015 decreased by CAD3 million to CAD11 million due to higher SG&A expenses, partially offset by gross margin. The increase in gross margin was attributable to higher revenues, largely offset by lower project margins due to product mix. SG&A expenses were higher in 2015 as a result of higher compensation costs on increased headcount, as the USA segment experienced strong growth in 2014.

Revenue in the rest-of-the-world segment for the first quarter of 2015 was CAD96 million. The increase of CAD25 million was a result of higher service and rental revenue due to increased activity in the Australia and EMEA regions, as well as a contribution of the rental business acquired from Axip. This was partially offset by the lower engineered systems revenue despite higher opening backlog, primarily due to lower activity in the EMEA region.

The rest-of-the-world segment recorded operating income of CAD13 million for the first quarter compared to an operating loss of CAD8 million in the same period of 2014 on improved gross margin, partially offset by higher SG&A expenses.

The higher gross margin was a result of improved project margins, as well as the impact of higher revenues and the corresponding impact on gross margin. In the first quarter of 2014, the Company experienced significant margin erosion on a large project in Oman. Variation claim discussions related to these cost increases on this project continue.

SG&A expenses increased in 2015, based on higher compensation expense and higher office and occupancy costs due to the Axip acquisition.

Turning our focus to Enerflex's financial position, the Company continues to maintain a strong balance sheet. The Company exited the quarter with a net debt to EBITDA ratio of 1.8:1 times net debt. Net debt totaled CAD396 million at the end of the first quarter compared to net cash of CAD131 million at the end of the first quarter of 2014.

The increase in net debt was primarily due to drawings on the Company's credit facilities which were used to fund the Axip acquisition. This debt was supported by significantly higher annualized EBITDA when compared to 2014.

This completes the formal component of the webcast. Additional details can be found in our May 6 press release. We will now be happy to take any questions. Operator.

(Operator Instructions) Scott Treadwell, TD Securities.

Thanks. Good morning, guys. I wanted to talk about the rental business internationally first. Can you just give us a sense -- and I don't know if it is a hard and fast number or if it varies by geography -- but can you give us a sense of what the CapEx would be, the construction units on a per horsepower basis?

And I'm assuming that the delivery would be -- would that be recovered through rental or would that be cost recovery before the startup of the project?

So with respect to the dollars per horsepower from a construction standpoint in past calls, we have given some rules of thumb around CAD900 to CAD1000 per horsepower to construct these units. And that is just pure compression and then there is some construction that goes in around that.

In terms of the recovery, the recovery obviously happens once the units are commissioned and they are up and running, and we start to earn revenue on those projects through a rental contract over a three- to five-year period with respect to these projects in question here. So we would be recovering construction costs and capital costs over the contract term.

With respect to the projects that we are in the process of executing now in the Middle East, we expect one of those projects to be fully operational by Q2, and then we expect the remaining projects to come online in Q3 and Q4.

Okay, perfect. Can you give us a sense maybe globally what the market is like for these rental contracts, either in a size of horsepower, just that sort of total market that you are kind of bidding on or that typically comes up on an annual basis?

Well, it will always vary by market and, obviously, macroeconomics come into play in each of the regions that we are operating in. We are still seeing a lot of rental opportunities coming out of Latin America. We are still seeing opportunities come out of the Middle East.

We have guided in the past that we see this market, at least from a total addressable market and what we expect to deploy annually, could be anywhere between CAD50 million to CAD100 million, depending upon the opportunities that we see in front of us.

Right now, we are in the process of building out the fleet by 70,000 horsepower, which is a significant jump relative to where we were when we bought the Axip business. And we will be deploying about CAD100 million of capital to those opportunities.

When you say CAD50 million to CAD100 million, is that a revenue -- an annual revenue estimate, or is that an annual capital estimate?

No, that would be a CapEX estimate. And again, it will all depend upon the timing of the opportunities and what is being put out there for RFP.

Okay, perfect. Last one for me. On the cancellation side, it doesn't sound like it has been too troubling just yet, but obviously something to keep your eye on. Has there been any discernible trend yet, whether it is geography, play type, customer size? Anything that makes you look at one segment of your customer base more than the other, or has it been kind of a role of the dice and guys just call you up and defer and cancel, and that is about it?

Right now of the cancellations that we have experienced, they are obviously all concentrated in North America; haven't seen any cancellations internationally at this point. In terms of play, we can't zero in on any specific play. I think they have been pretty much in different plays, at least in Canada.

One of the cancellations that we experienced in Canada, obviously, was related to the oil sands. And then we have also experiencing cancellations on the natural gas side, but I can't really zero in on any one specific play.

Okay, it is probably more a function of customer capital and their confidence than maybe the underlying economics of a play then.

I would say that is a fair statement.

Perfect. Guys, as always, appreciate the color and I will turn it back. Thank you.

Elias Foscolos, Industrial Alliance Securities.

Good morning. I am interested in a little bit of historical color as Enerflex was spun out a couple years ago, and don't have much color on 2008 versus 2009 in the engineered products system.

I was wondering if you could, if you feel comfortable, with giving some indication of how revenue might have changed year-over-year during that time period.

James Harbilas6

With respect to the entire business, or just with respect to engineered systems?

Engineered systems.

Obviously, it was a different company back then, not as geographically diversified as it is today as a result of the Toromont/Enerflex merger and some of the acquisitions we did. But if we go back to 2008, 2009, we saw a steep dropoff in engineered systems revenue between those two years, as bookings trended down as a result of the global recession.

Interestingly enough, back during that time period we experienced significantly more in the way of cancellations on a lower backlog base than we have seen so far in this cycle.

Okay. Next question has to do -- I want to move -- we have segmented or revised segmented data for Q1 2014 bookings. But if we look back to Q4 2014 where Canada and Northern US, US, Latin America and International totaled about, I think it is CAD423 million. I was wondering if you feel comfortable in giving a breakdown for those bookings, if you know them, in the current segmentation?

Well, we were planning to obviously disclose the comparable 2014 numbers as we report each segment throughout the year, and that is the plan that we are going to follow. But what we can do for 2014 is probably put something on our website after this call that breaks down the 2014 numbers under the new format.

That would be appreciated. Essentially, what I was trying to get at, and I will look at the information, is trying to get the change sequentially in Canada, was what I was interested in focusing on.

One last question has to do with again the engineered systems, which is product mix related. Are you seeing a change in maybe the size of the bookings that are coming in? Do they tend to be smaller projects that have quicker turnaround versus what you might have had a year ago or half a year ago?

Sorry, your question is with respect to Canada or again just globally some of the trends that we are seeing?

Actually, it was probably more focused on Canada, given that that looks like it has been the biggest change.

James Harbilas6

Well, the projects in Canada have always been smaller projects that make up our bookings and backlog. We have seen bookings that go from CAD2 million right up to CAD15 million, CAD16 million, maybe even CAD20 million. And the backlog in Canada has been made up of those projects which are much smaller and spend time on the floor from a fabrication standpoint.

The dropoff that we have experienced in Canada in the first quarter is directly tied to the low commodity price and the fact that producers are being cautious in terms of making decisions on capital allocation and capital investment decisions. That is really the single biggest driver. It is not really a change in the type of projects that we are pursuing. It is really directly tied to the commodity price environment that we are operating in.

And I'm guessing maybe from some historicals here or implying that if Canada -- I'll use Canada as an example -- tends to fall off quicker when there is a downturn in commodity prices, it tends to maybe pick up quicker when things change?

That really depends on the environment as well, but the smaller projects in the gas producers has tended to turn around quite quickly in Canada, just due to the nature, and that there doesn't seem to be a large inventory of wells that are ready to complete as well.

So we do see Canada typically turn a little bit faster than the rest of the world because the decision-making gets done quite quick as well.

Thank you very much and with that, I will turn it back.

(Operator Instructions) Jon Morrison, CIBC World Markets.

Good morning, all. Can you give an idea or a little bit more color on the 5.5% margins that you generated in the US in Q1, and just give some sense of where that was in Q4 and what you expect the trend to be in the coming quarters?

James Harbilas6

Yes, that is a good question, Jon. So we have obviously experienced a shift in terms of our product mix in the US. If we look at product mix in 2014 and what comprised the backlog for most of that year. Or to begin 2014, it was more of a 50-50 split between gas process and gas compression.

In the back half of 2014, Q3 and Q4, we started to see a shift away from gas processing and much more towards gas compression. And then even within the gas compression space, it wasn't high spec compression; it was more the standard compression packages that made up the bulk of the backlog.

So we entered 2015 with a mix that was heavily weighted to the compression side. Almost 86% or 87% of the backlog was made up of compression, and that resulted in the lower operating margin in Q1 of 2015.

So we expect that trend to continue into at least Q2 and Q3 as we work through the remaining backlog on compression. And in terms of margins going forward beyond that, it would really be dependent on the mix of the bookings that come into the business over the course of 2015, and what proportion is gas process versus gas compression.

So it is fair to assume that that falloff in margins, if you compare that to the previous Southern US and Latin American margins, was fairly true to the bookings or backlog that was process through as compared to disclosure changes?

Sorry, can you repeat that, Jon?

The falloff in margins from what it was previously under Southern US and Latin America versus now just under the US, it is fair to assume that that was an actual falloff in the throughput that you are putting through your facilities, and it wasn't driven by disclosure changes of not including Latam in that part of the business.

Yes, that's correct. No, I understand the question now, sorry. So it is not really a throughput issue because there was a lot of product going through the shop. It really boils down to product mix. It has nothing to do with resegmentation.

Before we bought the Axip business, if you go back and you look at our Southern US and Latam business, it was predominantly a product and service business; there was no rental there. We consistently recorded operating margins that were well north of the margin that we posted in Q1 of 2015. So this doesn't have anything to do with segmentation; it was really a function of product mix and it being heavily skewed or heavily weighted to the gas compression.

Like I said, going forward it will depend on the new bookings and the proportion that it makes. We've also been taking aggressive steps to take costs out of the Southern US and increase efficiencies to be able to improve that margin.

On the international side, was there any one-time variation claims in Q1 numbers that boosted the margin you posted for the quarter?

No, there was not. We have done a good job executing the projects that we have got in our backlog there. And obviously, the Latam business and the Middle East business and Asian business that we bought from Axip has performed extremely well during the quarter, which contributed to operating margins in that segment.

If you would have previously included Latam within international in Q4, would it have meaningfully boosted numbers in Q4 for margins?

Margins would have been stronger in Q4 if Latam was included there, yes.

Okay. Any update you can give on variation claims or whether you expect anything in the coming quarters, or it still kind of remains to be seen at this point on the Oman project?

John, we are still negotiating. We are meeting with them regularly on the claims, and we still have an expectation that payments will be made on the claims as they are justified. So as that unfolds further, then we will keep the investment community up to date.

Last one just for me. Can you give some idea of what bidding activity looks like by geography, and has the international market fallen off to the same degree as North America, or it is relatively stable at this point? And I'm thinking more on the engineered side?

The rest of world is actually still, I would say, stable in terms of the opportunities that we see. And frankly, North America, we are not actually closing any deals, but unfortunately we have lots of activity in bidding deals and looking at opportunities and that actually log is growing, but no one is actually spending any money. So that is the situation we find ourselves in. Until someone starts to spend money because of the stability that is being able to be foreseen, we are not going to be in any better position.

So I would say the international rest of world business looks pretty good right now, especially Latin America; and North America, it is the matter of someone starting to spend capital.

I realize it's hard to answer this question, but that increased or steady-state business or bidding in North America, do you feel that is a function of more guys going to more vendors to try to grind down on prices? Or it feels like you guys are still working on a number of projects; they just need commodity prices to improve?

Well, they don't need to go to more vendors to grind down the price. That happens regardless if it is just you in the room. So that is just something that everyone is living with right now. And there is no question that the longer they wait, the more aggressive everyone gets with respect to pricing. So I think that is part of the sequence here.

Appreciate the color. Good quarter, guys.

Okay, Jon. Thanks.

Thanks, Jon.

Jeff Fetterly, Peters & Co.

On the backlog side, how much visibility does the CAD715 million of backlog at the end of Q1 give you?

We have some very strong visibility right through to Q3 right now with the existing backlog, and probably into early Q4. Obviously, the booking levels in Q2 and Q3 will be very important to provide additional visibility for us throughout the rest of Q4 and into 2016. But right now, we have strong visibility through the end of Q3 and into early Q4.

What have you seen in terms of bookings and trends in bookings thus far in Q2?

In North America, it has been -- and Canada especially -- still somewhat slow. We have seen a little bit of a pickup in the US, but I wouldn't consider it materially or meaningful at this point. But Latin America I think continues to -- and the rest of the world continues to do well, and that has been off to a relatively strong start for Q2.

Okay. From a cost standpoint, a throughput standpoint, when do you make a decision about looking at further cost reductions or scaling back further if the bookings trend does not accelerate?

Jeff, that is under review, as I said during the presentation, every single day in this organization. We meet weekly and as we start to see things unfold -- and it is a very dynamic situation as I'm sure you can appreciate. One week you see nothing and the next day you pick up CAD30 million.

So by the time we get to June if we don't see this changing materially, we are going to have to start looking at the old world business again in probably a different light than what we are even looking at it today.

James, I know you mentioned you guys will post this, but if you have it handy, under the resegmented structure, what would US margins have been in Q4?

Jeff, I am sorry, I don't have that handy. But like I said, we will post something after this call.

Okay, great. Last thing for me; can you quantify cancellations that you have seen to date?

At the end of Q1, our cancellations were just slightly north of CAD12 million.

Okay. And remind me again what the aggregate was that you saw in 2008, 2009?

It was north of 25 and it was on a much smaller backlog base.

Okay. So your comment about seeing or potentially seeing an increase in cancellations on a go-forward basis, are you seeing anything different in the market or in the customer conversations, or is that just a call on the fact that commodity prices are weak and activity remains soft?

That is cautious and cautious behavior.

Okay, great. Thanks, guys. Appreciate it.

(Operator Instructions) There appears to be no further questions on the phone lines at this time. I will turn the presentation back over to you.

All right, thank you, operator. Since there are no further questions, I would like to once again thank everyone for joining us on the call, and we do look forward to giving you our second-quarter results in August of this year. Bye for now.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.