Enerflex Ltd (EFXT) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Enerflex Second Quarter 2017 Results Conference Call. (Operator Instructions) And as a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. Blair Goertzen, President and Chief Executive Officer. Sir, you may begin.

All right. Thank you, operator, and good morning, everyone. 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 3 months ended June 30, 2017, a brief commentary on the performance of our 3 business segments and a summary of our financial position at the end of the quarter. Approximately 1 hour following the completion of this call, a recording will be available on our website under the Investors section.

During this call, unless otherwise stated, we will be referring to the 3 months ended June 30, 2017, compared to the same period of 2016. I will proceed on the basis that you've all taken the opportunity to read yesterday's press release.

Enerflex's second quarter financial results reflect the improved market dynamics, which was demonstrated by the company's strength in the operating income and earnings relative to last year. With these improved market conditions and the stability in global commodity prices, Enerflex saw an increase in inquiries and opportunities leading to over $400 million in bookings in the quarter, the fifth consecutive period where bookings increased over the same quarter from the comparative period. This rise in inquiries and opportunities drove a 71% increase in revenue to $433 million in the quarter.

Enerflex is optimistic that further stability or improvement in commodity prices will continue to drive inquiries, bookings and revenues through the remainder of 2017 and beyond. Enerflex's financial performance also continues to benefit from the strategic decision to focus on the recurring revenue stream derived from new and existing rental and service contracts. However, we anticipate that in Canada and Mexico, these product lines will remain under pressure until we see a return to more profitable commodity pricing.

In the Canadian region, while the company experienced stronger bookings in the back half of 2016 and through the first part of 2017, Enerflex remains cautious as this region continues to face price volatility, which has created uncertainty with the customers' capital budgets. Moving forward, the region will leverage its extensive capabilities and expertise to continue to preserve market share.

In the U.S., the stability in commodity prices caused customers to proceed with further investments, which demonstrated in Enerflex's bookings activity during the quarter and the first part of 2017. As we look forward, Enerflex will continue to build on its successes for compression and gas processing solutions where liquids-rich plays in the region. The company remains optimistic that further stability will continue to drive increased inquiries and bookings in the U.S.A.

The recently completed acquisition of Mesa Compression, which has been rebranded to Enerflex Contract Compression, has an established and growing platform which will increase recurring revenues for this segment. It accelerates Enerflex's ability to deliver full-cycle contract services in the U.S.A. while increasing coverage in the major plays in Oklahoma, Texas and New Mexico through new operations. This strategic fit between both organizations, the talented resources being brought onboard and the growth opportunities in the region will enhance Enerflex's position in the contract compression business.

Focusing on the Middle East. Our rental fleet has grown to over 100,000 horsepower, which will continue to contribute to the results in 2017 and beyond. The target for this region remains on large rental and service opportunities where customers have also required construction and installation support at site.

In the Latin America region, Enerflex remains optimistic. In Brazil, the company is expecting a more stable environment and has an increased interest for natural gas fuel projects as a means to reduce dependency on hydroelectric power. The continued development of the Vaca Muerta shale play in Argentina in the short to medium term can also generate material opportunities for Enerflex's products and services.

Additionally, infrastructure developments in Bolivia and Colombia are expected to result in an increased Enerflex presence with these countries. The company will remain focused on integrated turnkey projects and build-own-operate-maintain solutions for customers in Latin America. This success is being recognized primarily in Argentina and Colombia. Large rental fleet with associated rental and service contracts in Mexico and the company's repositioning in Brazil to capture and capitalize on the future natural gas opportunities all position Enerflex well in this region.

Moving forward, the company is determined to diversify its revenue streams from multiple markets, to grow its backlog and ensure profitable margins globally by aggressively managing costs. Steps taken over the past 24 months have allowed for a greater focus on key global market opportunities.

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. Financial results for the second quarter strengthened year-over-year, largely due to stronger bookings over the last half of 2016 and into 2017, which drove significant increases in Engineered Systems revenue. The company's quarterly bookings were $400 million, a 159% increase year-over-year compared to the $154 million in 2016. Enerflex also saw a significant increase in backlog at June 30, 2017, which was $152 million higher than December 31, 2016, due to the stronger bookings in the quarter. As a result of this increased activity and the recent booking trends, the company has seen positive impacts on revenues and overall financial performance. As of today, Enerflex has recorded bookings for the third quarter of 2017 in excess of $92 million, the majority of which is in the U.S.A. segment.

Enerflex remains optimistic with further improvements in commodity prices will allow customers to continue to increase their capital investments, which should translate into further demand for the company's products and services.

Adjusted EBIT for the second quarter was $34 million compared to $22 million, with adjusted EBITDA being $54.5 million versus $45 million. EBIT and EBITDA were both adjusted for restructuring costs, gains on the sale of PP&E, goodwill impairments and acquisition costs related to the Mesa Compression acquisition. The underlying increase in adjusted EBIT and EBITDA is largely driven by the improved operational results in 2017 primarily in the U.S.A. segment.

Consolidated revenue for the second quarter was $433 million. This significant 71% increase was due to increased revenues in all 3 segments. Consolidated gross margin for the 3 months ended June 30, 2017, was $77 million compared to $64 million. Gross margin increased due to higher revenues, improved overhead absorption, lower inventory reserves and lower restructuring costs. The company's geographic and product line diversification also preserves margins in a competitive and constrained economic environment.

Gross margin as a percentage of revenue decreased to 18% from 25% resulting primarily from lower-margin contracts being signed in the last half of 2016, a change in product mix with higher revenues from the lower-margin Engineered Systems product line and the completion of a high-margin project in the second quarter of 2016.

Selling, general and administrative expenses were $45 million. This slight increase of $3 million was the result of higher share-based compensation costs, increased bonus accruals based on stronger earnings and foreign exchange losses, partially offset by lower legal expenditures.

During the quarter, Enerflex also generated net earnings from continuing operations of $21 million or $0.24 per share compared to net earnings of $17 million or $0.21 per share in 2016.

Moving on to our regional results. The Canadian region recorded strong bookings of $121 million in the second quarter, a $109 million increase. Backlog also increased to $305 million, which is a $138 million increase from December 31, 2016. Revenue in the Canada segment during the second quarter was $100 million, a $42 million increase primarily attributable to higher revenue from the Engineered Systems product line. The increase was largely driven by increased customer demand with the higher levels of confidence in economic environment and pent-up demand from reduced spending during the downturn.

Service revenue was also higher due to increased parts sales. Operating income for the second quarter improved by $3 million as a result of increased revenues and lower SG&A. The reduction in SG&A expense was attributable to lower compensation expense on lower headcount.

In the U.S.A. segment, bookings were $155 million for the second quarter compared to $88 million. At the end of the period, backlog was $349 million, a decrease compared to year-end 2016 due to revenue recognized on some significant projects in backlog at December 31, 2016.

Revenue in the U.S.A. segment during the second quarter of 2017 was $228 million. The significant increase of $134 million was attributable to improved Engineered Systems and service revenue, partially offset by lower rental revenue. Engineered Systems revenue increased due to the realization of strong bookings in the back half of 2016. Service revenue was also higher as a result of the commencement of 2 new long-term service agreements and increased demand.

Enerflex's current rental fleet using gas-gathering activities experienced slight declines in revenue due to weaker utilization and weaker rental rates. The company's U.S.-based rental assets acquired for Mesa are using gas lift activities, which are not experiencing the same pricing pressures.

Operating income for the second quarter increased by $19 million due to higher revenues and higher gross margin. The increase in gross margin was attributable to project margin improvements and improved overhead absorption.

In the Rest of World segment, bookings increased to $125 million compared to $55 million in the same period of 2016. During the second quarter, a $31 million booking in Latin America that had originally been recorded as an Engineered Systems contract was converted to a build-own-operate-maintain project with an associated 10-year contract, representing approximately 7,000 horsepower.

Backlog of $120 million at June 30, 2017, increased by $56 million relative to December 31, 2016. Revenue in the Rest of World segment for the second quarter was $105 million. The slight increase of $5 million was attributable to Engineered Systems' revenue being higher due to the commencement of some large projects in the Middle East region.

Additionally, service revenue was higher due to increased activity in the Middle East but remained under pressure with lower service activity in Australia as well as reduced parts sales in Australia and Asia. The decline in rental revenues is due to lower utilization and rental rates, primarily in Mexico, and slower economic conditions in some of the markets this segment serves.

Operating income of $6 million increased by $10 million over the same period of 2016 due to lower gross margin as a result of change in product mix with the lower proportion of sales coming from high-margin revenue streams and the completion of a high-margin project in the second quarter of 2016.

In managing liquidity, the company has access to a significant portion of its bank facility for future drawings to meet the company's future growth targets. As of June 30, 2017, the company held cash and cash equivalents of $181 million and had drawn $316 million against bank facility, leaving it with access to $404 million for the Mesa acquisition and future drawings. The company improved net debt as compared to the prior year and continues to meet its bank facility covenant requirements with a net-debt-to-EBITDA ratio of less than 1:1 as calculated for covenant purposes.

This completes the formal component of the webcast. Additional details can be found in our August 10 press release. We will now be happy to take any questions. Operator?

(Operator Instructions) And our first question comes from the line of Greg Colman with National Bank Financial.

I'd like to focus on the backlog for a little bit. First question I'd like to ask, Blair, is regarding some commentary we're seeing out of other channel partners that you've got, that will be suppliers for some of the engines and whatnot, citing increasing delays of delivering, say, Caterpillar engines out into the field, sometimes stretching as far as 1 year. I'm wondering if you're seeing these kinds of impacts. And what kind of financial results -- what kind of financial implications they have, whether it's taking the backlog and pushing out when it's likely to hit the income statement? Or does it mean your cost of goods are rising and hence we should be worried about margins? Or has this allowed the channel to have a little bit more pricing tension in it and implies that, in fact, prices will be increasing on the producer side and, therefore, margin expansion. I'm just trying to understand the dynamics of a tightening supply chain here.

Well, certainly, you're correct in your assessment or your information around certain supply chain items. And Caterpillar's one today that are in excess of 52 weeks on certain product lines. And so just to speak to the current backlog, the current backlog that we have today already has equipment designated for the backlog that we discussed, that was [up] $773 million, $771 million. So that's not at risk for our deliveries in any -- or margin erosion in any way, shape or form. Now we -- our discussions with our customers, then we need to talk about the deliveries and what tension that puts in the overall market dynamic in terms of pricing, traction, deliveries and alternatives. So that's where we find ourselves today and pretty much everybody else is in the same -- we have inventory as well in certain product lines that are going to give us, along with anyone else that's got inventory, somewhat of an advantage over the next 12 months. But if we continue with the types of bookings we've got, then inventory will be used up pretty quickly and deliveries will be -- and certainly with compression, will be stretched out to over a year. So that again will come with certain and different dynamics. But we approach it on a cost buildup basis for compression each time we go to market with a quote, whether it's in North America or globally. So it's all about delivery and how we manage the delivery cycles and maybe some creativity as well around different options instead of going with a single equipment and try to do something different. So anyway, that's the piece right now. But we are not at risk for margins around extended delivery per product.

And Greg, the other part of your question dealt with the timing of revenue recognition of the existing backlog. So Blair touched on it. So there's no price erosion that we're expecting or margin erosion with respect to that backlog, but there's no delays on the timing of revenue recognition and delivery because the engines, as Blair said, were in inventory and have already been designated to these projects.

So it sounds as though the tightness of the Caterpillar engine market is actually -- it doesn't impact you at all from a current pipeline perspective again because of your inventory? And then looking forward, as you continue to get new orders from now on in, Blair, you've kind of talk a little bit about it, but does that imply that you should be able to be moving to your higher pricing just because it is a tight market?

Well, it's only one -- it is a bottleneck, and it is a long-lead item, but everybody has the same situation. The only thing that you're going to get in margin is if you have inventory and you can deliver quicker than somebody else. If your delivery for the Caterpillar engine is 52 weeks and somebody else is 52 weeks, you may be able to get a little bit, but now you're really competing on an apples-to-apples basis. You've got to have better delivery times to start to get margin traction in this environment.

Okay, understood. On -- just staying on the backlog for a minute there, you mentioned that no risk of margin erosion because of kind of the dynamics we touched on. But is the type of margin we saw in Q2 associated with your backlog that was -- burns through in revenue in Q2? Is that indicative of what we should see for the balance of the year? Or is the margin held in backlog either materially higher or materially lower than what we've recognized so far in the year?

Yes, so is your question with respect to the net margin on a consolidated basis or specific to a region? I just want to clarify that before I answer your question.

I'm going to say regarding your Engineered Systems, not on a regional basis but the entire backlog as for Engineered Systems.

Yes. So look, I mean, if we look at Engineered Systems, there's going to be a couple of items that are going to impact realized gross margins between now and the end of the year. And one of the biggest ones is going to be product mix, okay? So we started the year -- we started 2017 with a very high proportion of gas processing in our overall backlog relative to compression, which has a higher margin. The bookings that we're seeing coming in here through Q2 and the start of Q3 are a little more skewed to gas compression not gas processing. So we're starting to see a little bit of a rebalancing in that mix for the back half of the year. But we feel that any kind of softness in that type of mix will be offset by increased absorption. Canada -- we expect the margins in Canada on Engineered Systems to continue to improve into the back half of the year because backlog has ramped up. Some of the low-margin work that we had in the backlog in Q4 '16 has already come through the revenue line in the first 6 months of the year. So the back half will be a lot stronger, and they will get better absorption. So we feel that the product mix shift will be offset by better absorption and some higher-margin work in Canada for that product line on a consolidated basis.

Got it. That makes sense. Shifting away to more of just the style demand, I mean, I guess keeping in mind of what you're talking about on compression. We're seeing a shift from smaller horsepower stuff away from that to a more larger central processing facilities. How does that play into your kind of strength and capabilities, both in terms of the rental products that you're looking to put out with your recent Mesa acquisition but also your manufacturing capabilities and specialties?

It's absolutely in a fair way larger projects, integrated solutions are right in the fair way of what Enerflex's expertise is. And to speak to the Mesa acquisition, obviously, gas lift is traditionally lower horsepower. It's also moving up the horsepower chain as well. So it's not as large a horsepower as some of the other compression business that we're doing out there. But clearly, anytime there's a larger gas plant, larger compression facilities that are looking for that integrated turnkey solution, it is where the sweet spot is for Enerflex North America and globally.

Got it. Okay. That's really good. Blair, I appreciate it. And then just the last one for me. Sorry to dominate the questions here. We've seen receivables push out quite a bit now over 100 days for 3 straight quarters now. Still seeing good free cash flow generation, but just wondering how we should think about that? Is that sort of thing that this is a level we're going to see in this cycle? Should we be anticipating the days sales outstanding rising or falling as we take a look at our working capital expectations?

No, we should be -- the expectation here is for them to continue to fall not to continue to rise. I mean, we've talked about it a couple of times now on previous calls where we as an organization made a strategic decision to fund the working capital requirements aggressively on certain projects here during the downturn. And we have completed those projects now, and we're going to start to collect some of those milestone payments that were back-end loaded on some of these projects and tied to delivery. So we would expect the DSOs to start coming down here as we return to more traditional forms of milestone payments and progress billings with these new orders.

And our next question comes from the line of Jon Morrison with CIBC Capital.

Can you give any more color on how throughput in Houston is expected to look in the coming period, like should it be declining based on the high throughput that we saw in the trailing basis in Q2? Or based on all your bookings that you're seeing today, could actually revenue and throughput could rise from Q2 levels?

We think that the back half of the year just given the activity that we continue to see in bookings in the U.S. segment could keep revenue in that segment in the back half consistent to what we've seen here in the first half of the year.

Okay. Would you expect, based on your line of sight for new orders, would you expect book-to-bill to be below 1x in that case since you're running such a high throughput?

Well, we continue to see strong bookings activity in that segment, John, so I wouldn't expect it to fall below 1.

Okay. You talked about the OEM supply chain and working through that. When you're going out and bidding your work today, are you messaging that delivery schedules will be extended not from an OEM supply chain perspective but just through physical capacity in Houston at this point? Or you feel you can continue to scale up and execute under what we'll call a normal delivery schedule?

We can scale up, Jon. We've got that capacity. It'll come down to, yes, we are messaging to our customers today. And everyone in the world is acutely aware of the bottleneck around large horsepower Caterpillar engines.

Yes. Okay. Can you talk about the composition of the bookings in backlog in the U.S. right now? Is it somehow primarily weighted towards the Permian? And are you seeing any slowdown in order inquiry at this point?

It is primarily in the Permian. And no, we're not seeing a slowdown in order inquiries or bookings at this point in that region.

Okay. Is there any more commentary you can give on international margins in the quarter? I realized that you mentioned sales mix being a driver, and you had elevated Engineered Systems revenue which will dilute the margins. But just wondering how we should think about go-forward margins for the next little while based on what you've got booked and embedded in awards that have been won.

Yes. We think that if we look at the international margins for Q2, there was a few items in there that are worth mentioning in terms of having a negative impact on those margins, right? So we had a -- given the weakening U.S. dollar relative to some of the currencies internationally, we've seen about a $2 million swing in FX year-over-year that impacted operating income in that segment. And then we also had about $1 million of impairments and restructuring provisions that we took as we consolidated our footprint in Southeast Asia and streamlined our costs. And then the OOCEP legal cost in the quarter also had a drag of about $2.4 million on operating income. So if we look at it net of those items, the EBIT margin or operating margin was about 10.5%. Looking into the back half of the year, though, another item that's noteworthy to mention is that some of the discounts that we had given customers on rental contracts in that segment during the downturn, which is something that all service providers, including our competitors, had to do. Those are starting to roll off, and we're going back to historical rates on some of these contracts as well. So that should offset some of the softness in operating margins that we saw in the Rest of the World segment during Q2.

Perfect. And Blair, can you give any sort of an update on international bidding right now. You saw strong bookings in the quarter, but I think the majority of those were preannounced when you had put out your Q1 numbers. So just wondering if there's any lull on large project opportunities out there right now?

Yes. Both in Lat Am and the Middle East, we're seeing inquiries. Some of them have been around a couple of years. And again, as we continue to talk about the gestation period that it takes to bring those across the line, and some of those ones have been around 1 or 2 years or longer are now very much back in the books again as high-medium, high-highs. So we expect to see some of that as well. And the attention that we're giving it come to fruition over the next 6 to 9 months in both Lat Am and the Middle East.

James, core profitability in Canada improved nicely from negative territories last couple of quarters. Would you expect that trend to continue in Q3 based on all of the awards that you've been given to date and the embedded margins you planned to make on those?

Yes, we were definitely happy to see core profitability in Canada here for the first time after a couple of quarters, and especially now because I can shave his beard that I've been growing, waiting for that to happen. But looking at the back half of the year, we expect that to improve, not only as a result or a function of stronger margins in the backlog relative to some of the work that we booked in Q4 '16, but just better throughput into the facilities and better overhead absorption in those facilities as well will continue to help us improve that margin going into the last 6 months of the year.

You guys officially closed Mesa. I think that you've probably spent quite a bit more time as a management team in platform now. How do you feel about the opportunities that they had been bidding into the market when you had acquired them and similar to Axip when you completed the deal in 2014. Would it be a stretch to think that Enerflex's contract compression's win rate runs at an elevated level for the next 6-plus months, since I'm assuming that they were probably bidding on projects and Enerflex is bidding on projects independently without Mesa?

We are much more optimistic in terms of how impressed we are with the business, first of all, just generally speaking. We're also impressed with the level of inquiries that have come through the door. We weren't actually bidding against Mesa in the areas that they're operating in, at all. So collectively, our sales forces have been able to look at the market in totality and bring a lot more opportunities to the Mesa business even in the past 3 months. So we're very impressed with the people and the business, and we're very impressed with the inquiries and the quality of the inquiries that have come in over the past 3 months.

Just as a point of clarification, is the growth in U.S. products accord(inaudible), specifically in Q2, weighted towards spot market wins? Or did that reflect largely some of the longer-term contracts you've won in conjunction with some of the large equipment delivery award that you had?

Yes. Jon, it was the latter. So it was these contracts that we announced when we announced our Q1 results that have become operational now. We've ramped up and mobilized and have started to provide services under those contracts. So that was the primary driver. But spot market parts sales have contributed to a rebound and strength in that service segment in the U.S.

Last one just for me. On the dividend, can I ask whether an increase was discussed at the board level this quarter? And where's you guys head at on and pay out on a go-forward basis?

We discuss at each third quarter, and it'll be again discussed at the third quarter. So that's the position that we've always done for the last 4 or 5 years, and that'll be the same position this year, Jon.

(Operator Instructions) Our next question comes from the line of Ben Owens with Royal Bank of Canada.

I wanted to follow up on a question on margins. I think on the first quarter call, you guys talked about having a line of sight on overall company operating margin approaching 10% by the end of the year. I just wanted to get your thoughts on whether that -- you're still on track given what's in backlog at this point?

I think that the margins, as I said in response to a couple of earlier questions, is going to continue to improve through the back half of the year through the back 6 months just based on stronger throughput in the Engineered Systems product line and better overhead absorption, stronger margins coming online on Engineered Systems product line in Canada, and then obviously the discounts rolling off. So we will start to creep higher through the back half of the year. And the target is for us as an organization is to get to that 10% or as close to that 10% as possible over the remainder of the year.

Okay. And then, yes, to follow up, just on the bookings that you already have booked for the third quarter. You mentioned the strong pipeline of bidding and booking activity particularly in the U.S. Based on what you're tracking today, do you think there's a chance that third quarter bookings in aggregate could exceed what you printed for the second quarter?

I think that at this point, based on the visibility that we have in front of us, it feels very much like Q2 is going to be the high watermark from the standpoint of bookings in the year at $400 million. We still have very strong line of sight in the U.S. segment as we touched on. And we continue to see strong activity in places like the Permian, and places like the STACK and even some activity in the Marcellus. The real wild card for us will be the international opportunity that tend to be a little lumpy. When they usually hit bookings, they hit -- they're large and they tend to come in bunches. So assuming that those kind of follow a historical pattern, I think that Q2 bookings will be the high watermark for the year at $400 million.

Thank you. And at this time, I'm showing no further questions. So I would like to return the call to Mr. Blair Goertzen for any closing remarks.

All right. Thanks, operator. And since there are no further questions, I once again like to thank you for joining us on the call today, and we really look forward to giving you our third quarter 2017 results in November. Have a good weekend. Bye for now.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.