Enerflex Ltd

TSX:EFX

Earnings Call Transcript 2022-Q1

[Operator]

Good morning, ladies and gentlemen, and welcome to the Enerflex First Quarter 2022 Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Stefan Ali, Vice President, Strategy and Investor Relations. Please go ahead.

[Stefan Ali, executive]

Thank you, operator, and good morning, everyone. Here with me are Marc Rossiter, Enerflex' President and Chief Executive Officer; Sanjay Bishnoi, Enerflex' Senior Vice President and Chief Financial Officer; and Ben Park, Enerflex' Vice President, Corporate Controller.

During this call, we'll be providing our financial results for the 3 months ended March 31, 2022, a brief commentary on the performance of our 3 business segments and a summary of our financial position. Today's discussion will include forward-looking statements regarding Enerflex' expectations for future performance and business prospects.

Forward-looking information involves risks and uncertainties, and the stated expectations could differ materially from actual results or performance. For more information, please see the advisory comments within our news release, MD&A and other regulatory filings.

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'll be referring to the 3 months ended March 31, 2022, compared to the same period of 2021. We'll proceed on the basis that you've all taken the opportunity to read yesterday's press release.

I'll now turn the call over to Marc.

[Marc Rossiter, executive]

Thanks, Stefan, and good morning, everyone. We are pleased to report a successful first quarter and continued positive momentum across our business. Our ability to secure higher volumes of work in recent months is a function of robust supply and demand fundamentals in the oil and gas industry where ongoing strength in commodity prices, improved balance sheets of our customers and a renewed focus on energy security, led to quarterly Engineered Systems bookings of over $230 million and grew our backlog for a fifth consecutive quarter.

Increased industry activity is the first step towards normalizing Engineered Systems gross margins and as a result of recent bookings activity, we've generated a quarter-over-quarter gross margin improvement of 200 basis points in our manufacturing business, despite increased supply chain pressures. While we're cautiously optimistic about the trajectory of the recovery, we continue seeing many of our customers maintain their commitment to our capital discipline and there remains some uncertainty in predicting the impact of geopolitical events on the global energy landscape and pace of energy development across our regions.

Our recurring revenue businesses delivered stable predictable contributions to our overall performance. Aftermarket service business continues to recover from the downturn and is expected to do so throughout the year, though we'll be contending with broad-based OEM supply chain challenges on the timely delivery of spare parts along with inflationary operating cost pressures.

Our Energy Infrastructure business continued its strong performance. Improved activity within key U.S. basins drove demand for our U.S. contract compression fleet, which grew to 405,000 horsepower during the quarter and maintained an average utilization of 91%. In our Rest of World segment, our assets continued to perform as expected. We commenced operations for a 10-year natural gas infrastructure asset in early January and progressed another 10-year infrastructure contract that was awarded to Enerflex during the fourth quarter of 2021. Collectively, these assets reinforce our strategic goal of generating long-term stable cash flows. Overall, I am proud of our team's efforts to keep our assets performing to the benefit of our customers and stakeholders.

In our energy transition business, we continue progressing several opportunities across the carbon capture, renewable natural gas and hydrogen spaces. We are also seeing continued demand for electrified solutions across multiple regions, which are helping our customers eliminate Scope 1 emissions from their operations. Constructive public policy support will assist in promoting investment in this emerging market, which should benefit Enerflex in the coming years.

Lastly, we continue to progress all necessary matters to close our all share acquisition of Exterran that was announced in January of 2022. A number of regulatory approvals have already been obtained, and we are currently not aware of any reason that would prevent us from obtaining the remaining approvals.

As we progress our pre-integration planning work, we are increasingly excited about the strategic fit of the 2 companies. The support of macroeconomic fundamentals for global natural gas production growth and the support received by the market. Upon closing, this transaction will create a true energy infrastructure company and Enerflex remains focused on delivering on the strategic rationale of the acquisition, including increasing recurring pro forma gross margin to approximately 70% of total, striving for a sustainable cost structure through synergy realization and providing better capabilities to our global client base.

I will now turn the call over to Sanjay Bishnoi to review our financial results.

[Sanjay Bishnoi, executive]

Thanks, Marc. First quarter revenue of $323 million increased significantly versus the prior year period from a combination of higher Engineered Systems revenue on stronger bookings in recent periods, revenue recognition on a previously announced 10-year natural gas infrastructure project, higher utilizations on our energy infrastructure and the increased volume of work across all segments.

Bookings momentum continued in the quarter totaling $237 million, up significantly from $99 million in the same period last year. Our Engineered Systems backlog exited the quarter at $620 million, which is over 3x higher than the backlog at March 31, 2021, and provides a healthy backdrop for 2022. During the quarter, management completed its continuous review of how expenses are classified. Following this review, certain expenditures were reclassified between cost of goods sold and SG&A. Although the reclassification has no impact on net earnings in prior periods, this change provides more relevant information to users of the financial statements and better reflects the costs that are directly attributable to the production of goods and the supply of services.

The resulting gross margin was $54 million or 16.6% for the first quarter of 2022 compared to $45.5 million or 22.4% for the comparable period. The lower gross margin percent in the current quarter is primarily due to a shift in the product mix, less government grants received and competitive pricing pressures on material and labor.

SG&A costs of $46.8 million in the first quarter of 2022 were up from $38.5 million in the same period last year. The increase is primarily due to the transaction costs associated with the pending Exterran transaction and the reduced cost recoveries from government subsidies. These increases are partially offset by lower share-based compensation.

During the quarter, we invested $29.2 million towards construction of a natural gas infrastructure asset that was awarded in the fourth quarter of 2021 and which will be accounted for as a finance lease. We also invested $2.5 million of capital primarily towards units in our USA contract compression fleet which has grown to approximately 405,000 horsepower.

From a capital allocation perspective, 2022 growth CapEx will continue to be limited to the funding of in-flight projects and those opportunities satisfying stringent investment criteria. With respect to liquidity, Enerflex has $133 million of cash on hand and access to $672 million on our bank facility, giving us ample liquidity to fund our required investments in working capital and capital assets. We continue to maintain balance sheet strength exiting the quarter at a bank adjusted net debt-to-EBITDA ratio of 1.43x.

Lastly, Enerflex' Board will continue to evaluate dividend payments on a quarterly basis based on the availability of cash flow and anticipated market conditions. Yesterday declaring a dividend of $0.025 per share to be paid on July 7, 2022.

This completes the formal component of the webcast. Additional details can be found in our May 4 press release. We will now be happy to take any questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Michael Robertson with National Bank Financial.

[Michael Storry-Robertson, analyst]

Given the noted increase in volatility of raw material pricing and availability, are there any initiatives you've implemented in order to try and firm up pricing or delivery date from suppliers to help solidify your targeted timing and margins? And I guess, are there differences in your approach, whether it's parts of the service segment or components for larger-scale projects?

[Marc Rossiter, executive]

Michael, this is Marc Rossiter. Thanks for the question. I'll take that. Dealing with supply chain is probably issues #1, 2 and 3 for the professionals in our Engineered Systems business and the aftermarket service business, and there are different strategies in both those businesses. But by and large, it's mostly about being extremely nimble and fast acting when we hear news in the supply chain and also having relationships with our customers that allow us to pass on those unforeseen cost increases as effectively as possible to those clients.

In Engineered Systems, frequently when we close a job, we get the opportunity to update all the prices in the nature of equipment before we accept the order and that can lock in 80% or more of the overall cost base. And so that mitigates some of those issues. In the service business, spare parts that go with projects, they're frequently quoted right at the moment. We know exactly what we can buy them for.

Some of the downward pressure in our AMS business margins in the quarter was due to some other things like fuel costs, a little bit of Omicron wave that had our people at home. And the biggest issue in AMS is just waiting for parts. So if we have technicians ready to go to go perform a service job, and they don't have the parts, then they start out to sit around until they show up and that leads to some inefficiency.

[Michael Storry-Robertson, analyst]

Got it. Got it. That's really helpful color, Marc. I appreciate it. Just one other one for me. I was wondering if you've seen an impact in terms of inbounds or sentiment in Canada on potential CCUS related opportunities following the CCUS investment tax credit in the federal budget?

[Marc Rossiter, executive]

I don't think we've seen -- we had a lot of inbounds on CCUS prior to the announcement. There's a lot of oil and gas customers, especially that have been looking at how to decarbonize themselves for over a year now. And so the investment tax credit, I don't think sped up those conversations significantly. That's my take. Sanjay, do you have any different take on that?

[Sanjay Bishnoi, executive]

Yes. I think maybe echoing Marc's comments, we already felt like we had a pretty healthy set of dialogue going with those customers. And I think that the investment tax credit, certainly, from a finance guy's perspective, it's going to be very helpful to get these projects closer to actuality. But we think that we are already having some pretty high-quality dialogues before the budget.

[Operator]

Your next question comes from the line of Aaron MacNeil with TD Securities.

[Aaron MacNeil, analyst]

I'm wondering if you could provide any details or anecdotes on your preliminary steps on integration with Exterran. I appreciate there's not probably a whole lot you can say, but maybe you can give us a sense of what you've done to date, what's still outstanding? And if you're more or less confident in your synergy target and 2023 guidance?

[Marc Rossiter, executive]

Andrew -- Aaron, sorry -- Aaron, thanks for the question. After we made the announcement, we had integration teams established at Exterran and Enerflex. And to the degree that we're allowed to do pre-integration planning, we've been doing it along a lot of strategic and also functional lines. And I'm quite pleased with the progress the teams have made to date. We're still competing in the market. We're still two independent companies, and we're competing against one another in all the regions within which we operate. So there's some limits on how much integration planning we can do. But within those limits, I'm quite satisfied and quite happy with the progress that's been made.

[Aaron MacNeil, analyst]

Okay. With respect to -- this one is probably for Sanjay. But with respect to the high-yield offering that you intend to pursue at the close, were the ratings you obtained from S&P and Fitch in line with your expectations? And are you at all concerned with your ability to obtain high-yield debt at a reasonable coupon given the rising interest rate environment?

[Sanjay Bishnoi, executive]

So I'll take them one by one, Aaron. The ratings were very much in line with where we thought things would shake out. No surprises there. I would say in terms of the high-yield market, it's something that we're monitoring quite closely. And I would say that interest rates, as everybody knows, have gone up, and that's a bit of a headwind. But I would say that the tailwind that we're getting is the macro fundamentals around energy and oil and gas, in particular.

And so you've actually seen some strength in oil and gas-related issuances in the high-yield market. And so we still think that it's a very constructive market for the offering that we are going to bring to market and we're really waiting to get through some of these regulatory approvals and other conditions and then ready to go to the market once the time is right.

[Aaron MacNeil, analyst]

Understood. Maybe since your prepared remarks are so quick, I'll sneak another question in. Just wondering if you can speak to your involvement with the Meadowbrook CCUS Hub? I know it's early days, but can you give us a sense of time line, what your involvement might be, both from an operational and capital perspective?

[Sanjay Bishnoi, executive]

Yes. No, we're delighted to be working with the Bison team and with our partners on that project. Our involvement is really primarily because we want to be doing as stewards of the industry and proponents of carbon capture here in the province of Alberta. We want to be doing everything that we can to be supportive to the industry. And we just -- we thought it was a neat project. We like the management team. We like the partners. And we're happy to be part of a solution that's moving to the next phase, which is going to be really an evaluation phase, but delighted to be part of that story.

[Aaron MacNeil, analyst]

So you're in an evaluation stage, but what might a commercial time look like? And actually be involved?

[Sanjay Bishnoi, executive]

Yes. No, we'll be a part of the consortium. I mean that's how we are participating in that project. We're not the operator of that project. We have a nonoperating minority investment in it. But -- and we continue to expect to be involved in that capacity. And yes, I think part of the evaluation days, which is really -- when I say evaluation, it's really that's how the that's how Alberta Energy has sort of couched the next phase is that we have to do some evaluation work and some test wells to evaluate the formation and the safety of the formation as well.

And so beyond that phase, we'll -- and during this phase of it, we'll be generating a more detailed sort of idea of how the capital of the project will unfold. So probably early for us at this point to be commenting on the capital commitment to the project, but we'll certainly keep the market appraised as that develops.

[Operator]

[Operator Instructions] Your next question comes from the line of Cole Pereira with Stifel.

[Cole Pereira, analyst]

I wanted to start on the U.S. Engineered Systems margins. I think we're all aware of the margin pressures, and obviously, work mix is a consideration as well. But I mean, from your commentary, I do get the sense that you should see an improvement in that metric over the next few quarters. Is that fair, acknowledging there is some uncertainty, obviously?

[Marc Rossiter, executive]

That's fair, Cole.

[Cole Pereira, analyst]

Okay. Perfect. And on the supply chain front, as you think about potential impacts from the COVID shutdowns in China, do you think the worst has passed? Do you think it could get worse? Or do you think there's still not enough visibility? And you commented on the U.S. ES side, you can pass through a lot of the costs. So is it more the risk is in terms of timing and logistics of inputs, et cetera?

[Marc Rossiter, executive]

Cole, in February 2020, I predicted COVID was not going to be a big deal. So I'm not going to predict anything about COVID hopefully ever again. It's difficult for me to really consider how the shutdowns in China will impact our supply chain. Almost every one of our projects that goes out the door has a control system on it, it's got a computer chip in it. And so that's one sort of commodity that's been challenging over the last couple of months. How the Chinese shutdown specifically impact our supply chain going forward is difficult to predict.

[Cole Pereira, analyst]

Okay. Got it. Yes, that's totally fair. Just quickly on the Mexican Exterran lawsuit, I'm wondering if there's any additional details you can provide just on how exactly it occurred? I mean I acknowledge it's a complicated jurisdiction, but I'm just surprised that any termination lawsuit would have a $120 million payout, which obviously helps support that it was made an error.

[Sanjay Bishnoi, executive]

Yes, Cole, this is Sanjay. I think we would point you to Exterran's 10-Q that this is an issue that the Exterran management team has been managing. And I think they've articulated some of the things that you said, which is they believe there's a calculation error and they believe that it's not material.

[Cole Pereira, analyst]

Okay. Got it. And just quickly, on the closing of the acquisition, any additional guidepost you can add? I mean, do you think it could be late Q2, early Q3, late Q3? Or is there just still not enough visibility at this point?

[Sanjay Bishnoi, executive]

Yes. So we were optimistic that we could get there in Q2. We don't believe that we can in Q2 anymore. What we can tell you is that we're very happy with the way the teams are working together. We feel like we've got really good dialogue with the Exterran team at all levels, like from the C-suite down to the working level. And so we're working diligently and as fast as we can. We're hopeful that we can get to close in Q3, but that's really, I guess, we'll have to wait and see how things unfold on the regulatory side of things and the other conditions that we're trying to satisfy.

[Operator]

Your next question comes from the line of Tim Monachello with ATB Capital Markets.

[Tim Monachello, analyst]

Just a follow-up question to Cole's on the labor dispute in Mexico. I'm just -- regardless of how unlikely this is to be material, and I think it probably is unlikely. Is there -- is that a hurdle that you need to get over before you close the transaction?

[Sanjay Bishnoi, executive]

I guess what I would say is that on the issue itself, really we are operating as 2 separate companies right now because we have to. And so I would point you to Exterran's disclosures on the subject. And from a deal timing perspective, it's really -- we're very focused on clearing the regulatory hurdles that we've got in front of us. We did get some comments back from the SEC, they're down the fairway comments. They are going to take a little bit of time to process them. But we think there's really nothing that is of concern in those comments. So we're really focused on clearing those regulatory hurdles, lining up a shareholder vote and getting to close, we believe, hopefully in Q3, but in the second half of 2022.

[Tim Monachello, analyst]

Okay. So you don't need to see a formal resolution to this matter before you can close the deal whether you'd be comfortable closing a deal with this still serve in limbo?

[Sanjay Bishnoi, executive]

Yes. We're currently monitoring the situation, Tim, and I think that's where we would leave it here today.

[Tim Monachello, analyst]

Okay. And then second question, we saw bookings come down in Canada, and there's a little bit of a cautionary statement just around slowness in demand related to egress capacity constraints. Can you talk a little bit about the Canadian market and what you're seeing for demand on the increment there?

[Marc Rossiter, executive]

Tim, this is Marc. We're seeing customers in Canada that want to do work. And they're getting out in front of a lot of the CapEx spend with engineering work with detailed pricing with sort of lining up supply chains with us in a really collaborative manner. We're optimistic that Q2 forward in Canada will be a more positive story on the bookings front. That's what we're hoping for. And based on the conversations we've been having with customers, we believe the addition of infrastructure into the Western Canadian Sedimentary Basin should be more significant in the coming quarters than it was in the last few.

[Tim Monachello, analyst]

Okay. And then last one for me just on service margins. Obviously, those came down in the quarter, but you guys have been dealing with supply chain issues for the better part of the last year, maybe the full year. So what changed in Q1 that brought those margins down? And what's the outlook for your service margins going forward here?

[Marc Rossiter, executive]

Yes. In Q1, there was kind of an acute parts issue from a number of our suppliers from a delivery point of view. So we had been managing supply chain like everybody has been for a year. But in the quarter, for one or two of our key suppliers, they had a particular challenge getting parts to us on time. And that impacted our AMS business globally. I would say, a little bit more locally. We had Omicron issues and our North American business is in January that had a lot of our technicians in sidelines, which was too bad, but we think that's behind us. And I'll reiterate that, that margin returned at AMS for the quarter is not what we're looking for. We really expect it to return to upper teens numbers, which is traditional in short order.

[Operator]

All right. I'm showing no further question at this time. I would now like to turn the conference back to Marc Rossiter.

[Marc Rossiter, executive]

Thank you, operator. Since there are no further questions, I'd like to once again thank you for joining us on the call. We look forward to giving you our second quarter results in August.

[Operator]

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.