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Enerflex Ltd
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Ladies and gentlemen, thank you for standing by, and welcome to the Enerflex Third Quarter 2019 Results Conference Call. [Operator Instructions]I would now like to hand the conference over to your speaker today, Stefan Ali, Director, Investor Relations. Sir, please go ahead.
Thanks, operator. Good morning, everyone, and thank you for joining us today. 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, Vice President, Corporate Controller. During this call, we'll be providing our financial results for the 3 months ended September 30, 2019, a brief commentary on the performance of our 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 that could differ materially from those expressed in these statements, please see our advisory comments within our news release and other regulatory filings for more information on forward-looking statements and associated risk factors. 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 September 30, 2019, compared to the same period of 2018. 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.
Thanks, Stefan. Good morning, everyone. Enerflex delivered another quarter of strong results across each of its product lines, driven by the continued growth of its recurring revenue business and operational excellence within Engineered Systems. Revenues of $544 million and EBIT of $88 million are indicative of the focus and commitment of our workforce, whoever -- they exemplify our values of integrity, commitment, creativity and success. We entered 2019 with a record Engineered Systems backlog, which we've executed to exacting standards of quality, safety and profitability throughout the year.This backlog included a small number of higher-margin projects that were booked in 2018, and which are now progressing through the manufacturing and installation stages. As these large projects are completed through '19 and into 2020, we expect that consolidated gross margins will normalize to the 5-year average of approximately 19%, offset positively by future contributions from our growing asset ownership platform. Bookings in the quarter continued the trend that emerged during the first half of 2019, bringing our backlog to $701 million. The current backlog consists of approximately 50-50 weighting between gas processing and gas compression projects and gives Engineered Systems revenue visibility to the first half of 2020. While we believe our market share remains unchanged, demand has suffered from a combination of restrained customer spending, global trade and political uncertainty and constrained access to capital for many industry participants. As a business line that is invariably linked to our customers' CapEx, we expect Engineered Systems' bookings to remain challenged into late 2020. As in previous downturns, we have and we'll continue to aggressively manage costs and working capital while we navigate this environment.All of that said, where we have not seen a slowdown is in our asset ownership platform. Our strategic pivot towards asset ownership, which commenced in 2014 has provided a platform for growth within what we believe to be the largest opportunity set for the global natural gas market today.Our contract compression fleet in the USA has grown to a highly utilized 280,000 horsepower, bringing our total global fleet to over 700,000 horsepower. This market continues to show strength and what we expect to continue deploying capital to these opportunities throughout 2019 and beyond.We are starting to see some downward pressure on rates for small horsepower applications, particularly in challenged U.S. basins. But by and large, our rates and utilization have not just held their own but strengthened in the quarter. Since the acquisition of Mesa in 2017, our U.S. Rental platform has grown by 100%, having added approximately 60,000 horsepower in 2019 alone, across a combination of wellhead, gas lift and midstream applications.While our U.S. Rental platform has experienced significant growth, so too has the total U.S. rental compression market, which remains constructive and which we expect to offer substantial opportunities for both organic and inorganic growth. In our Rest of World segment, we continue progressing the 3 previously announced BOOM projects from which we expect to combine annualized revenue contribution of approximately $30 million commencing in the first half of 2020.We are also in discussions for additional large-scale BOOM projects within Latin America and the Middle East. These opportunities are more complex in scale with longer contract durations, but also tend to have longer gestation periods before converting to executed contracts. Our regional teams will continue pursuing these opportunities to further the company's goals.With respect to our assets in Mexico, we previously stated that a portion of the contracts for the company's fleet will expire in December of 2019 and June of 2020, and that we elected to not participate in the bid process to replace those contracts.What's transpired instead is that the winning bidders were unable to deliver on their obligations. So we have seen a 1-year extension on some of our previously deployed units, taking these out to December 2020. We intend to continue aggressively pursuing opportunities with either Pemex or independent producers in Mexico and deploying idle units to global opportunities where they can be utilized.We are also seeing some asset ownership opportunities emerging in Canada, where customers are beginning to adopt electric power offerings on a rental basis.Overall, asset ownership represents the most significant growth prospect for the company, and we intend to continue deploying capital to this higher margin, less cyclical business. As we explore these opportunities, we are guided by our ambitions of bettering the quantity and quality of our earnings, to provide stakeholders with a growing base of stable and predictable earnings while maintaining sector-leading returns on capital employed.For the right opportunities, we are prepared to exceed our 2019 expectations of CapEx, while conservatively utilizing the advantageous strength of our balance sheet. Ultimately, we are aiming for continued growth with at least 50% of revenues being derived from recurring sources in the future. Going into year-end and looking at 2020 and beyond, global natural gas fundamentals remain constructive.In the U.S., produced volumes of natural gas continue to grow, and takeaway capacity is starting to increase. Although the growth stories in the U.S. have moderated, particularly in the Permian Basin, which is transitioning to a more mature development phase. The U.S. contains world-class basins, whose long-term development will demand Enerflex' products and services.In the Rest of World segment, several countries within Latin America and the Middle East are continuing efforts to displace the burning of coal and crude oil for domestic power generation and replacing it with cleaner burning natural gas.The gas compression and processing infrastructure requirements to fulfill these initiatives are significant and form a large part of our international opportunity set for both Engineered Systems and Asset Ownership.We remain cautious on the outlook for Canada as egress issues and an uncertain political environment are limiting near-term opportunities for growth. However, opportunity still exists in relation to LNG development and electric power, both of which our teams will pursue in earnest.I'd also like to address our increase in the dividend. Returning money to shareholders has been a priority for the company since 2011 and will remain a priority going forward. Since 2011, we have increased our dividend by over 90%, and we are proud to show our commitment to the sustainable and predictable return of cash to shareholders.Lastly, I'd like to welcome Sanjay Bishnoi to Enerflex' executive management team as Chief Financial Officer. Sanjay brings a wealth of experience to Enerflex and will be instrumental to future growth.I will now turn things over to Sanjay to review our financial results.
Thank you, Marc. Enerflex delivered another strong quarter of operational and financial results. Record revenue of $544 million and adjusted EBITDA of $107 million represents 22% and 63% increases over the prior year period, respectively.As Marc mentioned, our performance this quarter was driven by a combination of improved gross margin percentage from Engineered Systems projects in the backlog and contributions from both the organic expansion of the contract compression fleet in the U.S. and increased aftermarket service activity. Increased revenues and improved gross margin resulted in a record EBIT for the quarter of $88 million. Net earnings of $63 million or $0.71 per share, reflect a 66% increase over the prior year period. SG&A totaled $45 million, a $5 million increase, partially driven by compensation costs for a larger workforce and the effect of cost recoveries recognized in the comparative period.During the quarter, Enerflex invested $55 million in Rental assets, largely in the U.S., continuing the organic expansion of the U.S. contract compression fleet. Excluding additions to PP&E, year-to-date growth CapEx of $141 million has been deployed towards our global asset ownership platform.In the absence of inorganic opportunities, our full year expectation for growth CapEx remains consistent with previously indicated $160 million. Turning to bookings. Engineered Systems across all regions saw $126 million of new orders in the quarter, reflecting decreased customer spending, as Marc mentioned. Certain growth engines, such as the Permian Basin, appear to be transitioning away from smaller producers towards major oil companies and large independents.While our expectation during the first half of 2019 was that Engineered Systems bookings activity would improve into year-end, we now believe that bookings will be challenged in the near to midterm while this transition unfolds. However, we believe that this shift across all basins is a positive dynamic for Enerflex that will allow us to utilize our strengths of size, scope and reputation to capitalize on future opportunities. Demand for Enerflex' service expertise continues to grow. Service revenue saw an increase across all regions due to higher activity levels and the company secured several new long-term service agreements in the quarter. Consolidated rental revenue grew by 13% over the comparative period as a result of the organic growth in the U.S. contract compression fleet.As Marc mentioned, we continue to assess opportunities to allocate capital to this initiative as we believe it -- in its ability to provide a significant base of predictable, sustainable profitability.Turning to the balance sheet. Enerflex continues to invest in fleet expansion and has access to a significant portion of its bank facility for future drawings to meet its growth targets.As of September 30, 2019, the company held cash and cash equivalents of $220 million and had drawn $88 million against the bank facility, leaving it with access to $589 million for future drawings. The company's net debt-to-EBITDA ratio currently stands at 0.6:1. We also continue to diligently manage working capital to maximize flexibility as we pursue [Audio Gap]Demand for natural gas is growing globally, which will drive demand for Enerflex' products and services.Although we have seen some near-term challenges in the customers converting inquiries into bookings, growth in our asset ownership and aftermarket services platforms is expected to add stability to future earnings.Enerflex continues to benefit from the strategic decisions to diversify both its product offerings and geographic footprint, and we remain committed to this strategy. This completes the formal component of the webcast. Additional details can be found in our November 7 press release. We will now be happy to take any questions.
[Operator Instructions] Our first question comes from the line of Greg Colman with National Bank Financial.
Congrats on the strong quarter. I'd like to start by taking a look at the margins here. On the margin, you mentioned in your prepared remarks sort of a normalization of margins going forward. I might have missed the timing on that. Can you give us an idea of when it should happen? And if I just missed it, I'll go back and read the transcript. But is this like a Q4 thing where it's going to snap back? Or does the high-margin project work keep those margins elevated going into year-end, and it's more of a 2020 when we start to see it normalize?
I think into 2020, you'll see it normalize. I'd say probably Q2 onward.
Okay. That's useful. On the recurring revenue side and on the EBITDA margins and whatnot. We have a very good feel for what your recurring revenue was for the quarter. We got it at about 27%, the Rentals and Service business there. But how much of the $106 million in EBITDA was associated with those recurring revenue groups?
Well, that's a good question, Greg. We don't disclose that in practice. I think that we've mentioned before that we think roughly 1/3 of the EBITDA is from recurring revenue. But we don't give the exact number.
No problem. It was worth a shot. On -- switching over to the backlog. We are continuing to see it roll, obviously, and your comments suggest that the bookings aren't about to reignite in the near term. I guess I have 2 questions there. One is, can you give us an idea of how far out the current backlog stretches? You did mention it provides comfort for 2019 and into the early part of 2020. But at the risk of being too pedantic here, is early 2020 Q1 or H1?
I'd say it's more like H1, Greg.
All right. So this will stretch out into the end of Q2. And then in the longer term, when we start to see the backlog growth reignite, where geographically do you see the highest likelihood of that occurring?
The pipeline right now is a little bit more buoyant in the United States than it is in Canada. The -- for opportunities. They're just, they look better, they have a better feel to them in the Lower 48 than they do in Canada. In the Rest of World segment, a lot of our business development activities are circulating around BOOM opportunities, not necessarily Engineered Systems that you'd see in the backlog. So that's the relative strength of each one.
Got it. Okay. So number one, U.S.; number two, Canada, I guess; but then number three would be Rest of World.
That's right.
On that Rest of World segment, bookings in the quarter have been under $10 million for 3 of the last 4 quarters. And now the backlog is under $20 million. You did $19 million in Engineering Systems revenue for that segment this quarter. Is there a risk that there's no contribution from Rest of World, Engineered Systems moving into 2020?
I don't think there's a risk of that, Greg. I think the -- maybe the reduction in Engineered Systems revenue from Rest of World is due to a couple of factors. The most significant of which is, we're really directing our business development teams towards asset ownership opportunities as much as possible. The second thing that is putting downward pressure on the ES bookings for Rest of World is that we sort of changed our risk appetite for integrated turnkey projects globally. And those fall under Engineered Systems bookings, and that's probably the last 12 to 18 months that we've done that. So I'm not saying this is the new normal from Rest of World for Engineered Systems bookings by any stretch. We would sure love it to be higher. We like that business. But that's why it's a little bit lower. And it's a little bit too early to say what we'd expect from 2020. We would love it to be much higher than that. We'd love to find a lot more opportunities to sell equipment globally and to do the appropriate integrated turnkey projects as well.
Okay. That makes sense. This is -- and then lastly, this is it for me. On the broader bid pipeline, bookings for the first 9 months have averaged $140 million, which is well below the Q2, like the pre-Q2 '18 average of $270 million, which is kind of something in the past you guys have pointed to as something that would normalize. Based on your prepared remarks today, is it fair to assume that you're not about to snap back way above that bookings level, that $270 million level, in order to make the average around $270 million simply because things are a little bit softer right now?
I think if you look at the macro in the areas where we operate. I think it's pretty reasonable to assume that getting back up to $270 million in the immediate future is unlikely. And I don't think that's really a big surprise to anybody that's watching the space. I think that $270 million was benefit of a couple of real big upturns over the last 5 years.
And our next question comes from the line of Keith MacKey with RBC.
Just on the recurring revenue, particularly the service side, we did notice a decrease in service revenue quarter-over-quarter in, I think, all geographies. I guess 2 parts to this. What would you say is the cause of that? And do you expect a material risk of that trend continuing?
I'm going to ask Ben Park to answer that question.
So if you actually take a look, it was a high proportion of part sales or higher-than-expected proportion of part sales in Q2. If you actually take a look at Q1 versus Q3, you'll see that Q3 is higher than Q1. So that was just something that we saw in Q2 that was -- which was beneficial, but it was a little bit unexpected in terms of the levels that we saw there. And there are some fluctuations that will occur as we get part sales within a quarter.
Got you. So we shouldn't expect to see that as a trend downward then? It's just an anomaly that Q2 was higher?
Exactly.
Okay. And how should we be thinking about service revenue next year, particularly in the context of all of the work and projects that you're delivering this year? Should we expect to see contracts put on some of that stuff to help kind of support that service line? Or are we not seeing that yet?
Keith, that's a very reasonable assumption. We do commission and provide service support right after delivering things. So we always see -- service always gets a beneficial uplift when we've had a good run of Engineered Systems bookings and delivering those things. So that's a pretty reasonable assumption.
Okay. And the last one for me. When we say bookings is going to be challenged into late 2020. Are you not optimistic about them improving from current levels? Or are we just thinking that it's going to be much lower than the historical $270 million number?
So there's probably a couple of things I'm thinking about, Keith. First of all, 2018 was a really busy year in the United States, like really busy. And so I think that there was a lot of people bought a lot of stuff. And we're currently -- we're sort of suffering from an overhang from '18, but also the capital constraints. That's a dynamic that we just don't fully understand when it might ease off. We understand pressure on our business from commodity issues. That's what we've dealt with for a long time. Sort of a capital imposed restrictions on our customers is something that is difficult for us to predict when it's going to change meaningfully. So that's -- we're being somewhat pessimistic by saying into the latter half of 2020 because it's just tough to say.
[Operator Instructions] Our next question comes from the line of Jon Morrison with CIBC Capital Markets.
Has there been any change in the delivery schedule for the current backlog as we see producers pull back on CapEx plans and temper their growth? Or should we think about the backlog having a fairly firm high-conversion rate as those Engineered Systems orders naturally had fairly definitive delivery schedules?
The orders had definitive delivery schedules. And we haven't seen, by and large, the customers asking us to push those things out.
Okay. It's fair to assume that there is no major cancellations to talk about either?
That's safe to assume. Yes.
Okay. Of the $125 million of bookings that you made in the quarter, would the delivery schedule on those be fairly typical to what you've seen over the past year or faster or slower?
I think they'll be faster. Let's say that in 2018, we were talking in terms of 9 to 12 months was an average delivery. And I'd say now, we're probably talking in terms of 5 to 9 months depending on the product.
Okay. So is it fair to assume that the delivery schedule over the last 12 to 18 months, since it was such a robust market was more limited by your own delivery and your peers' delivery ability more so than customer demands?
Yes. I think so. And a lot of that 9- to 12-month delivery that we were providing customers was based on how quickly we could get engines and compressors. There's a couple of OEMs that have a big market share and their deliveries went out into the 40-week range, which pushed ours out into that 9 to 12 months. Those deliveries have come in. Our shops are not as busy as they used to have been. But still, there's a natural speed with which our customers can react. If it's a midstream build project, they take some time to get the overall project done. If we're talking about putting field compression in, we'll be able to meaningfully deliver that faster, like well inside of 6 months going forward. And our customers will be able to install that stuff faster. So I think the backlog, new bookings in Q4 and Q1, they'll have a much shorter delivery time, especially if it's directed towards compression and smaller projects in the Lower 48 and Canada.
Okay. So in line with, like, the data points that we're seeing where a high horsepower Cat engine or a large-frame compressor may be down to 15, 16 weeks. That means that should we see spending in select in call it mid-2020, your ability to convert that into revenue and cash flow you believe is much shorter than has been the case over the last 18, 24-ish months?
I agree completely. Yes. I think the bookings in Q4, Q1, Q2, will have a much higher likelihood of converting to billings for 2020 than would have been the case a year ago. Exactly.
Marc, did the bookings number surprise you this quarter? As I know that you would have loved too, if it had a 2 handle on it. But I guess, we weren't shocked by the number, just given some of the spending pullback that you're seeing in the market. Is that fair and in line with your view?
Well, I was disappointed, but maybe I wasn't so surprised. I was hoping for some things. But the end users just didn't have the CapEx to spend and they're really being quite cautious. As much as they're cautious on CapEx, OpEx doesn't seem to be under the same sort of pressure, hence, the recurring revenue and the service numbers are really quite good. But I was disappointed, but not surprised.
Okay. You continued to see solid rental opportunities in the U.S., deploying another north of $50 million on equipment adds in the quarter. Is that at all slowing the last 2 to 3 months? Or again, since your customers aren't under as much pressure on the OpEx side, you might actually see those inquiries uptick slightly in the coming period?
Yes, this is Sanjay. There's a couple of variables that are going into that. Definitely, overall activity is coming down a bit, but then the desire to get things off balance sheet is going up. So you've got a couple of things that are sort of working in opposite directions there. I think it's fair to say, like $55 million in a quarter was a pretty good clip. So I think we would expect the foot to come off the gas pedal a bit. But we're still seeing a pretty robust investment in the rental fleet.
Okay. That's very helpful. The contract extensions that you did in Mexico, did pricing on those largely hold at the previous rates? Or were you in a position to perhaps push pricing since some of the peers that couldn't deliver left them needing those packages?
I think it's fair to say that they were pretty much at historical levels.
Okay. Sanjay or Marc, I guess, can you give any color around the conversations with the Board on calibrating the dividend increase that you did to a 10%? And what underpinned that? Was it largely payout based? Or was there something else that underpinned the denomination that was ultimately chosen?
I think it was really a commitment to return money to shareholders. And I think that the management team and the Board have used the dividend as a very efficient way to do that. It's not really placing any undue strain on the balance sheet and -- as you guys are probably aware. And so we felt like it made a lot of sense to a lot of our shareholder base to support the dividend and return money in that fashion.
Is it fair to assume that, that level of increase is probably the max that you'd want to push it at? As ultimately, sustainability and long-term durability of that commitment to shareholder cash returns really doesn't want to be questioned.
Yes, I think -- I mean those are all the variables that we're looking at, right, quarter-to-quarter as we're looking at the dividend. So absolutely, we don't ever want to be in a position where the dividend is straining the free cash flow that's available. So I wouldn't expect us to want to accelerate or decelerate. I think we feel pretty comfortable with the rate of growth that we've shown historically and that we're showing today.
Maybe just one last one for me. Marc, has the level of bidding in LatAm changed at all in the last 6 to 12 months? As you referenced, there's still a lot of BOOM projects out there. Or have you seen any major projects that either were canceled or you weren't awarded that you thought you were well positioned to win?
I'll take that last question first. We haven't had any, what I would call, significant losses in the last 12 months in Latin America. I would say that the projects we would have hoped to have converted by now were largely deferred due to elections in Argentina, different things going on in Mexico. We like the Brazilian market and the projects in Brazil are big. And there's big industry players that look at them, so they never move as quickly as we wish they would. That's more the flavor of it than any meaningful losses or a change in market share.
And our next question comes from the line of Matthew Weekes with Industrial Alliance Securities.
So my first question is just a clarification. Sorry, I think I just missed this earlier. When it comes to those build, own, operate, maintain contracts that you said would be starting in H1 '20. Did you say that'd be contributing $30 million in revenue annualized?
Yes.
Okay. Great. And would that be sort of all kind of right at once? Or would it be a bit more of a ramp-up?
I think it's pretty close. Isn't it Ben?
Yes. It really -- I don't know that the projects are slated to all hit at the same time. So I don't think that we can say that it's going to be a huge ramp up. But they're not that far apart, right? We're talking only a 6-month difference there when we're talking first half of the year.
Okay. Great. And I'm also just -- one question about the Engineered Systems revenue. I was just wondering if you could quantify what sort of proportion of that would be sort of book and turn business? Projects that are booked and converted in the same quarter?
So let me try to understand your question, Matthew. The -- are you talking about the bookings in the quarter that we had? Like how much of that is going to be turned? If you can just ask the question again to make sure I get it right.
Sorry. Just kind of wondering, generally kind of in any quarter, what sort of proportion of Engineered Systems bookings would be converted within the same quarter as opposed to the work done later on?
Hardly any of those would be. Sometimes we have inventory that we can sell and deliver in the same quarter. That hasn't been all that common. I wouldn't say that, that's a material part of our numbers. So the majority of our Engineered Systems bookings will be turned into billings at the earliest 6 months, and it could stretch into 12 months from the date of booking until they roll off into billings.
Okay. And just one last question, switching to U.S. compression rental. In terms of the demand you're seeing there, would you say that from the time that you invest in additional horsepower to the time that it's utilized, is that pretty quick, would you say? Does that happen right away?
It happens pretty quick. If we have idle equipment, it can happen within weeks. If we have to build it from scratch, which we have had to do so far this year because our utilization is pretty high, then it's really from the day we get the signed rental contract until its making revenue could be 4 to 6 months, just depends on the package.
Okay. Would you be able to quantify sort of where your utilization is right now?
We -- Ben, I'm looking to you to make sure that we're...
I mean I don't think that we've ever really disclosed that. But we are...
We're at 87%.
Yes. We are above 80%. We're well above 80%.
Globally.
Yes.
And I'm showing no further questions at this time. And I would like to turn the conference back over to Marc Rossiter for any further remarks.
Thank you, operator. Since there are no further questions, I would like to, once again, thank you for joining us on the call. We look forward to giving you our fourth quarter results in February. Have a good weekend.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.