Enerflex Ltd
TSX:EFX

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Enerflex Ltd
TSX:EFX
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Price: 13.64 CAD 1.34%
Market Cap: 1.7B CAD
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Earnings Call Transcript

Earnings Call Transcript
2020-Q3

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Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Enerflex Limited 2020 Third Quarter Conference Call. At this time, I would like to turn the conference over to Mr. Stefan Ali. Sir, please begin.

S
Stefan Ali
Director of Strategy, Risk & Investor Relations

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 September 30, 2020, 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 September 30, 2020, compared to the same period of 2019. We'll proceed on the basis that you've all taken the opportunity to read yesterday's press release. I will now turn the call over to Marc.

M
Marc Edward Rossiter
President, CEO & Director

Thanks, Stefan, and good morning, everyone. Before discussing the quarter, I want to first thank all of Enerflex' employees for their continued positivity and commitment to safety protocols. Our people have worked diligently to limit the impact of COVID-19 on our business, allowing our facilities and assets to continue operating with minimal disruption. While our ability to maintain unrestricted access to active construction sites was challenged by governmental health and safety protocols in certain countries, we were able to complete and commission 3 BOOM projects in the quarter and expect to commission a fourth BOOM project in the fourth quarter of 2020, barring additional work site access restrictions and delays. The oil and gas sector continues to see uncertainty around commodity prices, driven by the impact of COVID-19 on demand for energy products. Recent improvements in natural gas benchmark pricing is helpful for industry sentiment, but will take time to translate to increases in customer CapEx, which is needed to drive the company's Engineered Systems bookings.Outside of our traditional Engineered Systems offerings, we are seeing increasing levels of interest in nontraditional applications, such as electrified compression and lower carbon intensity projects. While these are positives, we still anticipate that the broader weakness in Engineered Systems bookings will persist for at least the remainder of this year and into 2021. Our aftermarket services business continues to show resilience compared to prior downturns, supported in part by the return of North American production that was shut in during the early stages of the pandemic. AMS is most impacted when production volumes decrease. But if wells are flowing, equipment must be serviced in order to run reliably. With broader service capabilities compared to prior downturns and service personnel in all operating regions, Enerflex is better positioned to manage an AMS downturn in any single region.During the quarter, our global asset ownership platform performed well, with our U.S. fleet maintaining an average utilization of 81% on steady demand for contract compression. In addition, we saw contributions from BOOM projects in Argentina and Brazil that were commissioned in this quarter, with additional contribution from the Middle East BOOM expected to commence in the fourth quarter of 2020.While stability from the business line is expected, significant weakness in the commodity price environment may cause producers in the U.S.A. segment to slow production, which could affect demand for our products and services. In contrast, business in our Rest of World segment is less sensitive to commodity price fluctuations, given that the drivers are more heavily linked to factors such as satisfying local electricity demand. This dynamic has translated to recent successes in Latin America, including renewed interest in certain units of our Mexican rental fleet and the sale of a power and gas treating plant in Colombia that will reduce carbon emission intensity by using a recaptured flare gas for local electricity generation.Similarly, we are seeing projects in the Middle East being developed to increase the role of natural gas in regional electricity generation. Enerflex has identified a number of opportunities in the Rest of World segment. However, the company is intent on maintaining capital discipline. And in the current environment, will only pursue the most attractive projects. Overall, 2020 has proven to be a difficult year for the Engineered Systems business with bookings and revenue down significantly from levels seen in previous years. Despite the headwinds faced by the Engineered Systems product line, we anticipate that the investments we've made in our asset ownership and AMS businesses will drive consistent financial performance for the remainder of 2020 and into 2021.We continue to monitor performance and outlook in all operating regions and make cost reduction decisions in response to the turbulence across the energy industry. Remaining vigilant in this regard while maintaining a defensive balance sheet should keep us well positioned to weather this downturn and succeed as the industry recovers. I will now turn things over to Sanjay to review our financial results.

S
Sanjay Bishnoi
Senior VP & CFO

Thanks, Marc. Third quarter revenue of $265 million decreased substantially versus the prior year period due primarily to lower Engineered Systems revenue on weaker bookings through 2019 and the first half of 2020. Service revenue was down 11% due to travel restrictions related to COVID-19 and pricing pressure on certain service offerings in the U.S., while rentals improved slightly on the organic growth of our U.S. contract compression fleet, which now totals approximately 350,000 horsepower. Although gross margins decreased over the comparative quarter, gross margin percentage is consistent due to increased contributions from the recurring revenue product lines.Looking forward, the company expects gross margins from Engineered Systems to decrease and margin contribution from recurring revenues to make up a larger proportion of total gross margin.SG&A was lower in the quarter due to decreased compensation expense on reduced headcount and decreased profit share on lower operational results as well as cost recoveries related to government assistance programs. In addition, cost-cutting measures have been effective in reducing travel, marketing and noncritical IT expenditures. While Enerflex remains vigilant in controlling costs across the platform, SG&A was negatively impacted by bad debt expenses from expected credit losses in the Rest of World segment. The work related to the bad debt, some of which commenced as early as 2017, was largely collected in prior periods, and the provision represents only the outstanding balance owing at September 30, 2020. Bad debt that was provided for in the second quarter of 2020 was settled in accordance with management's estimate, and the receivables and associated provision were derecognized.While headcount is down across many of the company's operating regions, Enerflex has utilized available government assistance programs to mitigate job losses. Reflected in adjusted EBITDA for the quarter was $6 million related to government grants received in the Canada and Rest of World segments. We saw $18 million of capital deployed towards previously committed projects in the U.S. rental fleet and completion of international BOOM projects, 3 of which were commissioned during the quarter, with the fourth expected to be commissioned in the fourth quarter.Capital spending for 2020 is now estimated at approximately $135 million to $140 million compared to the previously disclosed $125 million to $130 million. The increase is primarily due to project completion costs for in-flight BOOMs, resulting from COVID-19-induced worksite access restrictions and delays. In addition, we capitalized make-ready costs for the redeployment of certain assets within our Mexican rental fleet.Working capital saw a net decrease of $56 million in the quarter in response to our slowing of supply chain transactions to align with current market conditions. Inventory levels decreased in the quarter at a faster-than-expected pace and harvesting of our accounts receivable. Remaining inventories will be realized into Engineered Systems projects and new contract compression units over time. Notably, these inventory items are nonperishable and are fungible across our Engineered Systems and rental offerings, so we can consume them in either business line globally.From a capital allocation perspective, our near-term focus is on preserving balance sheet strength and completing capital expenditure commitments related to organic rental fleet additions. Enerflex has identified a number of opportunities to deploy capital globally. However, as previously stated by Marc, the company will be disciplined in the assessment and pursuit of additional projects.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 $0.02 per share dividend to be paid on January 7, 2021. With respect to liquidity, we exited the quarter at a net debt-to-EBITDA of 1.2x, which is unchanged from our position at June 30. Our net debt decreased by $62 million in the quarter and has reduced by $80 million since March 31, demonstrating Enerflex' discipline in using cash flow to decrease net leverage. With $100 million of cash on hand and available liquidity of $567 million, we have the flexibility to manage the business through the current downturn.This completes the formal component of the webcast. Additional details can be found in our November 5 press release. We will now be happy to take any questions.

Operator

[Operator Instructions] Our first question or comment comes from the line of Michael Robertson from National Bank Financial.

M
Michael Storry-Robertson

I understand the challenges in this environment of offering guidance, not knowing the potential demand impact of any further ways of COVID-19. But hypothetically speaking, assuming the worst is in the rearview mirror and activity levels continue to gradually recover, do you see utilization levels for the contract compression fleet hanging in at current levels? Or do you expect further deterioration regardless based on what you're seeing today?

M
Marc Edward Rossiter
President, CEO & Director

Michael, that's a big assumption and a lot of hypotheticals there. And I don't really want to answer those hypotheticals directly. I would say that we've had 2 quarters now of pretty stable utilization in the fleet. In the middle of the pandemic, it's been tough. And I think the prognosis for our fleet in the U.S. is more stable now than it was 6 or 7 months ago. So we're feeling good about it, but it'd be -- we definitely would stop short of making any predictions about where utilization is going to go in subsequent months.

M
Michael Storry-Robertson

Okay. Fair enough. In terms of pricing pressure, it seems like you and your peers in that regard are being pretty disciplined. Could you provide any color on sort of the sentiment and tone you're seeing with discussions and clients right now?

M
Marc Edward Rossiter
President, CEO & Director

I think your characterization of the situation where the providers are being disciplined is quite accurate. And a lot of our customers in the first few months of the pandemic were very price sensitive, and they still are. But they've got a high need for reliability and good service. And so I think the companies that can provide that need to get paid for that reliability and good service. And I think that's what's sort of providing the stability in pricing.

Operator

[Operator Instructions] Our next question or comment comes from the line of Keith MacKey from RBC.

K
Keith MacKey
Analyst

Just wanted to start out on the CapEx number. So the creep during the pandemic is certainly understandable. But just wondering how confident and comfortable you are in your current controls to mitigate risks as you look to increase your asset ownership as well as stability and assumptions around your returns modeling for those types of projects, where you take on the CapEx and risk upfront and then on the asset?

S
Sanjay Bishnoi
Senior VP & CFO

Keith, this is Sanjay. I think we feel -- we do feel good after going through the 4 projects that we're bringing online this year, and most of those are online. And one of those is actually in the commissioning phase now. So looking back at those projects, I think we feel pretty good about our underwriting process and how we've evaluated risk. I think the overruns that we've seen this year are really a reflection of a lot of market volatility. All these projects that we're spending money on were signed up in 2018. And so -- or excuse me, 2019. And so what we've gone through in 2020, there was really no way to sort of predict what we're going to see through the COVID pandemic. And I think we're actually quite pleasantly surprised with the execution of the team given some of the dislocations that we've experienced. So going forward, new projects, I think, you always learn and that sort of adds to your bank of knowledge and allows you to derisk projects. But we also feel like the 4 that were in flight are largely behind us at this point as well.

K
Keith MacKey
Analyst

Got it. And just secondly, sticking with the CapEx theme. Do you have an approximate range of what you think you might spend for 2021, especially assuming the environment does not improve?

S
Sanjay Bishnoi
Senior VP & CFO

Yes. We're still obviously going through the budgeting process. So I think it's still a bit early for us to put any guidance down in terms of CapEx, at this point, Keith.

Operator

Our next question or comment comes from the line of Tim Monachello from ATB Capital Markets.

T
Tim Monachello

Just 1 question for you guys around bookings, and what you're hearing from customers around 2021? Some of your competitors have sort of said that green shoots are starting to appear, it might just be budgetary. And you have said that 2021 will likely be depressed. But have you seen any increase in demand around sort of gas focused drilling in Canada or the U.S. for 2021?

M
Marc Edward Rossiter
President, CEO & Director

Tim, thanks for the question. This is Marc. We've definitely been watching the quarterly releases of a lot of the drillers and fracking companies over the past couple of weeks. And indeed, a lot of them are signaling Q3 that was more positive than Q2. And if that continues, we'll see some benefits in customer inquiries and orders 3 to 6 months later. I don't want to comment about our -- how we're feeling about our Engineered Systems pipeline today. We don't typically comment about that. But I think that the -- a lot of the macro indicators would say that there's a very muted yet positive comeback in Canada and the United States. We very much like the fact that we're -- have a good customer base, both in the Montney and the Permian. Those are 2 basins that we believe will -- are good basins to be in, and they'll be part of the recovery as we go through this. So we're optimistic. Like we said in the press release, we have been cutting costs in our Engineered Systems business quite significantly because we don't really forecast a V-shaped recovery in that business. We expect it's going to be lower for longer, and we're adjusting our cost basis accordingly and competing hard for anything that is in the offering.

T
Tim Monachello

Okay. I guess we're entering sort of unchartered territory in terms of where the backlog sits.

M
Marc Edward Rossiter
President, CEO & Director

Yes.

T
Tim Monachello

Could you comment a little bit about the cost structure in the Engineered Systems business? And what level of throughput you need to see sort of breakeven cash flows on a quarterly basis?

M
Marc Edward Rossiter
President, CEO & Director

No, not really. We're not going to get into that level of detail. But the -- really, the last 3 quarters has been very, very low for Engineered Systems. Especially it's difficult as most people would know coming off such a peak in 2019. It's challenging for management to rightsize the business as quickly as the market has rightsized the orders. As Sanjay mentioned, we're right in the middle of doing a lot of capital planning for 2021, and getting those cost structures in place for what we feel will be the level of activity, not just in 2021, but really going forward in the 12- to 36-month period is probably the most important thing that Enerflex management is doing today. But as far as giving you sort of numbers of what breakevens are and whatnot, we don't -- we won't give that amount of detail out.

T
Tim Monachello

Okay. And as you look forward and sort of understanding that the business is extremely cyclical and orders can come through pretty lumpy, what are the challenges that might -- you might see in ramping up the business again? And do you think your supply chains are properly prepared for that sort of potential ramp-up, not that it's on the horizon today, but likely over the mid to long term?

M
Marc Edward Rossiter
President, CEO & Director

Yes. Tim, the most inelastic resource when it comes to growing, again, coming out of the downturn is our people, our engineers and our designers and our craft labor. And therein lies the rub of trying to fix the cost structure because if you cut too deep on the people, your ability to snap back is significantly limited. I don't see an issue in the supply chain. Talking to a lot of our bigger suppliers, they're chopping at the bit to get going, engines, compressors, air coolers and indeed all the welded fabricated equipment. We haven't seen a real problem with any of the supply chain out of China, which is where a lot of the valves and piping and whatnot comes from. So I don't see a problem with the supply chain. What Enerflex management has to do is make sure that we thread that needle between getting our cost structure right to be competitive going forward and provide the kind of returns our investors want, but also hanging on to that real talent that allows us to outperform the competition coming out of the -- this pandemic-induced downturn. So it's a challenge, but we've done it before. This is a deeper, longer than what we're used to. But we're on it is the best I can say without being too flippant.

T
Tim Monachello

Okay. Great. And sorry, just 1 more. I won't try to take up too much time here. But could you just comment a little bit about your comment on the electrified compression and sort of other alternative demand sources, like what's the size today? I'm imagining it's relatively small. How do you see that playing out going forward?

M
Marc Edward Rossiter
President, CEO & Director

It's -- we're very interested in seeing how it plays out, Tim. There's -- it's really customers are thinking about either their scope 1 or scope 2 CO2 emissions. If they buy an engine-driven package, they're going to add CO2 emissions to their scope 1. If they get an electric drive, they're going to add it to scope 2. And it's interesting for us to see how our customers are going to start making business decisions based on those because in North America, there's not a lot of actual financial impacts of moving emissions from a scope 1 to scope 2. Some people are looking to go electric because they're planning for potential carbon tax in the future, I suppose, but it's difficult for us to understand exactly what's driving those decisions. A lot of the decision around the electric versus engine-driven compression, it does come down to OpEx that you maybe trade some natural gas consumption and a little bit more complicated operations on an engine drive unit for something that's a little bit simpler on electric drive, but now you got to buy electricity. So -- and that's very specific to the grid where people are operating, the economics of gas versus electric drive in that location. We've been building an electric drive compression for over 20 years. So it's not new to us. I think what we'll be watching for is any shifts, wholesale, and going electric drive in the big basins we've been operating in over the course of the next 6 to 12 months. But it's not a capability that we need to work on. We have it in spades already. So if the customers would like to shift some of their attention to electric drive, we're ready.

T
Tim Monachello

Okay. And I guess just a follow-on on that. Does that give you reason to pause or think about how you go forward building out your rental fleet?

M
Marc Edward Rossiter
President, CEO & Director

I wouldn't say it gives us pause, but it's definitely in consideration when we talk to a lot of our customers that are looking for rental services. So we don't think that the engine drive is going the way the dodo anytime soon. But there's more people that would like to talk about what electric-driven rentals look like.

Operator

I'm showing no additional questions in the queue at this time. I'd like to turn the conference back over to Mr. Marc Rossiter for any closing comments.

M
Marc Edward Rossiter
President, CEO & Director

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 fourth quarter results in February. Remember its day is next week, on Wednesday. Veterans Day in the United States, Remembrance Day in the British Commonwealth. Enerflex will be taking that day off in Canada, and we will, for a long time. We're going to honor that as a stat holiday as long as I've got a say in the matter. I would like to recognize people in the United States, New Zealand, Australia, Canada, whose ancestors should be remembered from their contributions in World War I that finished 102 years ago next Wednesday. And as we take that day off to consider those sacrifices, it really puts the sacrifices of the last year in the middle of the pandemic in perspective. So again, thanks, everybody, for calling, and we look forward to talking to you in February.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day.