Enerflex Ltd.

Ladies and gentlemen, thank you for standing by. Welcome to the Enerflex fourth quarter of the year and 2020 results webcast. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you need to press star 1 on your telephone. If you require any further assistance, please press star 10. I would now like to use Phil's face to call Mr. Stephan Ali. You may begin.

Thank you, Operator, and good morning, everyone. Here with me are Mark Rossiter, Enerflex's President and Chief Executive Officer, Sanjay Dishnoi, Enerflex's Senior Vice President and Chief Financial Officer, and Ben Park, Enerflex's Vice President and Corporate Controller. During this call, we'll be providing our financial results for the three months ended December 31, 2020, a brief commentary on the performance of our three business segments, and a summary of our financial positions. Today's discussion will include forward-looking statements regarding Enerflex's 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 one hour following the completion of this call, a recording will be available on our website under the Investors section. During this call, unless otherwise dated, we'll be referring to the three months ended December 31, 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'll now turn the call over to Mark.

Thanks, Stephan, and good morning, everyone. Despite the unprecedented volatility in energy markets in 2020, Interflex's fourth quarter results benefited from a combination of strong project execution and minimal business disruptions. a testament to the company's employees and their commitment to health, safety, and doing the right thing. Although engineered systems bookings were challenged throughout the year, more positive signals began to emerge in the fourth quarter, where the combination of improving commodity prices and refreshed customer capex budgets led to an increase in bidding activity. Normalizing for de-bookings of dormant projects from prior years, fourth quarter bookings were $77 million, the highest since the first quarter of 2020. While positive, the recovery in customer spending is in its early stages and engineer systems bookings will likely remain subdued through the first half of 2021 with expectations for a modest recovery later in the year. Our aftermarket services business remained resilient compared to prior downturns despite challenges associated with operational and travel restrictions caused by the pandemic. While restrained customer spending is expected during a downturn, recovery within the services business is usually a gradual process and we expect that dynamic to play out again. Ultimately, AMS is most impacted when production volumes decrease, but as wells are flowing, equipment must be serviced in order to run reliably. With a larger service footprint, including broader capabilities and personnel in all operating regions, Interflex is better positioned to manage an AMS downturn in any single region. Our global asset ownership platform demonstrated its resilience in the most challenging of environments. Fourth quarter results benefited from the contributions of three boom projects that were completed in Argentina and Brazil in the third quarter, while the fourth boom project in the Middle East and Africa region was completed during the quarter and began generating revenue in January of 2021. In addition, we finalized two 10-year renewals for natural gas infrastructure that were previously announced with our second quarter results. These extensions reinforce our strategic goal of generating long-term stable cash flows. In addition, despite recent energy market volatility, we continue to see demand for our gas and power infrastructure through our asset ownership model in our rest of world segments. In addition, our U.S. contract compression fleet of over 350,000 horsepower maintained an average utilization of 82% on steady demand driven by strengthening commodity prices during the quarter. Overall, I am proud of our team's efforts and successes throughout the year to keep our assets performing and our customers happy. Enerflex's global vision is transforming natural gas to meet the world's energy needs, and we believe that natural gas is an important place in the overall energy landscape. Natural gas is the cleanest burning fossil fuel that can provide a practical reduction in global carbon emissions while synergistically supporting a global energy transition. Enerflex's focus on stabilizing cash flows to defend against the natural yet unpredictable cyclicality in commodity markets has been put to the test throughout 2020. The investments we've made in our asset ownership and AMS businesses have helped in stabilizing the company's cash flow throughout this downturn. and will be an important part of our business going forward. We continue to exercise capital discipline with a focus on value creation via judicious capital allocation. Interflex believes that maintaining efficiency through optimized operations and preserving the strength of our balance sheet will allow the company to weather this downturn and will provide a stable foundation to succeed as the industry recovers. I will now turn things over to Sanjay to review our financial results.

Thanks, Mark. Fourth quarter revenue of $299 million decreased significantly versus the prior year period due primarily to lower engineer systems revenue on weaker bookings throughout 2020 and reduced contributions from some major projects that were largely completed by the third quarter of 2020. This was partially offset by higher rentals revenue, primarily due to amounts recognized on the 10-year renewal mentioned by Mark. as well as contributions from recently commissioned boom projects in Latin America and the organic growth of our U.S. rental fleet. The accounting treatment of the renewals is a conversion of boom contracts to a 10-year finance lease, which results in some one-time revenue recognition, as well as recurring revenue that will be recognized over the next 10 years. Although service revenue continued to see reduced demand versus the prior year, activity appears to have stabilized. Gross margins decreased over the comparative quarter on lower revenue, but gross margin percentage improved due to increased contributions from recurring revenue product lines. Until there is a meaningful increase in engineer systems bookings, the company expects gross margins from engineer systems to decrease and margin contribution from recurring revenue to make up a larger proportion of total gross margin. SG&A was lower in a quarter, primarily driven by decreased compensation expense on reduced headcount, cost recoveries related to government assistance programs, and lower travel costs. Previously announced cost-cutting measures remain in place, including reductions in travel, marketing, and non-critical IT expenditures. Enerflex continues to manage working capital, including monetizing our receivables and realizing inventory into projects. Remaining direct material inventories will be realized into engineered systems projects and new contract compression units over time. These inventory items are non-perishable and can be consumed in various projects across our engineered systems and rental offerings. From a capital allocation perspective, we saw $10 million of capital deployed towards previously committed projects in the USA rental fleet and completion of a boom project in the Middle East. This project began generating revenue in January 2021. Our near-term focus is on continuing to preserve the strength of our balance sheet. We've identified several opportunities to deploy capital investment criteria, and Enerflex has done a great job of maintaining conservative leverage throughout the cycle. We expect to generate significant free cash flow before growth capital expenditures in 2021. As a result, we expect to be able to spend $50 to $100 million in CapEx this year, with approximately $20 to $25 million being spent on maintenance CapEx and the remainder being spent on value-added growth projects. With significant liquidity on our revolver, the potential for additional harvesting working capital, and the possibility that engineer systems activity could pick up, Enerflex is well positioned to consider additional growth projects beyond this level as the year unfolds. Enerflex's 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 $0.02 per share to be paid on April 1, 2021. With respect to liquidity, Enerflex has $96 million in cash on hand and access to $593 million on our bank facility, which gives us the flexibility to manage the business through the current downturn and to consider organic and or inorganic growth. Our net debt decreased by nearly $30 million in the quarter as we continued using cash flow to decrease net leverage. And we exited the quarter at a bank-adjusted net debt to EBITDA of 1.3 times. This completes the formal component of the webcast. Additional details can be found in our February 24th press release. We will now be happy to take any questions.

Ladies and gentlemen, if you have a question or a comment at this time, please press the star then the one key on your touchtone telephone. If your question has been answered or you wish to move yourself from the queue, please press the pound key. Our first question comes from Eric McNeil of PD Securities.

Hey, morning, all. I'm not sure if Patricia is also on the line and would want to speak to this, but perhaps you could walk us through how the management team is thinking about your recent announcements and focus around energy transition and when we can expect something a bit more definitive from you in terms of the specific avenues that you'll be pursuing.

Aaron, this is Mark. Patricia is not on the call, but thanks for the question. We're thinking about the energy transition really in three ways. We said in the press release back in January when we announced Patricia's appointment to Chief Energy Transition Officer that we are actually currently working on decarbonizing the oil and gas industry by doing carbon capture projects, flare to power, and also electrifying compression both in our rental fleet and for our customers. So that's one way that we're doing it. But really, the more strategic work that Patricia is going to be focused on is really looking at new markets. And in the press release, we talked about RNG, hydrogen, carbon capture, biogas processing as some areas that appears to be our core competency of a modular approach to gas processing could really be applied to those industries and create some value for our shareholders. So that's what we're going to be looking at. We're resisting giving a timeline, but I can tell you that it's a priority for us.

Understood. In sort of a similar vein, could you maybe walk us through the ESG scorecard that you published with the quarter and how you might stack up against some of your peers and if there are any initiatives underway that might positively impact those metrics when you report again next year?

Well, thanks for noticing. We put the SASB metrics on the web yesterday for the first time in our company's history. We're proud of getting through that work. We put a lot of energy into it. It would be difficult for me to try to draw any conclusions and compare us against our peers. I think that's something that the market will do. I'm really happy with our social and governance activities. We've been a very well-governed company for a long time. Our commitment to safety is one of the primary ways that we, you know, engage socially with our employees and our communities. On the environmental front, you know, we put a bunch of effort into understanding our scope one and scope two greenhouse gas emissions. And they're there. It's not surprising, but engine-driven compression is relatively carbon intense. But that's the oil and gas industry. And, you know, like I said a few minutes ago, electrifying our fleet, not, you know, but looking for opportunities where the grid could support an electric fleet is one way that we can lower the carbon intensity, and it makes good business sense in some instances. So that's really the biggest thing that we're looking at. From a sustainability point of view, one of Patricia's jobs and one of the reasons we created the position is that we really wanted to differentiate our revenue streams and really start looking at deriving revenue from low-carbon industries. And that doesn't really show up in the SASB metrics as far as what our personal carbon footprint is, but that's something that we're going to be looking at really closely.

Understood. And switching gears a bit, Sanjay, you spoke to the CAPEX, obviously, a pretty wide range. How much has the board approved at this point, and does that entirely relate to awards to date, or how are you guys thinking about that?

Well, you know, the specifics around what the board has approved, I'm not sure we'll get into that detail. But, you know, I think we announced a $35 million long-term rental project in the press release. You know, certainly the 20 to 25 of maintenance capex, you can certainly, you know, check the box on that as virtually assured. And so I think that gets you sort of to the lower end of the range. We've got some contract compression projects that we're excited about as well. So I think that will get us towards the middle of the range in terms of what's really committed to at this point. And we continue to see some good projects and hopeful that we can convert some of them throughout the year.

Okay. And then finally, as it relates to the reclassification of the boom project, how are you thinking about replenishing the contract compression and boom assets over time as some of your customers elect to move assets onto their books?

Well, I guess first, just a point of clarity, that actually is still a 10-year commitment from the customer to pay us for the exact same services that we've been providing historically on those assets. So There was certainly a component of, you know, from an accounting perspective, bringing forward some revenue. But, you know, from a cash perspective, we still expect to be, you know, enjoying the benefits of working with that customer for the next 10 years. You know, it was really, I think, more of a one-off. Like, we're not seeing this as a huge trend. As people are not necessarily kind of migrating things from our balance sheet to their balance sheet, there continues to be pretty strong interest in using the Enerflux capabilities and the balance sheet to engage with us in boom projects and finance leases.

Okay, perfect. That's all for me. I'll turn it over.

Our next question comes from Keith Mackey with RVSync.

Hi, good morning. Thanks for taking my questions. First one is just on the new $35 million project. Just curious if you can give any more details or indication of timing of spend or when you might expect it to come online.

Yeah, we do expect the CapEx to be spent predominantly in 2021. And I don't think that this project will materially impact, you know, earnings in 2021. So it should make a meaningful impact in 22, but I wouldn't expect to see a big impact in 21.

Got it. Okay. And maybe just on the growth CapEx, so, you know, given you've got some potential room for more spend and you might have some, you know, larger projects in the hopper or there's, you know, still decent utilization on your, U.S. compression assets. Just how are you thinking about allocation for growth capital now in the context of those opportunities versus even a potential buyback or dividend increase, I should add?

Yeah, no, good question, Keith. I think we are continuing to be conservative about putting capital out the door. You know, we want to make sure that we're getting a healthy return on new projects that we take on. You know, having said that, I do think that the market is showing us some good projects. You know, I think we're always balancing the equation of, you know, do buybacks make sense? Do dividend increases make sense? That really is an analysis that we keep pretty fresh as a company. What I can say is that we still believe that the growth projects are the best way to add value to the company. The share price has recovered quite a bit, as you're aware. I think that makes buybacks less attractive, and we feel like the best use of our dollars is to continue to grow the business. We'll continue to be pretty patient in making sure that we're getting the right level of return on the CapEx that we're putting out the door. And the other thing that I'll mention is we're constantly looking at how the market's evolving. And if we start seeing an uptick in the engineered systems business, that brings a lot more EBITDA and therefore a lot more financial capacity to the table for us to invest in future projects. So All of those are variables that we continue to look at. They're evolving throughout the year. You know, I think calling a recovery is we feel really good about natural gas, but the timing of that recovery is really what is, we think, uncertain. So those are all the variables that go into that thinking. Keith, hopefully that's helpful.

Yep, that is. That's all I had. Thanks very much for the color.

Again, ladies and gentlemen, if you have a question or a comment at this time, please press the star, then the one key on your touchtone telephone. Our next question comes from Josh Gibson with VMO Capital.

Morning, all. Morning. First, I'm just wondering how the cold weather the last few weeks, specifically in Texas, has impacted your operations, both at your fabrication facility as well as on your compression fleet.

John, thanks for the question. Our shop was shut down for four days last week. a manufacturing shop in Houston. Our rental fleet fared very well, and we kept a lot of that equipment running, so I wouldn't say any material impact on our assets. But our shop was shut down for four days, and, of course, what matters to us is a lot of our people suffered last week a lot more than just inconvenience, but there's a lot of issues they had in their home life, and we thought about them all week, but they're back at work, and the shop is operating, and we're building stuff.

Okay, great. Glad to hear that. Switching gears a little bit, Shell came out with an announcement this morning that LNG Canada is an important part of their portfolio. So if we're talking about a 2025 startup, when would contract discussions around the facility start for Interflex?

I don't know what you mean by contract discussions.

Just around the potential facilities for the infrastructure for LNG Canada.

Oh, well, I would like to say that the knock-on impact of LNG Canada has been felt. And it's a driving force for several projects that are in pipeline in Canada already. It's from people that are actual consortium members or people that believe their gas will find a home in the plant. So it's been a positive boost to the sentiment of gas producers and processors in the province. And I'd say a lot of projects are in the engineering phase. And I think we would hope to start getting orders on equipment, you know, latter half of this year, early 2022. And you could trace that equipment either in whole or in part to the demand created by Shell LNG.

Okay, great. That's all from me. I'll turn it back.

Our next question comes from Tim Bonicello with ATB Capital Markets.

Hey, everyone. A couple questions from me. First one just on rental utilization in the first quarter. Are you starting to see that move higher in the U.S.?

Hey, Sam. It's Stephan speaking. So I would say that the stability that we started to see emerge coming out of Q3 or within Q3 and that carried into Q4 is consistent with what you're seeing with commodity prices and given what we're seeing in Q1 so far. It's been a supportive environment, and provided that continues, we'd expect a gradual recovery in utilization.

Okay, that's helpful. And then the second one, just on, I guess, growth capital spending. The announced boom award that you guys got, $35 million, is a pretty digestible size, I would say, smaller than some of your historical projects. That leaves you about $40 million for the rest of the year, and you mentioned Sanjay that, um, you know, if, if you start to see as your systems tick back, that could grow. Now I'm just curious, has there been any larger projects that you've had to pass up just in sort of thinking about, you know, being a conservative, the balance sheet and what's going to give you like what, what barriers internally are you looking for or indicators that, that would give you comfort for larger projects?

Yeah. Um, I'll take the turndown question first. Short answer is no. We haven't had to turn anything down. I would say in the heart of the downturn, there was one or two smaller things that we passed on. In terms of big projects that take a long time to come together, we've been able to plan around those so far. Yeah, I think, you know, look, we're sitting with a really conservative balance sheet right now. We're, you know, 1.3 times levered relative to our bank covenant. And so, you know, we certainly want to maintain that. We certainly are trying to stay within cash flow. But for the right projects, you know, I think that we could also consider, you know, going a little bit higher on leverage, and that's certainly a consideration that we'll take. into account. And when you look at that, we can handle pretty significant projects relative to the size that we've seen historically. Okay.

And then I guess the remaining growth capex, how much of that do you think will be allocated to the U.S. rental fleet?

You know, we're still – that's really on a sort of opportunity by opportunity basis that we assess that. So tough for us to nail that down, Tim.

Okay. I appreciate the details. I'll turn it back.

Our next question comes from Michael Robertson with National Bank.

Hey, good morning, all. Thanks for taking my call. You guys have done a pretty good job to date so far in the sort of pullback in terms of monetizing working capital. Just sort of wondering if, like, this has sort of changed your view on moving forward in terms of, like, how much, you know, how much inventory you want to carry on the balance sheet, or should we sort of be suspecting a return to what we saw pre-pandemic, I guess, as things gradually recover here?

Michael, this is Mark. I'd like to say we'll be more disciplined on inventory going forward.

Okay. Do you have like a level in buying sort of like a sweet spot or just?

We really don't. You know, what happened pre-pandemic was that we were at the tail end of the four or five year uptick in engineered systems business. And we got hit by the pandemic, which was largely unexpected. At the same time, we were putting quite a bit of growth capital into our rental fleet. So the working capital that increased just part of the pandemic was really a combination of really good demand signals for engineered systems that stocked and also a pretty aggressive growth CapEx program for our asset base, which also was slowed down quite a bit. Now, going forward, we feel that the supply chains globally have – gotten to the point where we don't need to build up the same levels of inventory to serve our customers. And so I just don't have a number or a level to tell you. I just know that minimizing working capital while making sure we can serve our customers with our products is that balancing act that we always play, and we want to be on the conservative side of it as much as we can. Got it.

Switching gears, I just wanted to ask, One of your peers noted on a recent call that you're seeing some ENPs leaning on additional compression as a method of maintaining flat production without necessarily drilling more as a relatively cost-effective measure to maintain production. I just wonder if you guys are seeing any of that as well.

As well as decline, they'll need more compression to keep them flowing. And the number of frack crews in some of the bigger basins is going up, kind of completing those ducts that have been out there for a while. Except instead, support for our compression rental business in the U.S. has been good. And production in the U.S. has been pretty stable. So I'm not about to tell you that the easiest thing for an operator to do is add compression to keep production flat. There's a lot of things they have to do. But, you know, to the degree that they're not drilling a bunch of wells and the ones they have are declining, they'll need compression to keep those going. The dynamics are they're complex, to say the least, but we think compression's got a home as long as gas demand is robust, which we think it will be for a long time.

All right. That's a great call. Thanks for taking my questions. We'll turn it back.

And I'm not showing any further questions at this time. I'd like to turn the call back over to Mark.

Thank you, Operator. Since there's no further questions, I would like to once again thank you for joining us on the call. We look forward to giving you our first quarter results in May.

So, ladies and gentlemen, this concludes today's presentation. You may now disconnect and have a wonderful day.