Enerflex Ltd.

Thank you for standing by, and welcome to the InterFlex first quarter 2021 results webcast. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to your host, Stephan Ali, Director of Investor Relations.

Thank you, Operator, and good morning, everyone. Here with me are Mark Rossiter, Interflex's President and Chief Executive Officer, Sanjay Bishnoi, Interflex's Senior Vice President and Chief Financial Officer, and Ben Park, Interflex's Vice President Corporate Controller. During this call, we'll be providing our financial results for the three months ended March 31st, 2021. a brief commentary on the performance of our three business segments, and a summary of our financial position. 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 investor section. During this call, unless otherwise stated, we'll be referring to the three months ended March 31st, 2021, compared to the same period of 2020. 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. Our first quarter results benefited from the continued resilience of our recurring revenue businesses and a nascent recovery in engineered systems bookings activity. While industry spending is in the early stages of recovering, a stable commodity price environment is assisting our customers in affirming their 2021 spending plans, resulting in increased bidding activity across our regions. In particular, we have started to see meaningful opportunities for new equipment orders in our Canada and rest of world segments, and are fielding an increasing number of inquiries for solutions that can lower the intensity of carbon emissions. While it is certainly a positive to see a quarter-over-quarter build in our engineered systems backlog for the first time since early 2019, additional bookings will depend on the pace at which bidding opportunities are converted to executed contracts, and our expectation is for bookings to remain relatively subdued through the first half of 2021 with a modest recovery later in the year. Our aftermarket services business was stable through the quarter with improved contributions from our Canada and rest of world segments versus the comparative period, but was impacted by a combination of seasonal weakness and delays caused by extreme weather events in Texas. We are expecting improvement in AMS revenues throughout the year as the industry continues to recover. Our global asset ownership platform continues to perform very well, proving its resilience through the downturn and supporting the company's gross margin profile. In our rest of world segment, all assets within our boom portfolio are performing as anticipated, and we continue to see opportunities to grow our portfolio in the Middle East and Latin America. In addition, our U.S. contract compression fleet has grown to 375,000 horsepower and maintained a first quarter average utilization rate of 82%, which we expect to gradually improve this year. Overall, I am proud of our team's efforts to keep our assets performing to the benefit of our customers and stakeholders. Turning to our energy transition business, our analysis of addressable markets continues to evolve and has so far presented an interesting and diverse opportunity set across several aspects of the energy value chain. EnerPlex's near-term focus is to continue its work on crystallizing strategies that ensure a sustainable growth-oriented and profitable approach to energy transition, and those strategies will be communicated in due course. Throughout 2021, our focus will remain on strong execution and maintaining the performance of our assets. It is refreshing to see some renewed optimism in the energy space as the industry looks forward to the opportunities that will present themselves in the post-pandemic era. Our financial discipline through the downturn leaves us well-positioned to compete for these new opportunities moving forward. I will now turn things over to Sanjay to review our financial results.

Thanks, Mark. Fourth quarter revenue of $203 million decreased significantly versus the prior year period due primarily to lower engineered systems revenue on weaker bookings in recent periods and reduced contributions from some major projects that were largely completed by the third quarter. quarter of 2020. Included in the quarter's 98 million of bookings is the manufacturing portion of the 10-year boom project booked during the quarter in which we disclosed as a subsequent event with our fourth quarter 2020 results. Given its status as a new finance lease on equipment that we will be manufacturing, the manufacturing portion of this project is being included in bookings for the quarter and will be recorded in engineered systems, while the finance lease income will be recognized in the rentals product line over the lease term. Service revenue was lower due to inclement weather in the US during the quarter, as well as pricing pressure on certain service offerings, while rentals revenue decreased due to lower rates on extended contracts in the Middle East and expiration of certain contracts in Mexico during the prior year. Revenue in many of our operating regions was also negatively impacted by a weaker U.S. dollar during the period. Gross margins decreased over the comparative quarter on lower revenue, but the decrease was partially offset by increased contributions from recurring revenue product lines, which carry a higher gross margin as a percent of revenue. SG&A was down slightly on the quarter, primarily driven by lower compensation expense and cost recoveries related to government assistance programs, partially offset by higher share-based compensation on the increase of the company's share price during the first quarter. The movement in share price resulted in $5.3 million of share-based compensation in the quarter compared to a $5.1 million recovery in the first quarter of 2020, a net increase of $10.4 million period over period. Enerflex has continued to make good progress in monetizing our working capital commensurate with our reduced revenue. Remaining direct material inventories will be realized into engineered systems projects and new contract compression units over time. During the quarter, we invested $10 million of capital towards units in our USA rental fleet, which has grown to approximately 375,000 horsepower. From a capital allocation perspective, growth capex will continue to be limited to those opportunities that satisfy stringent investment criteria, prioritizing higher margin, less cyclical businesses with attractive returns. Enerflex continues to maintain a conservative leverage position with a bank-adjusted net debt to EBITDA of 1.37 times. With significant liquidity on our revolver, the potential for additional harvesting of working capital and the possibility that engineered systems activity could pick up, Enerflex is well positioned to consider additional growth CapEx should attractive opportunities present themselves. Our net debt decreased by over $40 million in the quarter, and we continue to using cash to decrease net leverage and strengthen our balance sheet. With respect to liquidity, Enerflex has $111 million of cash on hand, and access to $638 million on our bank facility, which gives us the flexibility to manage the business through the current downturn, manage our upcoming note maturity, and to consider organic and or inorganic growth. In addition, subsequent to the quarter, a subsidiary of the company finalized access to a credit facility secured by certain of its assets. This asset-backed credit facility of up to $52.5 million U.S. dollars is non-recourse to the company and will provide flexibility in efficiently financing our asset ownership investments. Lastly, 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 two cents per share to be paid on July 8th, 2021. This completes the formal component of the webcast. Additional details can be found in our May 5th press release. We will now be happy to take any questions.

As a reminder, to ask a question, you will need to press star one on your touchtone telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from the line of Michael Robertson of National Bank. Your question, please.

Hey, good morning, everyone. Thanks for taking my questions. In your outlook, you mentioned that bidding activity appears to be picking up for engineered systems opportunities related to the energy transition towards less carbon intensive energy sources. Was wondering if you could provide some additional color on that front regarding the specific types of projects. I'm curious if you're seeing more potential opportunities related to carbon capture and storage, or RNG, or hydrogen, or if it's sort of an even mix at this point.

Hey, Michael. This is Mark Rossiter speaking. Thanks for the question. We are seeing inquiries in decarbonizing oil and gas customers. We're seeing inquiries in carbon capture. We're seeing inquiries in landfill gas and renewable natural gas. And we're also bidding hydrogen compression.

And I guess as a follow-up to that, you know, looking at those channels, is there a standout in terms of equipment intensity as it would relate to potential demand for Enerflex equipment? Or, you know, maybe put another way, if you're looking at you know, projects in those realms that were of similar scale, would one offer more upside to Enerflex in terms of the amount of equipment required that would be in your sort of wheelhouse?

Based on what we know today, we feel that decarbonizing the oil and gas industry, which would be electrification, carbon capture, and storage, and also carbon capture and storage for other industries are very equipment intensive. And we think they really... lend themselves to a modularized approach. And we've got good experience lists in both of those areas already from the last 40 years of our business. So we think those things are the most equipment intensive.

Got it. That's helpful, Collar Mark. I appreciate that. And sort of just as a last follow-up, I know this is a tough comparison given the sort of breadth of the different end users of your equipment. How would that equipment intensity sort of stack up to your your more traditional projects?

A carbon capture and storage system of size from a distance would look very similar to a large gas plant or a big compressor station. It's tough for me to give you a great answer to that, but like you said, which ones are the most equipment-intensive? Carbon capture and storage is quite equipment-intensive, but it's the same pressure vessels, compressors, pipes, heat exchangers, et cetera, that would be all sort of put together to make a gas plant. Decarbonizing oil and gas operations, which is in addition to carbon capture and storage, is a lot of electrification from a distance that would look very similar to a normal compressor station or gas plant, just with fewer gas engines, more electric motors. Got it.

Got it. That's a really helpful call, Mark. I will turn it back. I appreciate you taking the call. Okay, you're welcome.

Thank you. Our next question comes from the line of Aaron McNeil of TD Securities. Your line is open.

Hey, morning all. Sanjay mentioned the potential for growth and given investors' continued focus on capital in the energy sector, how do you expect to balance future growth against those views and what characteristics would a potential capital project have to have for you to give it the green light?

Yeah, good morning, Aaron. Thanks for the question. We feel like the competitive environment has certainly reflected what you've just mentioned, which is that there's a little bit more discipline on capital. So we're actually seeing healthy returns on the projects that we're looking at. Our initial swag is to say we're going to live within cash flow, but we also are taking a look at the balance sheet. And, you know, Enerflex is in really good shape from a balance sheet perspective. So we continue to balance, you know, our views on leverage and, you know, just looking at balance sheet capacity and trading that off with returns on the projects. And where we see healthy opportunities to grow the business and good returns, we're going to take them.

Maybe a good segue into the next question, can you walk us through the decision to pursue a non-recourse credit facility in terms of overall rationale, if it has any advantages in terms of interest rate or other terms, and would you use this sort of instrument more in the future, and what might that imply for future leverage?

Sure, yeah, great question. We've always had the ability to do this within our existing financing documents, so this has always sort of been a built-in feature that we had, and it was largely an acknowledgment that the businesses that we're getting into, namely the asset ownership businesses, they can carry more leverage than the traditional Interflex manufacturing and service businesses. So it's really just an articulation of that strategy and feature that we've had in our existing finance agreements. When you look at some of the assets in our rental portfolio, under contract, good names, recurring revenue, those all sort of lend themselves to really competitive rates and the ability to access more capital. And so this was very much just, you know, realizing that our assets are getting to a point where we should think about doing something non-recourse. And, you know, we took advantage of available financing that was out there. So I think it net-net improves our ability to access capital. I think you can expect us to continue to look at additional opportunities here I don't think it's going to be a sea change in terms of our view of how we manage the company. I think we're still going to be very conservative with leverage. But there's certainly some pockets of capital out there that we can access really efficiently when we think about non-recourse.

Got it. And then last question for me. You mentioned you'd evaluate the dividend quarterly. Historically, I guess, Enerflex has made changes to the dividend with the third quarter results. Is that still the MO of the board or do the unusual circumstances around COVID make that decision a bit more fluid?

Uh, you know, we, we sort of, um, we take those decisions quarter by quarter. Uh, they're always subject to our board's, um, approval and, uh, you know, therefore I think we'll, we'll just continue to evaluate those and let you know when, when there's any change to the strategy there.

Okay, great. That's all for me.

I'll turn it over. Thank you. Our next question comes from Tim Manicelli of Manicello's, pardon me, of ATB Capital Markets. Your line is open.

Hey, guys. Manicelli, I don't think I've heard that one. I like it though. First question is just around the finance lease structure. So my understanding anyway is that the contract will be monetized the same way a normal boom would, like you'll get most of the cash flows over the 10-year term. That means that the bookings that you're getting now, as you recognize revenue on the manufacturing component, will largely be devoid of associated cash flows at least over the near term. So I'm curious how much you expect the deferred revenue component to be in 2021 and 2022. associated with that one contract.

Hey Tim, this is Sanjay. I'll take first stab at that one. Unfortunately, you're a bit muffled in your transmission, so hopefully we got it right here, but let us know if we didn't and we can clarify. You're absolutely right, and I think you're referring to the new booking that we announced And, you know, you're right, like, from an economic perspective, that is, you know, it's a typical boom contract, which is, you know, a 10-year term, including the construction period. And, you know, we get paid for – we get paid a steady state rate throughout that 10-year term. So, economically, there is really nothing different. What is different is the accounting treatment, and that's very much related to IFRS 16, as I think we've talked about in prior – discussions. The effect of that accounting treatment is that we end up pulling forward a lot of the revenue, a lot of the profit, and then we basically have a finance lease receivable and the earnings associated with that are accounted for over the 10-year term. We typically don't disclose particulars on specific deals. So unfortunately, we won't give you any guidance in terms of this particular contract, what you can expect over the next 10-year period. But again, we think the predominant thing to keep your eye on here is the fact that the cash flow is steady over the 10-year term of the contract. Okay, gotcha.

And then on the The rest of the world rental segment, you know, I guess the commentary a year ago would have been that you have three boom contracts coming online over the next, you know, that cap to 2020 and into 2021. Fast forward to today, you have all three of those contracts commissioned. Rental revenue was down on a year over year basis and understanding that you've had some renegotiates around contracts. And you mentioned some Mexican expirations. but how should we be thinking about rental revenue in the rest of the world segment progressing through the rest of the year?

Yeah, I think, you know, we had a lot of moving parts there, and, you know, unfortunately, I wish, you know, the accounting standards, their hearts are in the right place to make this more understandable to investors, but it does actually sort of move you know, it moves things around a bit. And I think that's what leads to a lot of these, you know, these questions. I would say that now that we're sort of over the noise of the three projects coming online and a lot of the recontracting, I would expect that we should level out quite a bit throughout the rest of the year. You know, some of the variables there might be our U.S. fleet where we do expect to increase, so that might be a variation to the positive. And, you know, we're also looking at, we're continuously looking at new deals and feeling really good about the pipeline there as well. So that might introduce some new deals that we need to talk through, but I think those are all things for the future.

Hey, Tim, this is Mark. Rest of World Rentals is a critical part of our business. We like it. There's way more good news than bad. During the pandemic, there is a small number of blend and extends, which, you know, it's somewhat negative that we gave some lower rates, but the upside is we got long-term extensions. In some cases, assets that we had operated for 10 years got another 10-year extension, so it really provides some stability to our cash flows for a long time. The U.S. rental fleet, like Sanjay said, you asked about ROW, but the U.S. rental fleet is a big component of our asset ownership strategy. And the trajectory we've seen there throughout the pandemic and indeed through Q1 has been very positive, both on adding new horsepower and the utilization of the overall fleet. But your question is well made, that ROW, we did start a bunch of boom contracts, and you're like, where's this all adding up? The impact of shifting some of the assets to a finance lease does make it complex when you're trying to analyze it on an earnings point of view. And I would say that impact is probably more significant than any of the blend and extend things we had during the pandemic. And in general, the cash flows we're getting from all those assets, the diversity of the countries we're operating in, and the clients that we have, I really like the portfolio of assets we've built up. And like Sanjay said, it's got a lot of upside going forward.

Okay, that's helpful. One more question here just on CapEx. Understanding that the finance lease contract there is probably going to be accounted for like it would be on an engineered systems project, so that won't be a CapEx item anymore. So what is the CapEx range you're expecting now on an adjusted basis for 2021? Yeah, so, you know, leaving that out,

Tim, you know, I guess I'd go back to the guidance that we gave earlier, which was 50 to 100 million of growth capex on the year. And so, you know, I think that if you take, you know, the announcement of this 10-year project out of those numbers, I'd say that the range is still where our heads are right now. You know, having said that, I do want to say that we're constantly looking at the balance sheet. We're constantly looking at the engineered systems business and the outlook for that. And, you know, we believe that there's a lot of great projects out there right now. And so, you know, we're always going to be evaluating whether we should bump that up. I don't see that necessarily that range that we gave you. I don't see that coming down. But I could see under the right circumstances us, you know, wanting to get some more good business on the books.

Okay, great. I'll turn it back. Thank you.

Thank you. Once again, ladies and gentlemen, to ask a question, please press star one on your touchtone telephone. Again, that's star one on your touchtone telephone to ask a question. Our next question comes from the line of Keith Mackey of RBC. Your question, please.

Hi, good morning. Thanks for taking my question. I just wanted to maybe start out with the gross margins on a pre-depreciation basis in engineered systems, around that 15% number for this quarter. How should we think about that over the summer quarters or so, given where the backlog is, what projects are in it, and your expectation that bookings remain muted for the next couple quarters?

Keith, this is Mark. We don't give specific guidance around gross margins, but macroeconomically, the industry is very competitive. And the backlog popped up in the quarter, which was really nice. It was helped by the boom contract we booked in the ROW segment. But in North America, activity, we stated, it's quiet. We don't want to say there's a major inflection going on. So it's going to continue to be competitive. But sort of beyond that, we're not going to provide too much commentary about the gross margin built into our current backlog.

Got it. Okay. And I guess maybe just a bit more commentary around your thoughts given where things have gone and where you expect them to go. But how do you plan to manage cash generation given the margin commentary that you just made for the enterprise over the next few quarters or even going into 2022 should the industry continue to stay challenged and bookings remain a little bit more scarce or the margins on the projects stay skinny as you mentioned?

Yeah. Keith, this is Sanjay. I'll take that one. You know, I'd say that that was a big part of our thinking through the pandemic, and it was really the planning that we were doing around managing cash flow through 2020 that's put us in a really good position, you know, from a balance sheet perspective to see us through the remainder of the downturn. So, you know, while we're expecting things to pick up um you know even if things don't pick up we will be just fine from a from a cash flow and and you know the health of the balance sheets perspective so i think it's really about what we did last year that put us in a good position this year got it okay so maybe just to clarify is it fair to say then that you can flex your growth capex to stay free cash neutral or positive in you know

in most booking scenarios then? Is that, have I gotten that right?

Yeah, I think, you know, if you look at the range that we gave, I think that we're in that range can stay, you know, within cash flow for the year. And I think even beyond that, you know, the balance sheet is in great shape, so we can always look to the balance sheet if we see projects that we just have got to have and we want to stretch a bit to get them. Got it.

Okay. Thanks very much. That's it for me.

Thank you. At this time, I'd like to turn the call back over to President and CEO Mark Rossiter for closing 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 second quarter results in August.

And this concludes today's conference call. Thank you for participating. You may now disconnect.