Enerflex Ltd.

Ladies and gentlemen, thank you for standing by, and welcome to the InterFlex fourth quarter and year-end 2021 results conference call. At this time, all participants are on a 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 0. I would now like to turn the call over to your host, Stephan Ali, Vice President, Investor Relations and Strategy. You may begin.

Thank you, Operator, and good morning, everyone. Here with me are Mark Rossiter, Enerflex's President and Chief Executive Officer, Sanjay Bishnoi, Enerflex's Senior Vice President and Chief Financial Officer, and Ben Park, Enerflex's Vice President Corporate Controller. During this call, we'll be providing our financial results for the three months ended December 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 December 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, Stefan, and good morning, everyone. To call 2021 a transition year would be an understatement. We entered the year with a very low backlog, no vaccinations, and a pervasive global uncertainty in the energy markets. The advent of vaccines has since led to a broad reopening of economies and a robust demand recovery for oil, natural gas, and natural gas liquids. Although our customers are continuing to exercise discipline in capital spending, Good projects with strong long-term returns tend to get funded, and supportive fundamentals have led to demand for everything from gas compression to gas processing to electric power solutions. Enerflex's fourth quarter results benefited from this momentum, delivering our highest quarterly revenue since the beginning of the pandemic. We continue to see healthy demand across each of our global regions, as evidenced by the strong engineered systems bookings of over $320 million. The recovery has been broad-based, with meaningful upticks coming from each of Canada, USA, and our rest of the world segments. We have been especially pleased with the increased bidding activity in Latin America, which was hard hit by COVID-19 and was expected to take much longer to recover. During the quarter, we commissioned a system to reduce flare gas and CO2 emissions in Colombia. Our teams did a good job of gaining margin traction for new bookings, though the overall market remains very competitive. In addition, we continue to navigate supply chain constraints that began to emerge in mid 2021. While these challenges have been manageable, we expect that our teams will be dealing with inflationary pressures on materials, freight costs, and delivery delays throughout 2022. Our energy transition team, formed in early 2021 and led by Patricia Martinez, continued to progress opportunities to meaningfully decarbonize the energy sector. Our deep expertise in modularized process solutions critical to the energy transition is the primary reason for our successful partnering with customers in this space. In addition to participating in several studies, we have executed multiple MOUs, project development term sheets, and engineering projects for strong counterparties who are seeking lower carbon solutions via CCUS, renewable natural gas, hydrogen, and electrification. Broad momentum within the energy transition space will require governmental policy that supports meaningful infrastructure spending on low carbon solutions. But nonetheless, certain customers are already exploring these opportunities and committing to either pilot projects or, in some circumstances, permanent facilities. For instance, in 2021, we were awarded the design, engineering, and fabrication of a hydrogen compression solution for a green ammonia plant. which, when commissioned in 2023, will be the largest of its kind in North America. We also electrified tens of thousands of horsepower in the compression space and continue to see strong demand for electrified solutions. More recently, we've entered into an arrangement with a major Canadian producer for a post-combustion CCUS pilot project, which has the potential to take the project site to net zero. While the energy transition landscape is still in its infancy, the early success of our team should help to solidify Interflex's position as a key partner for any customer who's seeking to decarbonize operations. Our aftermarket service to business performed as expected, gradually recovering from the industry downturn, despite the operational and travel restrictions caused by the pandemic. In 2022, we expect that our teams will have to navigate region-specific inflationary wage pressure and the same supply chain constraints as engineered systems, particularly regarding to the price and availability of OEM parts. Our energy infrastructure platform, formerly known as Rentals, demonstrated its resilience throughout 2021. Fourth quarter results benefited from improved revenues and higher utilizations from our U.S. contract compression fleet of approximately 400,000 horsepower that maintained an average utilization of 89%. Our fleet's performance was enhanced throughout the year from operational efficiencies captured through instrumentation and telemetry upgrades, which are maximizing uptime and value for our customers. In our rest of world segment, we secured a 10-year extension on a boom asset that has been operating since 2016. Renewals are particularly attractive to Enerflex and our shareholders as the extended revenues come with little or no new capital expenditure. Future quarters will also benefit from another large asset that we were awarded in early 2021 that commenced operations in early January 2022. Collectively, these assets reinforce our strategic goal of generating long-term stable cash flows. Overall, I'm very proud of our team's efforts and success throughout the year to keep our assets performing and our customers happy. Lastly, subsequent to the quarter, we announced our intention to close on an all-share acquisition of long-time industry participant Exterin. Since our announcement, we have progressed matters pertaining to regulatory, capital structure, and integration planning. Upon closing, this transaction will immediately create a true energy infrastructure company, and Enerflex remains focused on delivering on the strategic rationale of the acquisition, including increasing recurring pro forma gross margin to approximately 70% of total, striving for a sustainable cost structure through synergy realization, and providing better capabilities to our global client base. I'd like to thank all of our employees, customers, and suppliers for helping us execute on our strategy in 2021, and I look forward to the year ahead. I will now turn the call over to Sanjay Vishnoy to review our financial results.

Thanks, Mark. Quarter over quarter, EnerFlex saw an improvement in both revenue and operating margins, driven mainly by higher engineered systems revenue, improved gross margins on certain engineered systems projects, and lower SG&A. Compared to the prior year, operating income was lower due to competitive margin pressures on engineered systems projects that we discussed in our third quarter earnings call, the recognition of large finance leases at the end of 2020, and lower government grants received. Offsetting these decreases were improvements in engineered systems revenues on stronger opening backlog, reduced SG&A, and the recognition of finance lease for the 10-year boom extension that Mark discussed. From an accounting perspective, this finance lease results in some one-time revenue recognition and recurring revenue that will be recognized over the next 10 years. SG&A costs of $40 million decreased from the same period last year as a result of lower share-based compensation and decreased profit share expense. During the quarter, as a non-cash item, the company de-recognized $45 million in deferred tax assets related to unused tax losses and other deductible temporary differences in Canada. Generally, deferred tax assets are recognized for all unused tax losses, carried forward tax credits, or other deductible temporary differences if it is probable that they can be utilized against taxable profits. Management regularly assesses the unrecognized deferred tax assets to determine what portion can be recognized in response to changing economic conditions or recent events. During the quarter, it was determined as unlikely that sufficient taxable income will be available in the Canadian region to offset these unused tax losses prior to expiry. It should be noted that a portion of our corporate overhead costs that cannot be passed down to the countries in which we operate, as well as our interest and debt-related expenses, all reside in Canada and offset income generated by our Canadian business and contribute to our outlook on recovering these Canadian tax losses. Enerflex continues to manage working capital, including realizing inventory into projects, the balance of which has decreased by approximately $40 million versus the comparative period. From a capital allocation perspective, we directed $17 million towards energy infrastructure, the majority of which funded the organic expansion of our U.S. contract compression fleet. We also invested $13 million towards the construction of natural gas infrastructure assets, which will be accounted for as a finance lease. Our 2022 CAPEX It's premised upon the closing of our transaction with Exterin. As disclosed with our transaction announcement, expectations for pro forma 2022 expenditures in U.S. dollars are approximately $200 to $220 million for growth CapEx, $200 to $225 million for work in progress, and $40 to $50 million for maintenance CapEx. Our near-term focus is on continuing to preserve the strength of our balance sheet. Enerflex has done a great job of maintaining conservative leverage throughout the cycle, exiting the quarter with a bank-adjusted net debt to EBITDA ratio of 1.0 to 1, compared to a maximum ratio of 3 to 1, while maintaining substantial undrawn credit capacity and cash on hand. Interflex'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 2.5 cents per share to be paid on April 7, 2022. This completes the formal component of the webcast. Additional details can be found in our February 23 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, you should move yourself from the queue. Please press the pound key. Our first question comes from Aaron McNeil with TD Securities.

Hey, morning, all. Thanks for taking my questions. I've got a couple on the energy transition initiatives. So I guess first, it seems like you're getting good traction there. Can you give us any goalposts on materiality in terms of, you know, what's in the backlog or... what outstanding bids might look like? Second, what's your range of your typical market share on any given type of project? Are you a small portion of the total capital or are you a meaningful portion? And finally, it seems like most of the stuff you're working on in this arena is through more of a capital sale or engineered systems type of business model. Is it fair to assume that you wouldn't entertain owning and operating this type of equipment until... you know, the operations or economics of these types of assets are better understood. I know I've asked a lot, so.

Yeah, yeah, you've asked a lot, Aaron. This is Mark. Thanks for asking, though. The equipment that we booked in engineered systems that we talked about in the prepared remarks, they're between, say, $10 and $30 million worth of engineered systems bookings. They're in the hydrogen space. They're in the non-fossil fuel space and R&G space, et cetera. The big prize is... CCUS projects. You know, those will be meaningful projects. We think that a capture plant for a pre-combustion industrial source could be $30 to $60 million, maybe more. We know there's a lot of those sources throughout Canada and the United States. And in the U.S., the 45Q tax credit does make a lot of those projects profitable. And I think there's several infrastructure developers that we're working with in the Midwest of the United States, where we are really looking to build those capture plants. So to the degree that we could close two or three or four of those, that's definitely material money. And finally, I don't know market share, to be honest with you. I know that we've got good relationships with the major infrastructure developers in the United States that are looking at CO2 trunk lines and capture systems. It's very new. But finally, the comment about sales versus ownership, We definitely want to be owners of these assets. I think that our balance sheet isn't big enough to own every capture plant in the United States, not by a long shot, but there's definitely situations where our initial thought with the customers, please let us build on and operate this so that we could generate long-term sustainable returns for our shareholders. And that being said, if people want to own and operate it themselves, sometimes these plants will be inside the fence of an existing facility, not as easy to get somebody else to own that. They may engage us as a as a turnkey contractor or an equipment supplier, we'll essentially do what our customers want, but we'll be pushing the idea of asset ownership early as much as we can.

Understood. You said in the release that you've gained some traction on margins, understanding that it's going to take a few quarters before we see it in the results. Just hoping you can sort of quantify the magnitude and maybe share your thoughts. overall views on market tightness, and I guess I ask in the context of several multinationals announcing intentions to grow Permian production in 2021, kind of just wondering what you think associated gas demands could be on either engineered system segment bookings or practically your practical ability to increase utilization of your contract compression fleet beyond?

Well, we're closely reaching almost maximum theoretical utilization of the fleet. Collected wisdom on the fleet is once it gets to 90, over 90%, you're kind of at max because you need some stuff in reserve for your good clients. But as far as margin traction goes, yeah, we don't give out numbers. I would say we've been improving booking margins from several to a handful of points. So I'm going to be kind of vague for you, but definitely that's one of our top priorities for 2022 is making sure that we get the best possible margins that we think we deserve. We think we're one of the best purveyors of this equipment. We feel that our equipment is the best when it's in service, and we feel like we should get more margin for that equipment because of the value it generates for our customers. But the competitive dynamics throughout 2021 kept the lid on that. But when we say meaningful traction, it's several to a handful of points margin that we've seen increase just in the last quarter.

Okay, great. That was all for me. I'll turn it over.

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

Hey, good morning, everyone. Good morning. First question just around, I guess, what you're seeing for demand in terms of bookings and bidding activity in the beginning of 2022. Are you seeing an uptick that I guess would be consistent with, I guess, the optimism around the macro outlook, generally speaking, in North America?

The pipeline is good. It's the best way I can explain it. You know, the geopolitical unrest, uncertainty... doesn't help from that point of view. But the macroeconomic fundamentals in the bigger basins that drive engineered system sales, Permian Basin, Montney, Middle East, and Latin America for us, the fundamentals are all there. The pipelines are good. And we'll see if the geopolitical events that are going on today put a lid on those things or not. It's something we'll be watching pretty closely.

OK. I guess the occurrence of financially structured boom contracts has been increasing, which makes sense under the IFRS 16 guidelines. As we go forward and you see more renewals, is it likely that most, if not all, of those renewals will be accounted for as finance leases?

Yeah, I would say it's likely, Tim. We're going to have to evaluate them one by one. But I think it's likely, and it goes to how we underwrite these projects where we depreciate, you know, the balance of plant over the life of the original contract. So whenever you're getting a renewal, you've got a very low book value on the balance of plant. And so, you know, I think that fact alone makes it likely, but we're going to have to look at them one by one.

Okay. Is there any renewals that you know of that are coming up? in the current year, and can you help us reframe just sort of the size of the renewal picture this year?

Yeah, I think our big renewals are behind us, and so I don't think that we're anticipating anything big in the go-forward picture. I think that with the renewals that we've made that – the boom assets that are on the balance sheet are in really good shape in terms of contract tenure. They're all under really long contracts now.

Okay, got it. I guess once the extern business rolls in, there will be a little bit more renewal activity, I would imagine, just given the contract book in that regard. You guys had a pretty big cash windfall in the quarter related to deferred revenue, which I'm guessing is just milestone payments on some of the projects you have. are going to deliver this year. Can you speak a little bit just about, I guess, the duration of those cash flows that are getting pushed forward?

I think, Tim, you're referring to we had a big uptick on cash on the balance sheet at the end of the quarter. And that was very much related to just the team doing a really good job on collecting cash and and being mindful of when we pay our vendors. It was largely a working capital performance by our teams around the world. I don't think that that is necessarily sustainable. We saw a large amount of cash come in. We're not going to be seeing that going forward. I think we'll probably see that normalize a bit. but that was the underlying driver of the buildup in cash.

Okay, because I saw there was about an $88 million swing in deferred revenue in the quarter.

Yeah, it's predominantly just, you know, as industry conditions improve and as our backlog improves, we've got a little bit more deferred revenue that's on the books.

Okay. I appreciate the details, guys. Let's turn it back.

Again, ladies and gentlemen, if you have a question or a comment at this time, please press the star, then the one key. Our next question comes from Colper with Stifel.

Hi. Morning, everyone. I wanted to start on margins. So, I mean, you gave some good color there. Sounds like we've seen a bit of an improvement, and you have line of sight for a couple more basis points, but I'm just kind of wondering, you know, what's the line of sight in the engineered systems business to maybe get back to a more normalized level of call it 20% to 30%? I mean, could it happen by year end? Is it more of a 2023 event, or is there just too much lack of visibility at this point?

Cole, your 20% to 30% number, we're not going to comment on that. That particular thing. Like I said to Tim a few minutes ago, it's tough to really predict where margins are going. We're trying to get as much as we possibly can. One of the things that kept the margins low in 2021 was it was a compression-driven recovery in engineered systems. And compression is the segment of engineered systems that typically comes with the lowest margins. to the degree that international and gas processing and downstream and petrochemical business formulates a larger portion of the backlog. And those projects are all more complicated. And so they're more complicated. They're a little bit riskier, so they come with higher margins. So the degree that compression is a little bit de-emphasized in the backlog and those other businesses take up a bigger portion, you'll see the margins go higher. We don't give out numbers of where that's going to be. And when you talk about normal margins, it's been a few years since we've had any stretch of time that I'll call normal. So it's so fluid from that point of view. So it's very difficult for us to provide any public guidance on that front.

Okay, fair enough. That's good color anyways. So a strong Canadian engineered systems booking number in the quarter, but obviously segment margins do remain a bit challenging there. I'm just wondering, can you add some color on how you see the outlook for that business?

Canada, the outlook is good. The part that's challenging for us when we think about Canada as a market is that the operators are excellent. Our customers are good at what they do. The regulatory environment is challenging, to say the least. So just when the macroeconomic backdrop opens up with good egress and good fundamental condensate prices and crude oil prices, there are regulatory challenges to getting projects done. You know, we had projects in the quarter that got put on hold. They were either booked or they were in the pipeline that got put on hold by the Blueberry First Nations challenges in that area. So just when the market's getting some momentum about putting good infrastructure in the field, everybody has to stop, you know, and that's not helpful. And so I wish I had a crystal ball to say that Canada's going to be a big growth area for us. There's just too much uncertainty. We hope that it is. We feel like we've got a very advantaged footprint in Canada. We feel like we've got a good position in the market for our core products, our AMS business, and engineered systems, and our ability to do turnkey projects. We think lead the pack in a lot of those areas. So the degree that Canadian producers put infrastructure spending in facilities, we hope that'll be really beneficial for us. But again, it's more of a regulatory concern today than any of the macroeconomic fundamentals. We are really excited about this pilot plant for CCUS we're doing with a major Canadian producer. And that's an example where people are like, listen, the regulatory is uncertain, but we're going to go do stuff anyways because we feel quite certain about what the future of our company looks like. So let's do a pilot project to do CO2 sequestration post-combustion, which is a pretty big deal. And we're really excited about doing that pilot with that customer. So I want to highlight that. But sort of back to regular good old-fashioned gas processing, gas compression, increasing production of gas and liquids. Canada has everything they need to do all that. The only thing that it doesn't have is a real clear regulatory framework, both on conventional development and decarbonization.

Okay, got it. That's helpful. Thanks. And just kind of coming back to your comments on carbon capture, I mean, as we think about remaining hurdles, is what needs to happen next? Is it more of increased clarity on the regulatory angle, or is it more so just working out some of the project specifics?

Canada and the United States and the rest of the world are three completely different conversations. In Canada, anybody doing a carbon capture project today, well, first of all, very few people are spending significant money doing it because there's no value in carbon. Outside of the the Alberta large emitters project, which a lot of our customers don't fall under. Nobody's going to do any projects until there's a price on carbon for emitters that aren't part of the tier program. But people are lining up their toy soldiers to make it work. They're getting people like us to do studies. They're trying to figure out the size of the stuff, the capex. A lot of people have submitted proposals to the Alberta government to secure pore space, which is really the first step. Once they secure pore space, then Once there's a price on carbon that people can bank on, then they'll start doing these projects. There are a lot of dominoes that need to tip over before people start sanctioning large industrial projects in Alberta. We're in the middle of a lot of those, and we want to be. We want to be part of the solution. We think it'll be good for our customers and our shareholders when more clarity comes around. In the United States, the 45Q tax credit, which is currently in law, that pays for post-combustion carbon capture with a modest return, but it is enough for infrastructure companies to sanction projects and start building facilities. So that is where the majority of our real bidding work is happening. We would love to be able to talk about bookings in subsequent quarters for carbon capture facilities in the U.S., but we're not predicting any or providing any guidance to that degree today. So 45Q is good. The extra incentives that are in the Build Back Better plan would be even better if those come through. Canada has a long way to go, and we've been waiting for a long time from the federal government to come out with low carbon fuel standards and come out with some kind of a tax credit or a reimbursable thing for carbon capture and sequestration, but it's just nothing's coming quickly. And it's frustrating for us, and I know a lot of our customers that are ready, willing, and able to start doing these projects.

Okay, great. I appreciate the color. That's all for me. I'll turn it back. Thanks.

Our next question comes from Michael Robertson with National Bank Financial.

Hey, good morning all. Appreciate you taking my questions. Just had a couple follow-ups here quickly. Start with the energy, or pardon me, the engineered systems margins. Good to see the bookings and backlog continuing to trend up. taking a sort of step back and looking at the broader space, do you see your own and the industry's sort of excess capacity getting soaked up? And how do you sort of see that moving forward?

We do. I mean, we're busier in our shops in Calgary and Houston than we were a quarter ago. We can't speak for a competition, but we believe that they are as well. How that stays for the subsequent quarters is not something we we predict or disclose but the macroeconomic fundamentals are positive and the way that producers talk about developing production in the permian and the money shale is positive so we would hope that capacity utilization stays very high going forward and that would lead to better margins for all industry participants got it i appreciate that mark um just uh just one more from me um i suspect it's rather minimal

given that you guys sell globally and, you know, looks like the bulk of the rest of the world segment is focused, you know, Latam and Middle East. But I was just trying to get an idea of what, if any, sort of exposure you guys have with sales into Russia and or Ukraine.

Well, it would, just to make it clear, it's not material. We don't see the Russian invasion of the Ukraine as a material event for Enerflex from a particular sales and revenue streams that we have. it does destabilize the world. And one thing that business loves is stability and predictability. So we're not minimizing the potential impacts of this event. But with respect to business we do in Russia or the Ukraine, it's minimal and not something that we would have to talk about. Really, we stopped doing business in Russia after they invaded the Crimea in 2014. And at that point in time, the Canadian and U.S. governments, which is where a lot of our, you know, we have to follow those laws very closely, They pretty much said stop doing business in Russia, and we did. And so we're following the letter of the law and the spirit of the law. And really, since 2014, we haven't spent any real business development efforts trying to grow our businesses in Russia. So, you know, nothing really there for us. It's just we are going to watch very closely any impacts this has on global oil and gas spending.

Understood. That's great. Great call, Mark. Thanks a lot. Appreciate it. And I'll turn it back.

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

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

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