Enerflex Ltd.

Good morning, ladies and gentlemen, and welcome to the EnarFlex first quarter 2022 results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct question and answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded. I would not like to turn the conference over to your host, Stefan Ali, Vice President, Strategy and Investor Relations. Please go ahead.

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 March 31, 2022, 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's 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 stated, we'll be referring to the three months ended March 31st, 2022, compared to the same period of 2021. 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. We are pleased to report a successful first quarter and continued positive momentum across our business. Our ability to secure higher volumes of work in recent months is a function of robust supply and demand fundamentals in the oil and gas industry, where ongoing strength in commodity prices, improved balance sheets of our customers, and a renewed focus on energy security led to quarterly engineered systems bookings of over $230 million and grew our backlog for a fifth consecutive quarter. Increased industry activity is a first step towards normalizing engineered systems gross margins, and as a result of recent bookings, activity, we've generated a quarter-over-quarter gross margin improvement of 200 basis points in our manufacturing business, despite increased supply chain pressures. While we're cautiously optimistic about the trajectory of the recovery, we continue seeing many of our customers maintain their commitment toward capital discipline, and there remains some uncertainty in predicting the impact of geopolitical events on the global energy landscape and pace of energy development across our regions. Our recurring revenue businesses delivered stable, predictable contributions to our overall performance. Aftermarket service business continues to recover from the downturn and is expected to do so throughout the year, though we'll be contending with broad-based OEM supply chain challenges on the timely delivery of spare parts, along with inflationary operating cost pressures. Our energy infrastructure business continued its strong performance. Improved activity within key U.S. basins drove demand for our U.S. contract compression fleet, which grew to 405,000 horsepower during the quarter and maintained an average utilization of 91%. In our rest of world segment, our assets continued to perform as expected. We commenced operations for a 10-year natural gas infrastructure asset in early January and progressed another 10-year infrastructure contract that was awarded to Enerflex during the fourth quarter of 2021. Collectively, these assets reinforce our strategic goal of generating long-term stable cash flows. Overall, I am proud of our team's efforts to keep our assets performing to the benefit of our customers and stakeholders. In our energy transition business, we continue progressing several opportunities across the carbon capture, renewable natural gas, and hydrogen spaces. We are also seeing continued demand for electrified solutions across multiple regions. which are helping our customers eliminate Scope 1 emissions from their operations. Constructive public policy support will assist in promoting investment in this emerging market, which should benefit Enerflex in the coming years. Lastly, we continue to progress all necessary matters to close our all-share acquisition of Exterin that was announced in January of 2022. A number of regulatory approvals have already been obtained, and we are currently not aware of any reason that would prevent us from obtaining the remaining approvals. As we progress our pre-integration planning work, we are increasingly excited about the strategic fit of the two companies, the support of macroeconomic fundamentals for global natural gas production growth, and the support received by the market. Upon closing, this transaction will 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 will now turn the call over to Sanjay Vishnoy to review our financial results. Thanks, Mark.

First quarter revenue of $323 million increased significantly versus the prior year period from a combination of higher engineer systems revenue on stronger bookings in recent periods revenue recognition on a previously announced 10-year natural gas infrastructure project, higher utilizations on our energy infrastructure, and the increased volume of work across all segments. Booking's momentum continued in the quarter, totaling $237 million, up significantly from $99 million in the same period last year. Our engineered systems backlog exited the quarter at $620 million which is over three times higher than the backlog at March 31st, 2021, and provides a healthy backdrop for 2022. During the quarter, management completed its continuous review of how expenses are classified. Following this review, certain expenditures were reclassified between cost of goods sold and SG&A. Although the reclassification has no impact on net earnings in prior periods, This change provides more relevant information to users of the financial statements and better reflects the costs that are directly attributable to the production of goods and the supply of services. The resulting gross margin was $54 million or 16.6% for the first quarter of 2022 compared to $45.5 million or 22.4% for the comparable period. The lower gross margin percent in the current quarter is primarily due to a shift in the product mix, less government grants received, and competitive pricing pressures on material and labor. SG&A costs of $46.8 million in the first quarter of 2022 were up from $38.5 million in the same period last year. The increase is primarily due to the transaction costs associated with the pending extern transaction and the reduced cost recoveries from government subsidies. These increases are partially offset by lower share-based compensation. During the quarter, we invested $29.2 million towards construction of a natural gas infrastructure asset that was awarded in the fourth quarter of 2021 and which will be accounted for as a finance lease. We also invested $2.5 million of capital primary primarily towards units in our USA contract compression fleet, which has grown to approximately 405,000 horsepower. From a capital allocation perspective, 2022 growth CapEx will continue to be limited to the funding of in-flight projects and those opportunities satisfying stringent investment criteria. With respect to liquidity, Enerflex has $133 million of cash on hand and access to $672 million on our bank facility. giving us ample liquidity to fund our required investments in working capital and capital assets. We continue to maintain balance sheet strength, exiting the quarter at a bank-adjusted net debt-to-EBITDA ratio of 1.43 times. 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 2.5 cents per share to be paid on July 7th, 2022. This completes the formal components of the webcast. Additional details can be found in our May 4th press release. We will now be happy to take any questions.

Ladies and gentlemen, if you have a question at this time, please press the star and then the number one key on your touchstone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Your first question comes from the line of Michael Robertson with National Bank Financial. Your line is open.

Hey, good morning all and thanks for taking my questions. Given the noted increase in volatility of raw material pricing and availability, Are there any initiatives you've implemented in order to try and, you know, firm up pricing or delivery dates from suppliers to help solidify your targeted timing and margins? And I guess, are there differences in your approach, whether it's, you know, parts for the service segment or, you know, components for larger scale projects?

Yeah, Michael, this is Mark Rosser. Thanks for the question. I'll take that. Dealing with supply chain is probably issues number one, two, and three for the professionals in our engineered systems business and the aftermarket service business. And there are different strategies in both those businesses. But by and large, it's mostly about being extremely nimble and fast-acting when we hear news in the supply chain and also having relationships with our customers that allow us to pass on those unforeseen cost increases as effectively as possible to those clients. In engineered systems, frequently when we close a job, we get the opportunity to update all the prices of the major equipment before we accept the order, and that can lock in 80% or more of the overall cost base, and so that mitigates some of those issues. In the service business, spare parts that go with projects, they're frequently quoted right at the moment. We know exactly what we can buy them for. Some of the downward pressure in our AMS business margins in the quarter was due to some other things like fuel costs, a little bit of Omicron wave that had our people at home. And the biggest issue in AMS is just waiting for parts. So if we have technicians ready to go perform a service job and they don't have the parts, then they sort of have to sit around until they show up, and that leads to some inefficiency.

Got it. Got it. That's a really helpful color mark. I appreciate it. Just one other one for me. I was wondering if you've seen an impact in terms of inbounds or sentiment in Canada. on potential CCUS related opportunities following the CCUS investment tax credit in the federal budget?

I don't think we've seen, we had a lot of inbounds on CCUS prior to the announcement. There's a lot of oil and gas customers especially that have been looking at how to decarbonize themselves for over a year now. And so the investment tax credit, I don't think sped up those conversations significantly. That's my take. Sanjay, do you have a different take on that?

Yeah, I think maybe echoing Mark's comments, we already felt like we had a pretty healthy set of dialogue going with those customers, and I think that investment tax credit, certainly from a finance guy's perspective, it's going to be very helpful to get these projects closer to actuality, but we think that we were already having some pretty high-quality dialogues before the budget.

All right, that's great stuff. Encouraging to hear. I'll jump back in the queue. Thanks for taking my question.

All right, your next question comes from the line of Aaron McNeil with GD Securities. Your line's open.

Hey, good morning, all. Thanks for taking my question. I'm wondering if you could provide any details or anecdotes on your preliminary steps on integration with Xterrin. I appreciate there's not Probably a whole lot you can say, but maybe you can give us a sense of what you've done to date, what's still outstanding, and if you're more or less confident in your synergy target and 2023 guidance.

Aaron, thanks for the question. After we made the announcement, we had integration teams established at Xterra and Interflex, and to the degree that we're allowed to do pre-integration planning, we've been doing it. along a lot of strategic and also functional lines, and I'm quite pleased with the progress the teams have made to date. We're still competing in the market. We're still two independent companies, and we're competing against one another in all the regions within which we operate, so there's some limits on how much integration planning we can do, but within those limits, I'm quite satisfied and quite happy with the progress that's been made.

Okay. With This one's probably for Sanjay, but with respect to the high-yield offering that you intend to pursue at the close, were the ratings you obtained from S&P and Fitch in line with your expectations? And are you at all concerned with your ability to obtain high-yield debt at a reasonable coupon given the rising interest rate environment?

So I'll take them one by one, Aaron. The ratings were very much in line with where we thought things would shake out. No surprises there. I would say in terms of the high-yield market, it's something that we're monitoring quite closely, and I would say that interest rates, as everybody knows, have gone up, and that's a bit of a headwind, but I would say that the tailwind that we're getting is the macro fundamentals around energy and oil and gas in particular. And so you've actually seen some strength in oil and gas-related issuances in the high-yield market. And so we still think that it's a very constructive market for the offering that we are going to bring to market, and we're really waiting to get through some of these regulatory approvals and other conditions and then ready to go to the market once the time is right.

Understood. Maybe since your prepared remarks are so quick, I'll sneak another question in. Just wondering if you can speak to your involvement with the Meadowbrook CCUS Hub. I know it's early days, but can you give us a sense of timeline, what your involvement might be, both from an operational and capital perspective?

Yeah. No, we're delighted to be working with the Bison team and with our partners on that project. Our involvement is really primarily because we want to be doing, as stewards of the industry and proponents of carbon capture here in the province of Alberta, we want to be doing everything that we can to be supportive to the industry. We thought it was a neat project. We like the management team. We like the partners. We're happy to be part of a solution that's moving to the next phase, which is going to be really an evaluation phase. But delighted to be part of that story.

So you're in an evaluation stage, but what might a commercial timeline look like?

How might you actually be involved? Yeah, no, we'll be a part of the consortium. I mean, that's how we are participating in that project. We're not the operator of that project. We have a non-operating minority investment in it. And we continue to expect to be involved in that capacity. And yeah, I think part of the evaluation phase, which is really, when I say evaluation, it's really that's how Alberta Energy has sort of couched the next phase, is that we have to do some evaluation work and some test wells to evaluate the formation and the safety of the formation as well. And so beyond that phase, you know, during this phase of it, we'll be generating a more, you know, detailed sort of idea of how the capital of the project will unfold. So probably early for us at this point to be commenting on the capital commitment to the project, but we'll certainly keep the market appraised as that develops.

Understood. Thanks for taking my questions. Turn it over.

All right. Again, ladies and gentlemen, if you have a question at this time, please press the star and the number one key on your touchstone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Your next question comes from the line of Cole Pereira with Stifel. Your line's open.

Hi. Good morning, everyone. I wanted to start on the U.S. engineered systems margins. I think We're all aware of the margin pressures and obviously work mix is a consideration as well. But I mean, you know, from your commentary, I do get the sense that you should see an improvement in that metric over the next few quarters. Is that fair? Acknowledging there is some uncertainty, obviously.

That's fair, Cole.

Okay, perfect. And, you know, on the supply chain front, as you think about potential impacts from the COVID shutdowns in China, do you think the worst has passed? Do you think it could get worse, or do you think there's still not enough visibility? And you commented on the USES side. You can pass through a lot of the costs. So is it more the risk in terms of timing and logistics of inputs, et cetera?

Colin, in February 2020, I predicted COVID was not going to be a big deal. So I'm not going to predict anything about COVID, hopefully, ever again. It's difficult for me to really – really consider how the shutdowns in China will impact our supply chain. Almost every one of our projects that goes out the door has a control system on it that's got a computer chip in it. And so that's one sort of commodity that's been challenging over the last couple of months. How the Chinese shutdowns specifically impact our supply chain going forward is difficult to predict.

Okay, got it. Yeah, that's totally fair. Just quickly on the Mexican exterrin lawsuit, I'm wondering if there's any additional details you can provide just on how exactly it occurred. I mean, I acknowledge it's a complicated jurisdiction, but I'm just surprised that any termination lawsuit would have a $120 million payout, which obviously helps support that it was made in error.

Yeah, cool. This is Sanjay. I think we would point you to... Exterins 10-Q, this is an issue that the Exterin management team has been managing, and I think they've articulated some of the things that you said, which is they believe there's a calculation error and they believe that it's not material.

Okay, got it. Thanks. And just quickly, on the closing of the acquisition, any additional guideposts you can add? I mean, Do you think it could be late Q2, early Q3, late Q3, or is there just still not enough visibility at this point?

Yeah, so we were optimistic that we could get there in Q2. We don't believe that we can in Q2 anymore. What we can tell you is that we're very happy with the way the teams are working together. We feel like we've got really good dialogue with the externe team at all levels, like from the C-suite down to the working level. And, you know, so we're working diligently and as fast as we can. We're hopeful that we can get to close in Q3, but that's really, I guess, we'll have to wait and see how things unfold on the regulatory side of things and the other conditions that we're trying to satisfy.

Okay, great. That's super helpful. I'll turn it back. Thanks.

Your next question comes from the line of Team Monicello with ATB Capital Markets. Your line is open.

Hey, good morning, everyone. Just a follow-up question to Coles on the labor dispute in Mexico. Regardless of how unlikely this is to be material, and I think it probably is unlikely, Is that a hurdle that you need to get over before you can close the transaction?

You know, I guess what I would say is that on the issue itself, really, we are operating as two separate companies right now because we have to. And so I would point you to Exterin's disclosures on the subject. And from a deal timing perspective, it's really – We're very focused on clearing the regulatory hurdles that we've got in front of us. We did get some comments back from the SEC. They're down the fairway comments. They are going to take a little bit of time just to process them, but we think there's really nothing of concern in those comments. So we're really focused on clearing those regulatory hurdles, lining up shareholder votes, and getting to close, we believe, hopefully in Q3, but in the second half of 2022.

Okay, so you don't need to see a formal resolution to this matter before you can close the deal, or that you'd be comfortable closing a deal with this still serving limbo?

Yeah, we're currently monitoring the situation, Tim, and I think that's where we would leave it here today.

Okay, and then second question. We saw bookings come down in Canada, and there's a little bit of a cautionary statement just around slowness in demand related to egress capacity constraints. Can you talk a little bit about the Canadian market and what you're seeing for demand on the increment there?

Tim, this is Mark. We're seeing customers in Canada that want to do work, and they're getting out in front of a lot of the CapEx spend with engineering work, with detailed pricing, with sort of lining up supply chains with us in a really collaborative manner. We're optimistic that Q2 forward in Canada will be a more positive story on the bookings front. That's what we're hoping for, and based on the conversations we've been having with customers, we believe the addition of infrastructure into the Western Canadian 7-metre Basin should be more significant in the coming quarters than it was in the last few. Okay.

And then last one for me just on service margins. Obviously, those came down in the quarter, but you guys have been dealing with supply chain issues for the better part of the last year, maybe the full year. So what changed in Q1 that brought those margins down, and what's the outlook for service margins going forward here?

Yeah, in Q1, there was kind of an acute parts issue from a number of our suppliers from a delivery point of view. So we had been managing supply chain like everybody has been for a year. But in the quarter, for one or two of our key suppliers, they had a particular challenge getting parts to us on time. And that impacted our AMS business globally. I would say a little bit more locally. We had Omicron issues in our North American businesses in January that had a lot of our technicians in the sidelines, which was too bad. But we think that's behind us. I'll reiterate that that margin we turned in at AMS for the quarter is not what we're looking for. We really expect it to return to upper teens numbers, which is traditional in short order.

Okay. That's very helpful. Thank you.

All right. I'm showing no further question at this time. I would now like to turn the conference back to Mark Rossiter.

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 second quarter results in August.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.