Enerflex Ltd.

Good morning, ladies and gentlemen, and welcome to the Interflex first quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. Following Interflex's prepared remarks, we will conduct a question and answer session. Instructions will follow at that time. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Stephan Alley, Vice President, Strategy and Investor Relations. Please go ahead.

Thank you, Operator. Good morning, everyone, and thank you for joining us on our first quarter 2023 earnings call. With me today are Mark Rossiter, President and CEO, Matt Lemieux, Interim CFO, and Ben Park, Vice President, Corporate Controller. During today's call, we'll touch on highlights from our first quarter results and provide an update on how we're progressing our near-term strategic priorities. Before I turn it over to Mark, I'll remind everybody that today's discussion will include non-IFRS and other financial measures as well as 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, refer to the advisory statements within our news release, MD&A, and other regulatory filings, all available on our website and under our CDAR and EDGAR profiles. All dollar amounts discussed today are in Canadian dollars, unless otherwise stated. I'll now turn it over to our President and CEO, Mark Roster.

Thanks, Stephan, and thanks to all our listeners for joining today's call. Last night, Enerflex reported results that signal a strong start to 2023 as we continue to de-risk our near-term strategic priorities and realize the benefits of the Xterra acquisition. Headline results included a record quarterly revenue of $825 million, net earnings of $14 million, and adjusted EBITDA of $123 million. a reflection of the momentum we established in our business in 2022. Not only did our large platform of energy infrastructure assets generate significant cash flows, but elevated activity levels within our North American business supported strong financial performance. Our engineered systems bookings reached $517 million in the first quarter, as we maintained our backlog balance of $1.5 billion. Our backlog is an important indicator of future cash flow generation from our engineered systems business, and gives us additional confidence that we are on track to meet our debt reduction target. In addition, engineered systems gross margins continue to expand towards historical averages, including for new bookings in the quarter. We reduced our first quarter SG&A significantly from the fourth quarter of 2022, as we remain keenly focused on improving our cost structure and realizing the overhead synergies from the external acquisition. Operationally, the business is performing quite well across all regions and product lines. As I mentioned in our update at year end, we brought two major infrastructure projects to commercial operation in the Middle East this quarter, growing our current cash flows from the region. We also continue to advance work on the cryogenic facility in Kurdistan, which is expected to be completed in 2024. Today, our infrastructure first business model is rooted in our international operations in Latin America and the Eastern Hemisphere, where the market outlook remains very strong. Key drivers and customer demand, namely energy security and long cycle development, are expected to support healthy activity levels for the foreseeable future. Complementing our international operations is our U.S. contract compression fleet, which benefits from consistently high demand. Average utilization rates reached 96% in the first quarter of 2023, a record for Enerflex. While we continue to observe near-term weakness in North American natural gas pricing, I will remind our listeners that the vast majority of our activity within the region Both our engineered systems and our contract compression continues to be predominantly focused in oil-producing and liquid-rich plays. On the energy transition front, we continue to see strong demand for our product offerings. We secured $95 million of energy transition-related bookings in the first quarter. We also electrified about 7,000 horsepower of compression within our U.S. contract compression fleet. These electric assets provide clear pathways to reduce our customer Scope 1 greenhouse gas emissions. We anticipate continued success in this area. Growing our global energy transition business is a key long-term strategic priority for Enerflex. Looking now at our strategic priorities for 2023, first and foremost this year is about deleveraging and delivering on the cost savings and synergies from the Xterran acquisition. We continue to be laser focused on deleveraging through the course of this year. With construction and commissioning of these large infrastructure projects behind us and the ongoing execution of our sizable $1.5 billion engineer assistance backlog, we are now in a position to harvest free cash flow to strengthen the balance sheet. We expect that strong business performance through the course of 2023 will enable us to meet our debt target of below 2.5 times bank adjusted net debt to EBITDA by the end of the year. giving us additional flexibility to deliver increased returns to shareholders thereafter. Next, regarding the progress we're making in our integration efforts, we've now captured about $50 million worth of the expected $60 million of annual run rate synergies. Most of these synergies relate to headcount rationalization. To further increase operational efficiencies within the business, we will optimize our global manufacturing footprint by closing our facilities in the Middle East and Singapore later this year. Moving forward, we will focus our strong manufacturing capabilities solely in North America to serve the energy needs of our customers around the globe in the most competitive manner possible. Synergies associated with these closures, if any, will be incremental to the synergy figures I've spoken to. I'll now turn it over to Matt Lemieux to speak to the financial highlights from last night's release. Thanks, Mark, and good morning, everyone.

Enerflex's strong first quarter financial results demonstrated the economic benefits of Enerflex as a larger entity with scale and diversity. Our revenues of $825 million were up 20% from the fourth quarter as we saw improvements across each of our regions and product lines. We continue to expand our gross margin, delivering $161 million, or 19.5%, as a percentage of revenue, which included quarter-over-quarter improvements in both our engineered systems and aftermarket services businesses. As we focus on realizing the cost savings and synergies from the acquisition, we reduced our core SG&A significantly in the first quarter. SG&A of $116 million was 34% lower than the fourth quarter and included some integration costs and foreign exchange impacts recognized in the period. Reflecting higher cash flows from our recurring international businesses, increased engineered systems activity in North America and our lower cost structure, we reported adjusted EBITDA of $123 million in the first quarter, up 43% from the prior quarter. We generated distributable cash flow of $55 million, or $73 million when $18 million of integration costs are backed out, using this distributable cash to fund the completion of two large infrastructure projects. During the first quarter, Enerflex invested $51 million in growth capital expenditures and $16 million across maintenance capital and other expenditures. It is important to note that the growth capital invested in the quarter largely represents the final costs associated with the two water projects we brought online. The total cost of these two projects was budgeted for 2022, but there was some slippage into 23, and the growth capital invested in the first quarter was not incremental to the original budget. With these large energy infrastructure projects now online and generating revenue, we plan to prioritize debt reduction with distributable cash flow for the balance of the year. On that note, post-acquisition deleveraging is one of Enerflex's top priorities for 2023. At March 31st, our net debt balance was $1.2 billion, and our bank-adjusted net debt-to-EBITDA ratio was 2.9 times down from 3.3 times at December 31st. To reiterate Mark's comments, we expect our leverage to decrease to below 2.5 times by the end of this year. We will be disciplined in our capital allocation decisions. Lastly, demonstrating Enerflex's commitment to delivering sustainable value to shareholders, our board declared a dividend of 2.5 cents per share last night. The quarterly dividend is payable on July 6th to shareholders of record on May 18th. I'll pass it back over to Mark to deliver his closing remarks.

Our strong first quarter results have demonstrated that Enerflex is becoming increasingly more resilient, profitable, and better positioned for long-term success. We have the geographic counterparty and product line diversity to foster stability within our business. We're capitalizing on the momentum generated by excellent performance in our base business and from the extern acquisition. And we remain committed to delivering on our priorities for 2023, the leveraging and sustainable returns being at the top of the list. I'll now pass the call back to the operator for questions.

Thank you. At this time, we will conduct the question and answer session. As a reminder, to ask a question, you will need to press star 1 1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1 1 again. Please stand by while we compile the Q&A roster. Our first question, comes from Aaron McNeil of TD Cohen. Aaron, go ahead with your question.

Hey, morning all. Thanks for taking my questions. I know you mentioned the debt reduction as a priority. We obviously saw net debt increase sequentially this quarter, and I can appreciate that it's due to a combination of working capital balance changes, front-end loaded CapEx, transaction costs, and the ongoing foreign currency issues and maybe other factors as well. But I'm just wondering if you could sort of walk us through how those items being working capital, CapEx, transaction costs and foreign currency will play out over the balance of the year.

Aaron, this is Mark. We expect transaction costs to tail off throughout the year. We expect growth capex to be lower on a quarterly basis throughout the year. I think that the FX in Argentina is roughly stable. What you've seen this quarter is something we'd be shooting for subsequent quarters, although it's unpredictable. And I think you'd see our ability to put more cash on the balance sheet and reduce total debt will increase throughout the year.

Understood. For engineered systems, margins were up, I think, around 350 basis points sequentially. Is that all just higher pricing flowing through the backlog, or was there a shift in product mix in terms of compression versus processing? And can you give us a rough split of what the contributions were from those two product categories and how you expect that to evolve as the year progresses?

I don't have a specific split between compression and gas processing in the revenue mix for the quarter. But the increase in margin is something we've been signaling to the market now for four quarters. And these are bookings that we got probably six to 12 months ago that we're now hitting POC revenue on. So it's as expected. It's mostly because of increasing activity levels in the overall business and stability in the supply chain.

Maybe I'll just sneak one more in. You've obviously announced the closure of the two facilities, the two manufacturing facilities. Just taking a higher level view, are you now at the point where you think the overall portfolio is where it should be? Or are there other areas of the business that remain under evaluation? And then on the flip side, is there anything that's not in the portfolio today that you would think that would enhance the business overall?

Engineered systems specifically, we are where we want to be long-term. And we've focused our manufacturing facilities between Calgary, Houston, and Tulsa. And we feel with those three facilities, we've got the ability to address the global market needs for compression and gas processing and energy transition solutions. Outside of engineered systems, we will continue to look at simplifying our footprint and and focusing on the biggest growth areas for the next decade. And that work is ongoing, and I expect you will hear us talk about further simplification and further quarters of the overall corporate structure to make sure we've got the most competitive overhead structure from that point of view. I don't have any new products to mention. Our key products are compression, gas processing, and energy transition. And within energy transition, carbon capture, electrification, and some modest RNG and hydrogen business is what we've been seeing. I'm very encouraged by our team in Tulsa that have 30 years history in the cryogenic business, and that's been a really nice addition to our suite of gas-focused products, and that's been real positive. But nothing other than those things. I think we've got the footprint we need. Now it's really a matter of being as cost competitive as possible, increasing our margins as much as possible. And that's about it.

Thanks, Bob.

I'll turn it over.

Stand by for our next question. Our next question comes from Nick Corcoran with Acumen Capital.

Good morning, and congratulations on the record quarter. A couple questions for me. The first is, you mentioned you're on track to being below 2.5 times by the end of the year. How do you prioritize growth capex, return to shareholders, and debt repayment once you get back?

Well, once we get there, you know, we definitely will. Maintaining a conservative balance sheet, considering the nature of our cash flows long term, is the number one priority here. Hopefully forever. I do feel that once we get below 2.5x, we will have the ability to take a closer look at how we can return some of this cash to shareholders via a different view on our dividend. We would want that dividend to both be sustainable and marginally, or I should say not marginally, but growable over time on the back of our energy infrastructure assets. So that's a priority. And once we manage a very conservative balance sheet and once we believe we've been returning cash to shareholders, then we would turn our mind to other priorities.

And you mentioned that there's opportunities to simplify the portfolio. Can you give any indication how that might affect your OpEx going forward?

It would reduce the OpEx. That's the best way of putting it. That's That's kind of the whole point. I mean, it's twofold. The simplification is twofold. One very obvious reason is just to reduce OPEX. You know, whenever you're in a country that doesn't generate a ton of bottom line earnings, there's an opportunity there just to simplify. Strategically, simplifying allows our management teams to focus on the future and really think about the core geographies where we see sustainable growth in natural gas infrastructure and energy transition businesses for the next decade. So it reduces OpEx and it also will allow us to focus on increasing profit margins and revenue going forward. That's the whole point.

And one last question for me. You made progress on reducing the impact of the devaluation of the Argentine peso on the quarter. How much more room do you have to reduce that exposure?

Yeah, thanks, Nick. We did make some progress quarter over quarter. I think later this year we'll have an opportunity to import some equipment and move a little bit of cash out of the region. And so you'll see some further improvement, you know, late this year. And then from that point, you know, I think a lot depends at that far out with this type of situation. It's hard to say, but I think from that point on you'll see us be relatively flat on that metric.

Thanks. We'll pass the line.

Our next question comes from Keith Mackey with RBC Capital Markets. Keith, go ahead with your question.

Great. Thanks for taking my questions here. Just maybe to start off on the engineered systems bookings, the 517 number is certainly very, very strong. And I know you don't give booking guidance, Mark, but can you just give us an idea of what you think the shape of this booking cycle will be? Is it a Is it a sharp peak that you think you've already hit and now bookings will kind of slow down? Or do you think there's several more quarters where you could deliver a similar type of bookings number that you did in Q1?

Hard to predict the future, Keith, in engineered systems. There's a lot of things about our pipeline that make me very optimistic that our bookings will remain strong throughout the year. We definitely are keeping our eye on the price of natural gas in Canada and the United States. Like we said in the prepared remarks, we're quite strong in the Permian and the Montney, and those are very oil-focused or liquids-focused plays. And our operators, their interest in new equipment has been resilient despite the drop in gas prices, but we're keeping a close eye on it. So I would hate to tell you what the shape of our bookings going forward are going to be. We've got this increased footprint. We've got increased capabilities. Fundamentally, the products we have to offer our customers are different than they were a year ago or even three or four years ago. You know, something that's different with Enerflex is we used to be pretty heavy compression with the side of gas processing, if you will. I feel like we're a market leader in gas processing. Our carbon capture solutions and electrification, I also believe are market leading. and our compression opportunities are still best in North America, in my opinion. So we've got a larger suite of products. We address different customers in different markets, and we'll see where it goes. But you're right, we don't provide guidance, and we're keeping a close eye on the macro, but I feel quite positive about it.

Got it. Thanks for the color there. Just to turn to energy infrastructure, so the cash gross margin – Q1 was around 55%, which is sort of towards the lower end of your longer term, 55 to 65 sort of target. Can you give us some comments on how you think that margin might progress throughout the year? Certainly the U.S. contract compression business has been very strong with 96% utilization, and there's some projects coming online, you know, that that came online later in Q1 and now in Q2. So how should we expect the margins to trend in that segment relative to the 55% to 65% target throughout the year?

Yeah, thanks, Keith. As you said, the gross margin is still within our typical range. Some of the assets that we acquired through the exterior transaction were at a little bit lower gross margin than what the Enerflex Energy Infrastructure Portfolio experience in the past. We're working hard to improve those margins over time. It's a combination of blocking and tackling and being a good operator, as well as taking a look at harmonizing prices between the two companies. I think you'll see us improve that metric over time, but it does take us a few quarters to rationalize that and get back on track.

Got it. And just finally for me on the annual outlook, so certainly a strong quarter for EBITDA guidance or EBITDA in Q1. How do you think about your annual guidance? Are you still comfortable in that number or, you know, one of the questions we get asked is, you know, after a strong quarter like this, why not raise guidance? And certainly there's a lot of year left to go, but how are you thinking about you know, your confidence in your guidance range for EBITDA for 2023 right now?

We like where we're at, Keith. I can understand the sentiment from some foreigners. Why wouldn't they increase it? We like where we're at. We've got the backlog to support it. We've got visibility to engineer systems for the whole year. We've got visibility in our energy infrastructure and aftermarket service for the whole year. And we looked at all that in the corridor and maintained our guidance. So that's where we're at. We're quite comfortable with that. And our number one priority is delivering on all those aspects of the guidance provided in the investor deck. Perfect. Thanks very much.

Our next question comes from Cole Pereira with Stifel. Cole, go ahead with your question.

Good morning. I just wanted to start on the debt reduction and shareholder returns. So your bank-adjusted covenants are starting to get fairly close to your target. However, the prior exterrin EBITDA is also included in that, and you haven't really repaid any debt. So how do you really think about balancing reaching that target and making actual tangible debt reduction before you start returning more to shareholders?

Yeah, cool. This is Mark. Our number one priority is hitting the two and a half times. Once we hit the two and a half times, then we have to look at further debt reduction and return of cash to shareholders at the same time and understand what our business model looks like and what the market looks like and make some smart decisions on that front. Maintaining a long-term conservative balance sheet is the number one priority forever. And so I'm not going to give you a lot more specificity beyond that, other than just I would like investors to know conservative balance sheet's number one, return of cash to shareholders is second to maintaining a conservative balance sheet.

Okay, that's great, Collar. And Mark, can you talk a bit about how you see the carbon capture market evolving in the U.S. with all the regulatory support and how the pipeline for that business is looking for you?

Well, the word that comes to mind when I think about carbon capture in the United States is entrepreneurial. That the U.S. government has definitely put in a framework to allow entrepreneurial people to develop projects and start sequestering CO2 right away. We benefited from over $150 million of the bookings in 2022 because of that entrepreneurial dynamic. I think that a lot of people will have read that getting the sequestration rights is taking a little bit longer, like actually getting the wells permitted to do the injection is taking a little bit longer depending on what state you're in than a lot of our entrepreneurial clients would like. But there's definitely forward motion and you got business models that have revenue streams that are financeable and developable. And that's why we've seen so much actual orders for real business in the United States and much less in Canada. In Canada, people are doing CCUS. The forward-thinking, progressive operators are doing it because they have their own carbon targets to meet, even if there's not a framework to make those investments profitable on a dollars basis to their shareholders. So we're doing work in Canada. It's more like pilots, smaller projects, helping people plan out how they're going to do it once there's more certainty around the around the business model. But I'll go back to the United States, super entrepreneurial, lots of great development teams. A lot of them are the same people we worked with when we were building infrastructure throughout the shale basins, you know, from 2010 onward. So it's people that we know. It's similar business models. It's underpinned by a really robust regulatory framework, and we expect it to continue in subsequent quarters for sure.

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

Our final question will come from Tim Monticello with ABT Capital Markets. Tim, go ahead with your question.

Hey, everyone. So just to follow up on Cole's question there, Mark, you mentioned $95 million energy transition-related bookings in Q1. Was that all related to CCUS?

No, it wasn't all related to CCUS. I'd like to say we're a market leader in electrification of the oil and gas field, and so there's quite a bit of electrification opportunities in there.

Can you say what the CCUS number might have been?

No, no. They're just energy transition bookings.

Yeah. Okay. I'm curious if you could give a little bit of an update on Xterion's water solutions business, how that's fitting into the portfolio and what you're seeing from opportunities.

It's fitting in quite well. The two projects that we completed in the first quarter, operations have been 100% integrated within our Eastern Hemisphere overall operations. So that's been a real positive. The P&L is being managed by the Eastern Hemisphere Business Unit. And our water business, which is filled with talented engineers and project managers and VD personnel, are looking at what the next project's will be. And that will be a mixture of infrastructure in North America and the Eastern Hemisphere. So it's fitting in quite well. Even though it's water, not gas, it's pipes, it's pumps, it's tanks, it's project execution, it's field operations. So way more similarities than differences when you look at water within our overall natural gas and energy transition portfolio. And it really fits quite well. Same customers too. It's The customers we do water for are the exact same customers that we're doing natural gas and energy transition solutions for.

So if Sharon would have characterized that offering as one of their highest return product lines, do you see it the same way?

They're definitely holding their own within our suite of energy infrastructure projects, no doubt about it. And we're not going to start delineating between the two businesses publicly. It's just part of energy infrastructure. I definitely like the nature of the contracts. I like our success in operations, and I like the pipeline of new opportunities.

Okay. That's really helpful. And then I just wanted to follow up a little bit on the bookings trends in North America particularly. You mentioned that you've been watching natural gas prices, though. Natural gas prices have been sort of sub-economic for at least a couple quarters here. and your bookings continue to rise, and obviously there's a little bit of a lag in your oil basins. But are you seeing longer lead projects come to fruition within the bookings, like longer-term gas processing projects, and that's why you're seeing that lag? Or is there an aspect to it as well where you're seeing some revenue synergies from the transaction and you're getting better market penetration? I'm just wondering if you can kind of speak to that whole dynamic.

On the revenue synergy front, our ability to talk to customers with a really excellent cryogenic gas processing business and experience is definitely helpful. Canada's been much better the last two quarters than it has been maybe for four or five years on new equipment. And I think that Canadian midstream operators have all been quite public in their plans of increasing their infrastructure to support Montigny Shale and and LNG export production increases from the big gas producers in Canada. So that's good. Canada's sort of back, if you will. Canada's back is from a bookings point of view for both compression and gas processing after a number of years that were less ideal than what we saw in the United States. In the United States, frequently our bookings will track gas production increases, not necessarily gas price. And a lot of gas production increases come from oil drilling in oil-rich plays that have associated gas. So that's the dynamic we're seeing. We would love for our customers to be making a lot more money off the gas. We don't like it to be sub-economic. But the majority of our customers in the last number of quarters are people that are gathering gas to enable production of shale oil in those basins. So we're going to keep an eye on it. Sub-economic gas prices for now do not appear to be crimping exploration, especially in the Permian Basin and the Montnichel, and that would be reflected in our own pipeline conversations with our customers.

Are you starting to see some demand pull from LNG export facilities that are supposed to come online in the Gulf over the next couple of years?

I guess so. It's hard for us to draw direct lines between those things. If we think about market sentiment, I think that the LNG, the ability for people in the United States to build Gulf Coast LNG facilities is a really strong demand positive sentiment. And where there's strong demand positive sentiment, people just continue to drill and put gas on line. So that's all positive. I would say there's a more direct correlation between Canadian bookings and LNG Canada. You can sort of look at who's got capacity in LNG Canada, how much are they producing today, how much do they have to add to meet those commitments, and we can draw a pretty direct connection between those dynamics and orders we've received in the corridor. So in the U.S., I think LNG is a general positive sentiment, and Canada, with the Blueberry First Nations restrictions, at least providing clarity for developers. We've seen that pick up because people have to get after it, if you will, after a number of quarters of sitting on the sidelines waiting for more clarity from that point of view.

That's interesting. So in Canada, then, can you talk a little bit about the trend related to the, I guess, LNG-related bookings? Is it first inning, second inning kind of thing?

I think we're in the early innings. Our Canadian bookings have been positive the last two quarters, and we expect that to continue. If you look at the big midstream operators' public results just this quarter alone, many of them are talking about the need to add incremental infrastructure in Canada to support this gas production growth. And that's good for us, and we hope that that continues over the next year or more.

Okay. And then last one for me, I just wanted to get a little bit of an idea of the process that went into thinking about shuttering the UAE and Singapore facilities. Obviously, Xterra thought it was beneficial to have those facilities in his portfolio. So what are the gifts and takes there?

I mean, the most important thing for us to do is to Set up our engineered systems infrastructure to provide the most consistent, steady load in facilities. Any manufacturing facility operates best when it's busy. So our number one priority was to find out what facilities have the best opportunity of being busy long term. Engineered systems in North America is a decades-long business that is supported by a lot of transactions. In the Middle East and Singapore, it was definitely lumpier, if you will. So we would get great contracts, and those facilities are staffed by really talented people that did a very good job of it, but the consistently high loading, like 75% or higher, that the manufacturing facility really wants to operate at the highest possible margin, it was tough to get that out of those facilities long term because the market is just more of a lumpy, big project market. We are not giving up on the market. We're simply going to address that market from the three facilities in North America that will have this base load of North American business, and they'll be more than capable of handling the bigger international projects when they come. The overall cost basis goes down. Your ability to get higher margins goes up. And so that was the strategic logic behind it. And, you know, we looked in detail about the specific costs facility by facility, and they were all quite close. But the overarching was which facilities can stay the most steadily loaded and drive the overall fixed costs as a dollar of revenue down as far as possible. And that's where we ended up with the North American shops.

Got it. I really appreciate it. I'll turn it back.

That does conclude our Q&A section. I'd now like to turn it back over to Mark Rossiter for closing comments.

But no further questions. I want to thank everyone for joining us today. We appreciate your interest in InterFlex. We look forward to connecting with you again in August, and may the 4th be with you.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.