Enerflex Ltd.

Thank you for standing by and welcome to InterFlex Third Quarter 2023 Earnings Conference Call. At this time, all participants are in listening mode. After the speaker's presentations, there will be a question and answer session. To ask a question at that time, please press star 11 on your telephone. Please be advised that today's call is being recorded. I will now turn the call over to your host, Mr. Jeff Federley, Vice President, Corporate Development and Investor Relations. Please go ahead.

Thank you, Valerie, and good morning, everyone. Welcome to our third quarter 2023 earnings call. With me today is Mark Rossiter, President and CEO, Preet Dhinza, Interim CFO, and Ben Park, Vice President, Corporate Controller. During today's call, we'll touch on highlights from our third quarter results and provide an update on guidance and how we are progressing on our near and long-term strategic priorities. Before I turn it over to Mark, I'll remind everyone that today's discussion will include non-IFRS and other financial measures as well as forward-looking statements regarding Interflex'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 Plus and EDGAR profiles. All dollar amounts discussed today are in Canadian dollars. With that, I'll turn it over to our President and CEO, Mark Rossiter.

Thanks, Jeff, and thank you all for joining me on this morning's call. Last night, Enerflex reported its third quarter 2023 results, which reflect the significant progress we're making in advancing our strategic priorities, including the continued integration of Exterin. Our recent results and progress to date also underscore that we have more work ahead of us to unlock the full potential of our combined company. Our global footprint, expanded product offerings, and deepened ability to serve the energy value chain is generating operational results that are less influenced by the economics, rig counts, and commodity prices of any single region or producing basin. During the first nine months of 2023, approximately 60% of Enerflex's gross margin was generated from recurring sources, and markets outside North America contributed 43% of the company's total gross margin during the same period. I'm pleased to report that we delivered strong operating results across all of our geographies. Integration and synergy realization activities related to the Exterin acquisition remain on track. Since closed Exterin has captured approximately $50 million, sorry, Enerflex has captured approximately $50 million U.S. of annual run rate synergies and expects to realize the remaining U.S. $10 million for a total of U.S. $60 million of anticipated synergies within the next six months. In addition, the company continues to review opportunities to optimize its geographic footprint and business platform. To this end, we are in the process of consolidating our global manufacturing facilities from five to three, and in the early part of the fourth quarter, completed the sale of two non-core assets for gross proceeds of approximately $40 million. We expect these actions combined with additional optimization efforts will drive cash flow, enable continued debt reduction, and enhance our ability to generate shareholder returns over the mid and long term. Touching briefly on the quarter, Interflex delivered adjusted EBITDA of $122 million and operating cash flow of $71 million, demonstrating the strength and continued momentum from our occurring businesses as well as the North American Engineered Systems product line. We recorded strong engineered systems bookings in the quarter of $560 million, bringing our year-to-date total in the first nine months of 2023 to $1.4 billion, an increase of approximately $500 million year-over-year. Our bookings reflect demand originating from three continents and highlight robust customer activity levels, particularly in North America and notably for cryogenic and low-carbon solutions. Our bookings during the first three quarters of 2023 include $153 million for cryogenic projects outside of North America and US $111 million related to projects that advance our energy transition business strategy. A record engineered systems backlog of $1.6 billion provides strong visibility into revenue generation and business activity levels for 2024. Energy infrastructure contributed approximately 40% of gross margin during the quarter. This business is generating stable results, and we continue to evaluate opportunities to maximize performance across our geographic platform. Our U.S. contract compression fleet is operating at high utilization rates of 93% in the quarter. The aftermarket services business is benefiting from increased activity levels, inflationary price adjustments, and continued strong demand for spare parts. We remain committed to enhancing our financial position and repaid $41 million of long-term debt in the quarter, which is consistent with our focus on strengthening the balance sheet and enhancing the company's financial flexibility. However, our reported long-term debt declined by only $5 million in the quarter due to the negative impact of a strengthening U.S. dollar versus Canadian dollar. On today's call, I also have the pleasure of introducing Preet Dhinza, who we announced as our interim CFO last month, and Jeff Federley is our new VP of Corporate Development and Investor Relations. Preet is a seasoned financial leader with more than 25 years of experience primarily in the energy and financial service industries. He brings a proven track record of leading large international finance organizations, including through post-merger integration activities. Jeff is well-known to many listeners as a well-regarded thought leader in energy equity analysis. I'm excited to be working with Jeff and Preet at this important time for our company, and am confident that their experience will serve Enerflex shareholders well. Before I turn the call over to Preet, I'd like to emphasize that the underlying macro drivers for our business are robust, with the ongoing focus on global energy security, the growing need for low emissions natural gas, resulting in a strong demand for Enerflex's energy infrastructure and energy transition solutions. As customers aim to decarbonize their operations, Enerflex is poised to capitalize on the growing demand for sustainable energy infrastructure through our vertically integrated natural gas, produced water treatment, and energy transition offerings. With that, I'll turn it over to Preet to speak to the financial highlights of the quarter and provide an update on Enerflex's outlook for the balance of 2023 and 2024.

Thank you, Mark, and good morning, everyone. I am excited to step into the CFO role during a pivotal time for Enerflex. I've hit the ground running to support the strong global finance team as you work to ensure the company has financial stability and flexibility through industry cycles. Our consolidated third quarter revenues of $778 million were driven by continued strong performance from Enerflex's recurring businesses and North American engineered systems product line. Enerflex's gross margin was $146 million or 19% of revenue, comparable to Q2 2023. Energy infrastructure gross margin decreased quarter over quarter to 30%, primarily related to higher depreciation. Engineering systems, our gross margin improved to 15% as we executed a higher margin backlog. Our aftermarket services gross margin was 17% in Q3 2023, compared to 20% in the prior quarter, reflective of sales mix that include a higher proportion of part sales compared to most recent quarters. Enerflex's SG&A of $115 million increased by $15 million over the second quarter, which is largely driven by a one-time bad debt recovery of $12 million, does recognize in the second quarter. Transaction, restructuring, and integration costs were $6 billion in Q3 compared to $12 million in Q2. We do expect to see additional costs for restructuring and optimization, although, as Mark mentioned, Integration and synergy realization activities remain well on track. This brings me to our adjusted EBITDA of $122 million in the third quarter. Included in adjusted EBITDA are foreign exchange losses of $17 million during the quarter related to the devaluation of the Argentine peso. We continue to actively manage this exposure and generate $11 million in offsetting gains from associated instruments. The majority of this amount is reported in net finance costs and excluded from the adjusted EBITDA number we reported. Excluding the impact of foreign exchange, our business in Argentina continues to perform well and generate strong operating cash flow for the company. Enerflex also continues to manage foreign exchange volatility with the majority of exposure to the R2T Basel offset by associate instruments. Cash provided by operating activities was $71 million in the quarter, which included a working capital recovery of $15 million. Comparatively, in the second quarter, cash used in operating activities was $4 million, a $75 million positive swing Q over Q. We invested $26 million in capital expenditures, including $8 million in maintenance capital across the global energy infrastructure fleet and returned $3 million to shareholders through dividends. InterFlex's primary focus for 2023 is to progress the integration of Exterin and strengthen our financial position. During the third quarter, we repaid $41 million of long-term debt, although reported long-term debt declined by only $5 million, including the impact of a strengthening U.S. dollar. We reduced our bank-adjusted net debt to EBITDA ratio to 2.7 times at the end of Q3 from 3.3 times at the end of 2022. and we are on track to achieve a ratio of slightly less or less than two and a half times by year end 2023. We are reaffirming all of our full year 2023 financial guidance as last provided with our second quarter results. We anticipate adjusted EBITDA as currently reported to be at the low end of this guidance range, inclusive of the impact from volatility in foreign exchange markets, specifically Argentina. Please note, foreign exchange losses of $41 million during the nine-month end of September 2023 related to devaluation of the Argentine peso is included in our adjusted EBITDA. We continue to target total 2023 PP&E and growth capital expenditures of $80 to $90 million, which includes two large water projects that were commissioned in the first quarter and various small-scale customer sanction projects in the U.S., Latin America, and Eastern Hemisphere. Heading into 2024, we expect our performance to be underpinned by recurring energy infrastructure and aftermarket services product line and a robust engineered systems backlog. Enervex is targeting a disciplined capital program in 2024. Consistent with our current focus, we will continue to prioritize debt reduction, synergy realization, and operational efficiency. The company continues to review its target long-term capital structure and capital allocation parameters, and we expect to provide more clarity in the coming months. Finally, Enerflex is committed to delivering a sustainable dividend to shareholders with our board declaring a quarterly dividend of 2.5 cents per share. The dividend is payable on January 10 to shareholders of record on November 21. Before I turn over to Mark, I'll conclude by saying that within the support of Enerflex's strong leadership team and talented employees, we are improving the profitability and resiliency of the global business with an objective to generate sustainable cash flow. I am excited to have joined this team and to help unlock the business's full potential for the benefit of our shareholders, customers, employees, and stakeholders. With that, over to you, Mark, for closing remarks.

Thanks, Preet. Enerflex's third quarter financial and operating results highlight our continued ability to successfully execute against our strategy across our three core businesses around the world, our commitment to our key priorities remains steadfast as we work to maximize free cash flow generation, to strengthen our financial position, realize the benefits and synergies from the acquisition, and continue to offer best-in-class natural gas, produced water, and energy transition solutions to our customers across the globe. I look forward to building on our progress to create significant value and optionality across geographies, customers, and product lines. I will now hand the call back to the operator for questions.

Thank you. Again, ladies and gentlemen, if you'd like to ask a question, please press star 11 on your telephone. Again, to ask a question, please press star 11. One moment for our first question. Our first question comes from the line of Erin McNeil of TD Cal, and your line is open.

Hey, morning, and thanks for taking my questions. Can you give us a sense of, you know, the spending for working capital, work in progress, asset sales, any other discretionary cash flows for Q4 so we can get a sense of conversion rates of EBITDA into cash? And maybe if you have any preliminary thoughts on 2024 for these types of flows, that would also be very helpful.

Yeah, sure. Aaron, this is Mark, and I'm going to ask Jeff to answer that with a little bit more specificity. But we did confirm guidance, and guidance goes into a fair amount of detail on some of those cash flows. And I don't think we're in a position right now to provide any more guidance on specific areas of cash flow in Q4. Jeff, do you have anything to add to that?

Just to reiterate, Aaron, we talked about from a capital expenditure standpoint, including contract assets, a target range of $160 to $190 million U.S. for 2023, and the other non-discretionary expenditures, which is composed of the working capital, finance costs, cash income taxes, and dividends of between $180 and $210 million U.S. And as Mark said, we reiterated those, and we remain on track to meet those targets for this year. Going into 2024, as we said in the script for the prepared remarks, we're targeting a disciplined capital program for the year, and we'll continue to prioritize debt repayment.

Okay. Can you speak to the types of energy transition-related bookings in the quarter? Is it predominantly electric drive compression, or is there any other carbon capture or biofuels or other projects in there?

The majority of bookings is electrification. Understood.

Okay. Thanks. We'll turn it over. Okay.

Thank you. One moment, please. Our next question comes from the line of Keith Mackey of RBC Capital Markets. Your line is open.

Hi. Good morning. First, I wanted to just start out on the margin profile in energy infrastructure. I noticed it's trended down a little bit in this quarter. It's just a snick below the 55% to 65% target range or approximate range on a cash basis. Can you just speak to the factors behind where margins are in that business now? I noticed the U.S. contract compression utilization trended down slightly. So can you just speak to the factors behind where margins are now and hopefully where – you know, where we should be thinking about margins going over the next, you know, three to four quarters?

Yeah, those margins are kind of well within expectations for that business on a run rate basis. If you take a look back to Q2, I think we're closer to that than we were for last, than we were last quarter, or sorry, Q1, than we were in Q2. But it's well within the range there.

Got it. Okay. And Preet, so you joined the organization just recently, certainly as you mentioned at a pivotal time. Can you just speak to, you know, as you've kind of gotten into the company and seen the people in operations, can you just speak to some of the, maybe some of the strengths in the organization that you've seen, your first impressions, as well as some of the areas where you think there could be optimization for the future?

Sure. Thank you. Thank you for that. And so I've been here just under four weeks total time. And it's a great place to be. Very happy to be here. A wonderful group of people. I think the executive team, good interaction with the board this week and my global finance team is fantastic. So good group of folks all around. And I like the scale and scope of the organization. And we're working through integration as some of our priorities. R, where my focus is, is integrations, clearly important. We've put a milestone out there, 12 to 18 months, complete most of it. Number two, pre-cash flow generation debt reduction is a very important vehicle, and we have committed we will be under two and a half times the key leverage metric by year end. And then going forward, the long-term capital structure and the capital allocation priorities, we're working towards that to find out how we should be structured as a combined global entity post-acquisition given the mix of our business tied to recurring revenues and also the other side of the business. So we're working on that carefully, and dividends fall into this, leverage metrics fall into this, optimal debt amounts. So those are some of my priorities, I would say. And, you know what, I look forward to working with the team and very pleased to be here.

Okay, thanks. That's it for me. I'll turn it back.

Thank you. One moment, please. Our next question comes from the line of Tim Monticello of ATB Capital Markets. Your line is open.

Hey, good morning, everyone.

Can you guys hear me? Yeah, morning, Tim.

Okay. Just checking. We're here. First question, just on the engineering systems margins. You can see those ticking up a little bit. You've booked, I think, five cryo plants. in 2023. I imagine those are a little bit longer lead builds, but you've got the $1.2 billion of inherent systems backlog you're expecting to recognize over the next 12 months. Can you talk a little bit about how that margin, the embedded margins in that backlog compare to where you are today?

It's in line with where we're executing right now, Tim, and I think we've been pointing to a mid-teens sort of targeted minimum margins in that business, and we definitely would like to move it up higher through operational execution. But, you know, knowing the embedded backlog and what we're booking things at, it gives us a lot of visibility to revenue stream from that business line going all the way out through the end of 2024, and that mid-teens target for operating margin is pretty close to where we're going to be in my expectation.

Okay. That's helpful. And then in the energy infrastructure business, revenue is down a little bit, quarter over quarter, not much. But I would have expected to see some growth in that revenue line just given those water projects coming on through the first half of the year. Was there any movement in your contract book there?

So, Tim, it wasn't that, you know, we expected the revenues to be pretty stable from Q2 to Q3. The water projects, some of them started up in Q1 and Q2. So, yeah, it's not surprising to us that it was stable quarter over quarter.

Okay. Yeah, I think you answered all the rest of my questions. Appreciate it.

Thank you. One moment, please. Our next question comes from the line of Jamie Kubik. of CIBC, your line is open.

Yeah, good morning. Thanks for taking my question. I've got two here for you. Just on the engineered systems bookings, can you just talk about maybe the split between Canada and the US and if you've seen much recovery on the Canadian side given the agreement in BC between the First Nations and government to start the year? Thanks.

Yeah, the bookings in the corridor, They were very international. We had orders from Latin American segment. We had orders from U.S. customers, Canadian customers, and indeed from customers in the Eastern Hemisphere. A lot of those engineered systems orders go through the U.S. and Canadian shops. But yeah, very, very broad base of orders. To go to Canada specifically, we've seen an increase in inquiry levels, and I think a lot of our midstream customers have been looking at projects for some time, and it feels like the conversations we've been having, there's an increased conviction to start moving on adding natural gas processing and liquids processing infrastructure in the northwestern Alberta, northeastern BC area. whether that's a direct result of the Blueberry First Nation agreement or not is difficult to say. But we do expect bookings in Canada in 2024 to be more robust than we saw in 2023. And the most obvious macro drivers for that expectation really is the Blueberry First Nations and the LNG Canada, the two big drivers. And I think a lot of our A lot of the producers in Canada and a lot of the midstreamers are pointing to those same macros for why they see some continued positivity in the Canadian market for next year.

Okay, that's helpful. And then the second question for me is a bit along the same lines as what Aaron was asking. And, you know, respect if you don't want to provide more granularity on this, but I'll ask it anyways. But just with respect to 2024, you know, indicate you're targeting a disciplined capital program for next year. Can you just outline a bit what that ultimately means? Does it mean less capital spending than this year? And then you do talk about evaluating a target long-term capital structure and capital allocation parameters. Just what does that mean? Should we think about two and a half turns of debt relative to EBITDA as sort of the high watermark for where you want debt to be? And then Should we think about shareholder returns increasing at levels below that? Can you just touch on those items a bit further if you're willing to? Thanks.

Hey, Janice, Jeff. From a capital spending standpoint, Mark's talked about this in recent calls. After heavy investments in 2022 and 23, the expectation is that capital spending will come down and be lower in 2024. We are still in the process of evaluating our capital program for next year and expect to provide clarity to the market in coming months on that specifically. But from a directional standpoint, I think that's reasonable to see. In terms of the debt and the leverage side, as Preet said in his prepared remarks, We're on track to reach a leverage ratio of under 2.5 times by the end of 2023. Debt repayment will remain a priority for the company in 2024, both in absolute terms and on a relative leverage ratio basis. And we also continue to evaluate what the optimal capital structure and long-term ratio is for the company, and we expect to provide more clarity on that in coming months as well.

Okay, thank you.

Thank you. Again, ladies and gentlemen, if you'd like to ask a question, please press star 1-1 on your telephone. One moment for our next question. Our next question comes from the line of John Gibson of BMO Capital Markets. Your line is open.

More than all, most of my questions have been answered, but I've got one here, just I guess more high level. We're just over a year post-closing of the extern transaction, and I've seen some noise in the early part of the year. I guess, how close are you to getting the full-format entity to want it in terms of your facility footprint, cost in the system, etc.? What surprised you the most as you've worked through the integration over the past year or so?

John, we are pretty much complete on the vision of what we want Interflex to be long-term. We've executed on 90% of the people-related streamlining and synergies. We've got work to do on the processes and systems, and that's going to be a big part of the effort through 2024. Going into 2025, I want the company to be integrated, streamlined, all operating in the same processes and systems. But what you'll see from us operationally in 2024 is very close to the long-term Enerflex with respect to the markets we address, the geographies we're present in, and our emphasis on our three core business lines of engineered systems, energy infrastructure, and aftermarket services, and our sort of big macros of natural gas, produced water, and energy transition. So we're kind of there. We're going to be getting out of the two shops that we're closing by the end of this year early next year. And the cost to complete some of those exits has been better than we anticipated. If I want to flip to some of the things that were a little unanticipated, we do want to exit a lot of countries that we don't view as core and move on. The cost to exit some of those countries was a little bit higher than we thought, and we'll be putting some more thought into that. Additionally, making sure that the company is SOX compliant in accordance with our SEC filing and our NYSE listing. That's a lot of work, and that's something that our employees have been working really hard on all year to achieve that SOX compliance, and that's something that will require focus of Preet and his team and a lot of operational folks to close out the year and into the first quarter of 2024. Thanks a lot.

That was a great response. I'll send it back here.

Thank you. One moment, please. Our next question comes from the line of Nick Corcoran of Acumen Capital. Your line is open.

Good morning. Most of my questions have been answered, but I think in the prepared remarks, you mentioned a non-core asset sale after quarter end. Can you give a little bit more color on what that was and whether there's any other assets you want to talk about?

Sure, Nick. We sold a set of assets in Latin America and a set of assets in North America. And in both instances, we had the counterparties we sold to approached us and had thoughtful discussions about those sales. So it's good in a way that we sold one of the packages to an existing customer, and the positive is that they agreed to have a long-term O&M contract with Enerflex to keep those assets running. So it's good news. It helps us reinforce our debt reduction priority. The non-core assets don't have material EBITDA that we'll be taking off from our forecasts because of the sales. And in my opinion, it's a bit of a win-win story that we were able to achieve those sales subsequent to quarter close.

And just a related question, are there other assets that you can monetize in a similar way?

Well, we're always open to conversations with customers and business partners. And if our customers and business partners see significant value in some of our assets and it makes sense for us and our shareholders, we would have those conversations. I wouldn't say that we're actively... you know, out looking to pare back our business or make any significant transactions. But we're always in the market. We're always looking for thoughtful conversations with counterparties to make sure that we maximize, you know, Interflex's shareholder value long-term.

That's a good color. And then I think you kind of touched on this in the split between US and Canada, but there's been some consolidation in the Permian. Are you expecting that to have any impact on your business?

I think it's going to have a positive impact, Nick. I think that since the whole industry came out of COVID, the consolidation theme has been a theme in the service sector, in the midstream sector, and in the E&P sector. The Enerflex Exterin situation was part of that consolidation theme. One of the reasons we consolidated is that our customers are looking for solutions to bigger more complex, more long-term problems. And to that end, a bigger Enerflex is better able to serve bigger customers. You know, one of the things I like as an industry participant with the consolidation in the Permian and the Montney is that you got a fewer number of players that have very long-term sustainable outlooks on developing the overall basin. And so if we could get more stability and less boom-bust cycles in the market through the consolidation, that would be wonderful. you know, Enerflex's ability to respond to these bigger, more sophisticated customers has always been where we position ourselves. And so I do think it does play into our strategic positioning in the market, and it also plays into a more long-term sustainable development of those assets.

Thanks. I'll pass it on.

Thank you. One moment, please. Our next question comes from the line of

Cole Perea a steeple your line is open hi morning all some good color on how you're thinking about 2024 capex and can appreciate that it's still a work in process but high level should we assume that your 2023 maintenance capital guidance is kind of a reasonable run rate for the business going forward that's a reasonable starting point yes Okay, I got it. That's all for me. Thanks.

Thank you. One moment, please. Our next question comes from the line at 10 Monticello from ATB Capital Market. Your line is open.

Hey, just to follow up. On that non-core asset sale, can you quantify what the proceeds might be? And then, I mean, we're kind of halfway through the quarter here. How should we be thinking in terms of the direction of long-term debt from September 30th year and net debt?

The non-core asset sales, Tim, are going to generate roughly $40 million in cash proceeds to Interflex. And the second part of your question, where do we see total debt going for the balance of the year, Preet?

Yeah, I think we talked about the pay down this quarter, $41 million Canadian dollars. But we got the offset on the U.S. dollar strengthening FX impact, as we discussed. But I think Q4, think about something similar. We're continuing to focus on debt repayment, maybe a little bit more than where we're at today. However, the key metric will be we're targeting under two and a half times. And just be sensitive to the U.S. dollar continuing to strengthen as at now versus quarter end Q3. And just keep an eye on the U.S. dollar exchange. But that may also offset or temper our debt reduction. So we'll be breaking those out also at the end of the year. Okay, thanks a lot.

Thank you. I'm showing no further questions at this time. I'll turn the call back over to Mark for any closing remarks.

Thanks, Operator. I'd like to thank everybody for dialing in today. To reiterate our strategic priorities for the close of 2023 and into 2024 is having a disciplined capital program through 2024 focusing on generating free cash flow, repaying debt, and setting Interflex up for the future. I would like to take this opportunity to thank all current and former Interflex teammates that serve their companies in uniform as we prepare to remember those on Remembrance Day in the Commonwealth and Veterans Day in the United States. Thank you for your service. We look forward to talking to our investors and stakeholders again when we report Q4 earnings. Thank you.

Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect. Have a great day.