Blair Goertzen - CEO, President James Harbilas - Executive VP & CFO Marc Rossiter - Executive VP and COO.

Greg Colman - National Bank Jon Morrison - CIBC.

Good day, ladies and gentlemen. And welcome to the Enerflex Second Quarter 2018 Results Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] And as a reminder, this conference call is being recorded.

I would now like to turn the call over to Blair Goertzen. You may begin..

All right. Thank you, operator, and good morning, everyone, and thank you for joining us. Here today with me is James Harbilas, Enerflex's Executive Vice President and Chief Financial Officer; as well as Marc Rossiter, Executive Vice President and Chief Operating Officer.

During this call, James and I will be providing our financial results for the three months ended June 30, 2018, a brief commentary on the performance of our three business segments and a summary of our financial position.

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 will be referring to the three months ended June 30, 2018, compared to the same period of 2017.

I will proceed on the basis that you have taken the opportunity to read yesterday's press release. Enerflex's second quarter financial results were reflective of higher activity levels in some regions and the challenges faced in others. Bookings of $373 million represented Enerflex's second strongest quarter for bookings since 2014.

This is driven primarily by the USA segment, which continues to see significant activity across numerous resource basins in the region and for a variety of product offerings. Enerflex system's backlog in energy systems in the U.S. had a total of $749 million, a 12% increase compared to backlog at the end of 2017.

This provides a good visibility for Engineered Systems' revenue throughout 2018. Subsequent to the end of the quarter, the company recorded bookings of approximately $294 million, a significant portion of which was in the Canadian segment. Enerflex continues to see progress in generating recurring revenue from our Rental product offerings.

In the USA, the company continues to grow the rental fleet, expanding on the Contract Compression business acquired in 2017. In Latin America, Enerflex has seen success with a recent build-own-operate-maintain project in Colombia and continues to seek additional build-own-operate-maintain opportunities in the region.

In the United States, with strengthening commodity prices and lower corporate tax rates, the industry has experienced a surge in activity. Continued increases in production have resulted in significantly higher inquiry levels and bookings, as well as strengthened financial performance for the overall organization.

As we look forward in this market, Enerflex remains focused on building on its successes for Engineered Systems products for liquid-rich plays in this very prolific region.

The company expects 2018 to be a year of continued steady demand for compression and processing equipment, as evidenced by the strong bookings in the first half of the year, and is optimistic that these successes should translate into additional meaningful opportunities in the USA as Enerflex has a strong presence across multiple resource basins in the region.

The acquisition of the Rental assets from Mesa Compression in 2017 has added an established and growing platform, which contributes to the increasing recurring revenues for this segment.

During the quarter, Enerflex invested $15 million in rental assets in the USA, continuing the organic expansion of the USA Rental fleet, which has grown 32% since the acquisition to total approximately 170,000 horsepower. Enerflex remains focused on growing and investing in these assets throughout 2018.

As production in West Texas continues to expand, the company sees further growth potential in this high demand market. Rest of World delivered improved results for both Engineered Systems and Service revenues, resulting in increased profitability in the segment. Opportunities remain strong in many of the regions covered by this segment.

Looking at the Middle East, the region continues to provide stable rental earnings with the fleet that consists of approximately 105,000 horsepower. The company continues to explore new markets and opportunities within this diverse region in order to enhance recurring revenues as well as focusing on build-own-operate-maintain projects.

In Latin America, Enerflex remains optimistic about the outlook, as customers recover from the crash in commodity prices. The company believes there are near term prospects within Argentina, Brazil and Colombia and mid- to longer term prospects in Mexico.

In Argentina, Enerflex completed a significant project in the Vaca Muerta shale play last year and is close to completing another. Further development opportunities exist in this formation as producers expand their production, with Enerflex positioned to capitalize on these opportunities.

During the first quarter, the company also booked an Engineered Systems project in Colombia and commenced operations on a previously awarded build-own-operate-maintain project. As capital investments increase to develop Colombia's natural gas infrastructure, there will be further opportunities for Enerflex's products and services. Looking to Mexico.

With the presidential elections completed during the second quarter, there is some uncertainty on the impact to energy reform and capital investments in the country. The new President has expressed his desire to make Pemex more productive, which may be positive for the market, since compression services are a need for the oil and gas sector.

Enerflex will continue to aggressively pursue opportunities either with Pemex or with independent producers in the region. In the Canadian region, the oil and gas industry remained somewhat constrained by negative sentiment and low commodity prices.

Recent progress in transportation issues, optimism for liquefied natural gas projects and the improvement of realized prices based on stronger U.S. currency and benchmark pricing has resulted in an improvement in market sentiment.

This has been reflected in bookings during and subsequent to the quarter, which total over $200 million for the Canadian segment on the strength of some major projects. Going forward, Enerflex sees improved prospects in Canada through the back half of 2018.

It is important to highlight the company's strategic strategy of geographic diversification has significantly lessened the impact of the challenges of the Canadian market, and Enerflex is now solely dependent on the Canadian activity to drive growth in financial results.

Moving ahead, the company will continue to grow its revenue streams from multiple markets with a focus on recurring revenue. Rental revenue from the Contract Compression acquisition, along with the recent build-own-operate-maintain project wins and long-term service contracts, fit within Enerflex's strategic goal of increasing recurring revenue.

Given Enerflex's positive outlook, the Board of Directors has approved the quarterly dividend of $0.095 a share, which is $0.38 per share on an annualized basis. Enerflex has increased its dividend by 58% since emerging as a public company in 2011. I will now turn it over to James Harbilas and - for - to review the financial results..

Thank you, Blair. Revenues for the quarter decreased compared to the previous period due to lower Engineered Systems revenues in Canada and the USA, which were partially offset by higher Service and Rental revenues.

In Canada, Engineered Systems revenues declined due to weak bookings over the trailing 12 months, while the USA decrease was due to the inclusion of some large projects in the comparative quarter. Enerflex's Service and Rental product lines benefited from the company's focus on increasing recurring revenue streams.

Consolidated gross margin for the quarter was $72 million compared to $77 million as a result of lower revenues. However, gross margin as a percentage of revenue was consistent with the prior year. Selling, general and administrative expenses were $44 million compared to $45 million.

The slight decrease of $1 million was due to lower third-party costs and lower foreign exchange impacts, partially offset by higher compensation costs. The higher compensation costs are driven by an increase in the headcount in the United States and costs related to senior management departures.

During the quarter, Enerflex generated net earnings from operations of $20 million or $0.23 per share compared to net earnings of $21 million or $0.24 per share in 2017. Adjusted EBITDA was $51 million versus $57 million in the prior year.

The underlying decrease in adjusted EBITDA was largely driven by lower revenue and margins, as previously mentioned. The company's quarterly bookings represented 11% decrease year-over-year compared to 2017, with lower bookings in Canada and Rest of World segments, partially offset by $302 million of bookings in the USA segment.

Enerflex saw $78 million increase in backlog compared to December 31, 2017, due to strong bookings in the USA and lower Engineered Systems revenue recognized in the quarter. Backlog remains strong at $749 million, which provides good visibility for this product line through 2018.

Subsequent to the end of the quarter, Enerflex received the partial ruling related to the Oman Oil Expiration and Production arbitration. The tribunal awarded Enerflex the full final milestone payments as well as variation claims relating to additional costs and delays in construction and interest on the outstanding amounts totaling US$30 million.

The results of this ruling will be recognized in the third quarter. The allocation of costs and expenses of the proceedings will be the subject of a further round of submissions and a separate final award by the tribunal, which is expected later this year. Moving on to our regional results.

In the USA segment, Enerflex's bookings of $302 million represented a significant increase of 95% when compared to the second quarter of 2017. We continue to see demand for assets in this region, including a variety of product offerings spread across numerous resource basins.

At the end of the period, backlog remains healthy at $579 million, which represents the highest level of backlog for this region since 2014. During the second quarter, revenue in the U.S. was $219 million.

This decrease of $9 million was largely due to the lower Engineered Systems revenue, as the comparative quarter included the revenue recognition from a few larger projects.

Service revenues saw an increase due to higher activity levels, while Rental revenues improved as a result of the acquisition of the Contract Compression business from Mesa and the build-out of the fleet over the last half of 2017 and the first half of 2018.

Operating income and EBIT for the second quarter were lower compared to the prior year due to decreased Engineered Systems margins, driven by a product mix shift to lower margin compression work and the inclusion of higher-margin projects in 2017. This was partially offset by contributions from the higher-margin Service and Rental product lines.

In the Rest of World, the $24 million of bookings includes $17 million for power generation project in Australia. This segment's bookings are typically larger in nature, and as a result, are less frequent.

Backlog of $85 million at June 30, 2018, decreased by $18 million relative to December 31, 2017, due to Engineered Systems revenue outpacing bookings. Revenue in the Rest of World segment for the second quarter was $117 million.

This increase of $11 million was attributable to higher Engineered Systems revenue on the continued progress of projects in Latin America. Service revenue also increased due to higher activity levels in Australia.

Our Rental revenues was consistent year-over-year, with slightly decreased utilization rates in Mexico, being offset by Rental revenues on the new build-own-operate-maintain project in Colombia.

Operating income of $11 million represents $5 million increase over the same period of 2017, primarily due to improved revenues for the segment and a reduction in SG&A costs. In Canada, customer caution caused by challenging market conditions resulted in bookings of $47 million, a decrease of $74 million compared to the same period in 2017.

While the lower - while lower than the comparative period, it should be noted that this quarter's bookings were $30 million higher than the bookings from the first quarter 2018, and the company continues to see healthy inquiry levels, which was reflected in bookings subsequent to the quarter totaling $160 million.

Revenue in Canada was $69 million as compared to $100 million in the second quarter of 2017. This $31 million decrease is primarily attributable to lower Engineered Systems revenue as a result of weaker bookings over the trailing 12 months.

Service and Rental revenues also decreased from the prior year, with both product lines being negatively impacted by lower parts and equipment sales. Operating income and EBIT decreased by $4 million due to lower revenues and gross margin as well as a decrease in overhead absorption due to lower activity levels.

This was partially offset by lower SG&A costs for the quarter. Turning to the balance sheet. Enerflex continues to spend capital on Rental equipment to expand the fleet, which is consistent with our strategic objective of increasing recurring revenue.

The company also remains diligent in managing working capital to retain flexibility to pursue opportunities. In managing liquidity, the company has access to significant portion of its bank facility for future drawings to meet the company's future growth targets.

As at June 30, the company held cash and cash equivalents of $306 million and had drawn $175 million against the bank facility, leaving it with access to $538 million for future drawings.

The company continues to meet its bank facility covenant requirements, with bank adjusted net debt-to-EBITDA ratio of less than 1 and its interest coverage ratio of greater than 11 times to 1.

Demand for natural gas is growing globally, and with sustained pricing gains, Enerflex is optimistic that customers will increase capital spending in production, translating into increased demand for Enerflex's products and services.

We anticipate increases in activity levels in the USA and Rest of World segments as well as an improved outlook in Canada over the back half of the year, driven by recent bookings.

Building off the success of adding assets, which contributed to recurring revenues, the company remains committed to the strategy in the USA and Rest of World segments in 2018 and going forward. This completes the formal component of the webcast. Additional details can be found in our August 9 press release. We will now be happy to take any questions.

Operator?.

[Operator Instructions] Our first question comes from Greg Colman of National Bank. Your line is open..

Hey, gentlemen. Congrats on the quarter and the backlog growth..

Thank you..

A couple of quick ones here. On the subsequent wins, the $294 million afterwards, you mentioned $160 million was in Canada.

Can you give us any color on what the other $130 million was like? Is that predominantly U.S., Rest of World, lightly diversified focused?.

No, no, it was pretty much split roughly 50-50 between the other two segments, right, for the bookings subsequent to the quarter. And as we said, we continue to see a very healthy inquiry level and opportunities in the back half of the year across all three regions..

Great. Keeping in the U.S. for a minute there, on the U.S. manufacturing and the backlog growth, your commentary right now about healthy inquiry levels and the subsequent wins, looks like it's going to be up strong again in Q3.

We're also hearing from your competitors on the rental side that delivery times for high horse stuff is now 14 months, up from five months less than a year ago.

My question is can you handle this backlog with your current manufacturing capacity? What basically is max utilization? I mean, what can you do in terms of revenue per quarter, I suppose, for Engineered Systems? And when would you have to expand your capacity, and then what would that expansion look like?.

Yes, Greg, so it's a great question, because it's been part of our thought process here for the past six months. Not kind of getting into what we do have for capacity, but we are expanding our Houston facility, as we speak, by about 100,000 horsepower - 100,000 square feet.

And that's going to give us an opportunity to free up and create about 10 more bays, which at the end of the day would increase our overall capacity by about 25%, 27%. So that's going to have some meaningful impact on our ability to kind of debottleneck some of our existing constraints.

And the idea that large horsepower engines are getting slipped out to somewhere closer to a year, that's a true fact. Our procurement strategy also started about 18 months ago in what we needed in the queue as well. So there's been a few things done around here that I think gives us a bit of an advantage.

Clearly, the expansion in the Telge [ph] facility and also our supply chain around some of these long-lead items..

That's interesting.

The - that capacity increase, is that underway now? And when would we expect it to be, I suppose, commercially live?.

Yes, it will be ready to go early Q1..

What's the total cost of that? Is that included in your announced capital budget or incremental?.

Well, incremental..

Yes, that would be incremental..

Single digit million, tens of millions, hundreds of millions? Just want the magnitude..

Yes, so it's about $18 million to $20 million is what we've budgeted..

Great. And then just related to that. As we go down sort of the value chain there into the rental fleet, you're growing at, like you mentioned, something like 30%. And we see an industry growth rate of around 10%, implying that you're taking quite a bit of market share.

Should we expect this kind of growth rate to continue if we project on into late '18, into '19, especially because you can probably get your gear up quicker than your competitors who aren't vertically integrated on the manufacturing side?.

I think the growth rate that we're experiencing is probably equal to some of our competitors as well. So I don't think that - I think we are getting our fair share of the market. I think that there could be some modest market share increase for ourselves.

But again, we're taking the idea that we want to support this strongly with good service infrastructure support in the hot regions that are out there today as well too. And so there's - we're probably tempering some of our growth, given the fact that we want strong service support for this equipment when it hits the field.

So we don't see any reason to, at this point, back off on sort of 30% growth over what we've seen in the last 12 months..

Okay. That's fair. And that makes sense. And then, I guess, just lastly for me, it kind of comes up very conference call.

But could you give us a feel for your backlog margin profile and how it compares to the margin profile we've seen in Engineered Systems for the past six months?.

Yes. I mean, we have seen strength in pricing, for sure, across all of our product lines, especially in the U.S. region, and you touched on it, with delivery times being pressed. If people have inventory, we have seen some margin traction. So we would expect that to get stronger by a couple of percentage points here into the - into Q3 and Q4..

And James, is that because of pricing power or is that because of product mix?.

It will be a little bit of both, Greg, for sure..

Got it. That's it from me. Thanks a lot..

[Operator Instructions] Our next question comes from Jon Morrison of CIBC. Your line is open..

Morning..

Morning..

Can you give any more color on the nature and geography of the U.S. bookings that you had in the quarter? Specifically, how weighted is it to the Permian and its line of sight in the U.S.

Rockies starting to look better, just given some of the emerging gas takeaway issues that we are seeing in that market?.

Yeah. From our standpoint, we like to see diversity in the bookings across multiple resource basins. And that's the way the U.S. bookings have played out for us, not only in the quarter, but through the first six months of 2018. I mean, if we compare bookings activity in 2017, roughly 65% to 70% of it was concentrated in the Permian.

For the same period in 2018, the first six months that's dropped out to about 35% to 37% Permian and then very good diversity in other resource basins, predominantly up in the Powder River in the Colorado area and even out into the Marcellus, Utica and down into South Texas. So we have seen a lot more diversity, as I said..

And James, just in terms of some of that stuff in the Rockies that you are seeing momentum on, is there any plan to meet some of that demand from your Calgary manufacturing or it's all largely going to come from Houston at this point?.

At this point, we plan to service that market from the Houston facility. Given the healthy level of inquiries that we're seeing and what we expect to translate from backlog standpoint, what I touched on the fact that we're in the process of expanding that facility here starting in Q3..

Can you give any more color on the Canadian bookings post-quarter end? And I guess, my real question is, was it heavily weighted to one or two customers or more diverse?.

It was a handful of customers. There are a couple of large projects in there, and it was predominantly driven by mid-streaming activity, which is consistent with what we've said on the Q1 call is relative to the inquiry levels that we are seeing in Canada right now. And it was the same in 2017.

The midstream development in Canada is what drove large parts of our business activity on the Engineered Systems side..

So James, it would be fair to say that you likely believe that this is an infection point in Canada, and realistically speaking, based on both the bookings that you had in the last six weeks and bidding activity go forward, it feels like momentum should be rising in Canada and perhaps it should be at a point of creating cash in the coming quarters, is that fair?.

I think it will be fair to say that from a booking standpoint, we've definitely hit an inflection point and a backlog standpoint. So we've multiple or sequential declines in backlog. And the activity we saw to begin Q3 is going to shift back. I want to be careful with - in terms of when that starts contributing materially, though, to Canadian results.

And I - it would be fair to say that we'll probably get some contribution in Q4 from these projects. But the lion share of these bookings will be recognized in 2019 within the Canadian segment..

Okay. That's very helpful. There's obviously - or there were some issues in the international segment last quarter. There is no apparent hangover seen in the Q2 results this quarter.

Is that project that created some of the headwinds now complete and all financial components fully settled or is it still ongoing at this point?.

It's still ongoing. The scheduled completion date will be later this year. But you touched on it, we didn't recognize any further margin erosion on that project..

Okay. Positive to see the OOCEP really come through. Just two follow-ups on it.

One, is the arbitration award binding in that OOCEP can object and push it to a higher level through an appeal process on the ruling? And then secondarily, is there still an ongoing process where you're still trying to recover some of the legal costs in that? While it was positive to see the number coming through at where it's that, it could actually be higher in the coming period?.

So in terms of the first part of your question, all of our discussions with legal counsel point to the fact that this ruling is binding on both parties. And both parties, obviously, agreed to advance through the ICC Arbitration court. And as a result of that, the ruling is considered binding. So that's the answer to the first part of your question.

The second part of your question, yes, I mean, there is a third part to this, which will deal with cost that we've incurred with respect to this process.

And there's going to be another round of submissions to the tribunal to make an argument for cost recovery, and we would expect that decision to be tabled by the end of this year based on the guidance that we're getting.

And at the end of the day, there could be some further recoveries that would be recorded that are related to legal and expert cost recoveries that we've spent to litigate this matter..

Blair, just in terms of the U.S. manufacturing comments that you made, well, I realize that you're saying that you're adding square footage.

But would you also have the ability to outsource some of the work that you're doing to various vendors in Houston that you've worked with in the past and effectively increase throughput if you're in a major pinch from a short-term perspective as well?.

There is, obviously, a crunch across the U.S. supply chain, even in terms of outsourcing carbon steel welding. So this expansion is to debottleneck some of that. But the supply chain and the manufacturing process in the U.S. has always been to outsource carbon steel welding.

Some of what we're going to do now is to bring in-house some of the piping and vessel welding that has been traditionally outsourced and give us some opportunity to meet faster schedule. So it all works in concert together.

And so we've got good supply chain on carbon steel welding, and now it's to really accelerate our ability to package and do process and spools..

Perfect. Last one just from me. How active is U.S.

rentals bidding right now in terms of new opportunities? And can you give us any sort of a magnitude of what you have in your radar screen from an aggregate value or horsepower perspective that you might be bidding on?.

Yes. It's very, very active for the U.S. rentals business at the moment. And so again, the platform that we acquired was gas lift, which is smaller horsepower. That's pretty active at the moment.

And so when we think about our growth strategy and moving sort of up the horsepower chain, and it goes back to my earlier comments, what will we do with respect to the talent that is able to support that business growth in the U.S.

Both large horsepower and gas lift, it's very, very active, primarily in the Permian Basin, but it's not limited to the Permian either..

Is it more active than it was 3 or 6 months ago, Blair?.

I'd say it's - it would be relative to what was happening 3 to 6 months ago. But clearly even out into next year, there is significant opportunities..

Appreciate the color. Good quarter. I'll turn it back here..

Thanks, Jon..

Thank you..

Our next question is a follow-up from Greg Colman of National Bank. Your line is open..

Thanks. Just two quick ones that I wanted to come back with on margins again. Sorry to harp on it. But James, you mentioned that we could see a bit of expansion there. I just wanted to talk a little bit about cost inflation, because we are seeing that elsewhere in the space.

I am just wondering if we should be worried about comments in the next couple of few quarters about any margin compression because of cost inflation just over - due to general economic growth or if that's not a concern, because you can pass it through or your specific costs are not seeing that type of inflation, just wanted to get an opportunity to talk about it..

Yes. I appreciate the follow-up question. We've been pretty clear about that, that when it comes to service technicians, especially in some of the hotter basins like the Permian, that we have experienced some cost inflation there. And as contracts obviously come up for renewal, then we have been trying to push those increases through.

So we wouldn't expect any material margin erosion as a result of that. And then obviously, it's just steel prices with the tariffs that we've been very, very careful to manage and are going to be managing aggressively on future bids. But those are the two areas that we've been focused on.

So I wouldn't expect material margin erosion arising out of those two matters..

Great. Good to know. And then finally, just on Saudi Arabia. Given the current news - and I'm sorry I might have missed this with Mike's questions. I don't think you touched on it, though.

Could you remind us what your exposure in Saudi Arabia is right now and also in the backlog?.

There is no impact at this point for our business with the Saudi Arabia, Canada political issue..

Okay, great. That's it from me. Thanks very much..

Thanks, Greg..

There are no further questions. I'd like to turn the call back over to Blair Goertzen for any closing remarks..

All right. Thanks, operator. And since there are no further questions, I would like to once again thank everybody for joining us on the call. And we very much look forward to giving you our third quarter 2018 results in November. Have a good weekend..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day..