Ladies and gentlemen, thank you for standing by and welcome to the Enerflex Second Quarter 2021 Results Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] I would now like to hand the conference over to your host, Mr. Stefan Ali, Vice President, Strategy and Investor Relations. Please go ahead..

Thank you, operator and good morning everyone. Here with me are Marc Rossiter, Enerflex’s President and Chief Executive Officer; Sanjay Bishnoi, Enerflex’s Senior Vice President and Chief Financial Officer; and Ben Park, Enerflex’s Vice President, Corporate Controller.

During this call, we will be providing our financial results for the 3 months ended June 30, 2021, a brief commentary on the performance of our three business segments and a summary of our financial position. Today’s discussion will include forward-looking statements regarding Enerflex’s expectations for future performance and business prospects.

Forward-looking information involves risks and uncertainties and the stated expectations could differ materially from actual results or performance. For more information, please see the advisory comments within our news release, MD&A and other regulatory filings.

Approximately 1 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 3 months ended June 30, 2021 compared to the same period of 2020.

We will proceed on the basis that you have all taken the opportunity to read yesterday’s press release. I will now turn the call over to Marc..

Thanks, Stefan and good morning, everyone. At this time last year, WTI was recovering from negative territory, while natural gas was near all-time lows. Fast forward a year and commodity prices have staged an incredible rebound as the global economy recovers.

Oil is seeing its highest price since 2018 steadying around $70 a barrel, while both Henry Hub and AECO gas prices are respectively hovering near $4, their highest price in 5 years, underpinned by increased fuel switching, industrial use and power demand.

In addition, rig counts are increasing at a healthy pace, up over 100% since this time last year, with additional increases expected through to year end. This tailwind for the industry resulted in Enerflex delivering solid second quarter results across all regions and business lines.

Benefiting our results were stronger contributions from our asset ownership platform, where utilization of our U.S. contract compression fleet improved to a second quarter average of 85%.

While exiting the quarter at 88%, illustrating the resilience of these investments and meeting our expectations of stronger utilization, as commodity prices rebounded and production returned to the market. U.S.

gas production is approximately 93 Bcf per day, which is nearing 2019’s average of 95 Bcf per day and is concentrated in locations such as the Permian Basin, which is well suited to the configuration of Enerflex’s fleet.

Our contract compression business has been further supported by exercising patience in deploying large horsepower to ensure favorable contracts, including with respect to curation and pricing.

We have also witnessed increasing demand for electrified rental compression, as our customers turn their minds to managing their environmental impact and reducing Scope 1 emissions. In fact, over half of our 2021 contract compression build schedule is dedicated toward electric compression.

We expect that demand for e-compression will continue to strengthen in geographies, where it can be readily deployed as clients continue prioritizing their decarbonization efforts. In addition to our contract compression fleet, our international BOOM assets continue their strong performance across all geographies.

We are progressing the 10-year BOOM project booked during the first quarter of 2021 and have line of sight to several other 10-year BOOM opportunities in our rest of world segment that would be underpinned by take-or-pay contracts with strong counterparties.

As we have stated before, provided that our expectations for strengthening Engineered Systems bookings activity come to fruition, we are prepared to deploy additional capital this year toward accretive asset ownership opportunities that can further contribute to the stability and predictability of our earnings profile.

Consequently, very meaningful to us is the increase in Engineered Systems’ backlog for the second consecutive quarter. Bookings of over $154 million represent the highest bookings quarter since the first quarter of 2020 and are reflective of improved macro indicators for oil and gas demand and strengthening balance sheets across the sector.

As stated in our last earnings call, we anticipated bookings improvement to occur this year given the rapid increase in rig counts, which are bookings typically lagged by roughly 6 to 8 months. While bookings activity accelerated near the end of the second quarter, our outlook for the remainder of the year remains unchanged.

In that, we expect the second half of 2021 to show stronger bookings activity than the first half. Notably, bookings activity is roughly allocable in thirds by end destination, fueling optimism for a broad-based recovery.

While some regions may recover faster than others, our geographically diversified platform ensures we are positioned to participate wherever activity is focused.

We are also happy to see recent bookings more heavily concentrated towards gas processing applications versus compression, with demand coming from each of the upstream, midstream and petrochemical sectors.

We have dedicated resources over the years to increasing our capabilities and expertise in complex gas processing applications and are proud that our reputation for successfully delivering has assisted us in securing additional gas processing projects this year.

Our aftermarket services business was stable through the quarter, recovering from the prior quarter seasonality and weather-induced weakness. Our recovery for the AMS business will likely take several quarters, but we do expect a gradual return of activity as the year progresses.

Turning to our energy transition efforts, we have completed significant work in deepening our understanding of how the transition might unfold and are already seeing significant number of inquiries for lower carbon solutions, including in respect of e-compression, where we are currently bidding several opportunities and other constructive discussions regarding carbon capture and sequestration, bio-fuels and renewable natural gas and hydrogen.

With rig counts increasing, economies reopening in support of demand dynamics for both oil and gas and certain energy transition solutions, we are optimistic that the industry is turning the corner and are focusing our attention towards supporting our global customers and their development plans, while simultaneously building capabilities to capture opportunities within the energy transition landscape.

Lastly, I would like to once again thank Enerflex’s employees for their devotion and commitment through this downturn. This has been one of the most turbulent periods for the oil and gas industry, which we can only navigate because of the talents of our hardworking dedicated team.

As we return to in-person collaboration, the future looks bright for Enerflex and we are well positioned to continue participating in the industry’s recovery. I will now turn things over to Sanjay to review our financial results..

Thanks Mark. Second quarter revenue of $205 million decreased versus the prior year period due primarily to lower Engineered Systems revenue on lower opening backlog and reduced contribution from some major projects that were largely completed by the third quarter of 2020.

Despite lower Engineered Systems revenue, bookings of $155 million improved our backlog by over 80% relative to December 31, 2020, reflecting the improving conditions for the oil and gas industry and for our Engineered Systems business.

Both service revenue and rentals revenue were in line with the comparable period as industry activity improved off the lows seen in the preceding quarter. Rentals continued to benefit from the improved utilization of our USA contract compression fleet and contributions from our growing portfolio of international BOOM assets despite a weaker U.S.

dollar negatively impacting revenue in many of our operating regions. Gross margins decreased over the comparative quarter on lower revenue, but the decrease was partially offset by increased contributions from recurring revenue product lines, which yields a higher gross margin as a percent of revenue.

Overall, gross margin as a percent of revenue increased. SG&A decreased versus the comparative period driven by lower compensation expense, cost recoveries related to government assistance programs, and the absence of bad debt provision that were taken in the second quarter of 2020. Enerflex remains disciplined in managing working capital.

Remaining direct material inventories will be realized into Engineered Systems projects and new contract compression units over time, including as part of projects booked during the quarter.

As business activity increases, we expect to manage our talent, shop capacity and supply chains to capitalize on any uptick while continuing to balance working capital across each of our regions. During the quarter, we invested $12.5 million of capital towards units in our U.S. rental fleet, which has grown to approximately 380,000 horsepower.

From a capital allocation perspective, we are seeing several opportunities to deploy capital globally at attractive returns and with our counterparties with whom we have deep relationships.

We have a current opportunity set exceeding $100 million, an improved outlook for Engineered Systems bookings and our balance sheet strength we expect to pursue additional asset ownership investments through to year end funded through a combination of cash on hand and debt.

However, we will maintain a conservative leverage position having exited the quarter with a bank adjusted net debt to EBITDA of 1.18x compared to a maximum ratio of 3:1.

This bank adjusted net debt to EBITDA ratio relates specifically to the company’s bank facilities and notes and excludes the new non-recourse credit facility, which had approximately $43 million drawn on June 30.

With significant liquidity on our revolver and the possibility that Engineered Systems activity could pickup, Enerflex is well-positioned to consider additional growth CapEx as attractive opportunities present themselves.

Our net debt decreased by over $150 million versus June 30, 2020 as we continued to use cash to decrease net leverage and strengthen our balance sheet. With respect to liquidity, Enerflex has $99 million of cash on hand, using cash during the quarter for more substantial repayments of long-term debt.

In addition, we have access to $685 million on our bank facility, giving us significant flexibility to manage our resources as the industry recovers and to consider organic and/or inorganic growth.

Lastly, Enerflex board will continue to evaluate dividend payments on a quarterly basis based on the availability of cash flow and anticipated market conditions, yesterday declaring a dividend of $0.02 per share to be paid on October 7, 2021. This completes the formal component of the webcast.

Additional details can be found on our August 4 press release. We will now be happy to take any questions..

Thank you. [Operator Instructions] Our first question will come from Michael Robertson with National Bank Financial. Please go ahead..

Hey, good morning all. Congrats on the solid quarter and thanks for taking my questions. You posted really impressive margins in the quarter driven by what appears to be a combination of revenue mix and SG&A savings.

With bookings picking up for Engineered Systems, I was wondering what kind of capacities you have right now to absorb additional activity with your sort of current headcount and should we expect a similar level of SG&A moving forward or are you anticipating more of a ramp up as that segment recovers?.

Michael, this is Marc Rossiter. Thanks for the question. We have done a lot of work in probably the last two or three quarters thinking about our human capital and making sure that we have the appropriate human capital to take advantage of the ramp up in activity in our sector. So we are – we got the people to execute on the work that we need to do.

I don’t think that you will see a meaningful change in our SG&A as a percentage of revenue that if you go back a number of years into the ups and downs of the business, but it’s hard for us to predict quarter by quarter where it’s going to be..

Fair enough. That’s helpful color. I guess in that vein, given the expected pickup in Engineered Systems activity and the inflationary pressures we are seeing in the cost of raw materials and labor.

Are you at a point where you are facing some headwinds on input prices or are you able to avoid the bulk of that at least in the near-term by continuing to chip away at existing inventory?.

Yes, good morning, Michael. This is Sanjay. I would say that that we have been able to manage the inflationary pressures that we have seen in the supply chain so far through as you mentioned our inventory, which has been coming down, but at the same time also just being able to pass it along to the market.

We feel like we have been able to manage those pressures today..

Based on what you are seeing today, how much more, I guess one way do you think you have in that regard before you would be encountering a more significant increase in input costs?.

Yes, Michael, this is Marc. I mean, we work very closely with our supply chain, obviously and we understand the price increases that they are going to bring to us with enough advance notice to deal with those numbers with our customers. So, like Sanjay said, we do have some inventory that’s obviously at old prices.

And we chip away at that, but really is the bulk of the new orders, the costs are going to be new things we have to buy to fulfill the orders. And as we estimate those things, it’s very much in real time sort of bang-bang stuff to make sure that we got the right input costs..

Got it. Well, that’s really helpful color. I will jump back in the queue. Thanks a lot for taking the question..

Thank you. Our next question will come from Aaron MacNeil with TD Securities. Please go ahead..

Hey, good morning all. Thanks for taking my questions.

You guys mentioned in your prepared remarks that you are seeing several opportunities for doing projects internationally that in aggregate kind of similar than $100 million, can you sort of frame the opportunity a bit more in terms of number of projects, the potential timeline to award or spending? And as you mentioned as well in your prepared remarks, you are tying increased CapEx to higher bookings activity.

So I am wondering, is there any reason or implications for the remainder of your 2021 capital program?.

Aaron, this is Marc, I will talk about the opportunity, and I’ll ask Sanjay, to give you an update on the CapEx for the year. The opportunity set for BOOM is what it’s always been, it’s international.

It’s 5 to 10-year take-or-pay contracts, its compressor stations, gas plants, natural gas infrastructure, the projects can be anywhere from $50 million to $150 million, over the years that sort of been the brackets of the projects we do. I wouldn’t want to get into the number of projects or the value of each one today.

What I would like to let you know is that the pipeline of new opportunities is quite solid for those investments and its business that we would like. It provides above average return and it’s a real priority for the people in the international segment..

Yes, and I will take your question on the capital budget for 2021. We gave some guidance, $50 million to $100 million in growth capital. And I say that we are – I still firmly within those guardrails.

Given the pipeline, I would expect that we are going to come out towards the higher end of the range there by the end of the year, but also we are getting to the point in year where even if we kickoff projects, now there is not a whole lot of time to get down the spending curve, if you will, on new projects.

So, right now, we still think that range that we gave earlier in the year is a good range, but I do think we are going to be towards the upper end of it..

Got it. Okay. Sticking with the capital discipline theme and understanding that it’s a Board decision and this actually can say but historically Enerflex with Q3 has evaluated the dividend.

So instead of asking you about the dividend, specifically, maybe you give us a sense of higher you currently ranked the dividend versus other capital allocation priorities like growth CapEx, M&A, including potential acquisitions to bolster your energy transition ambitions, debt repayment or an NCIB?.

Yes, sure. So, I would say that our priorities have stayed very consistent, Aaron. It’s as you know number one priority has always been about maintaining a healthy balance sheet and that’s priority number one. We are seeing really good growth opportunities as we have just mentioned and as Marc just talked through.

So, that’s certainly our second priority. And then I think the dividend would sort of fall behind that, but as – and I appreciate you are caveating the question the way that you did like that’s very much a board discussion that we have every quarter and we sort of look at all the factors before making the decision for each quarter..

Understood. And last question for me to start with margins, I assume there is a lot of idle capacity among your peers.

In terms of the manufacturing capacity, maybe could you just talk about the competitive environments for your recent bookings and potential future bookings? Obviously, you also mentioned that gas processing, your bookings were heavily weighted to gas processing, which I think historically is at a higher margin.

But should we temper margin expectations going forward as you kind of add incremental bookings to the backlog?.

And this is Marc. I think it would be smart to temper those expectations, especially for compression bookings. There is a lot of great competition in the compression packaging and service space. And although we are very happy with the quarter that we have had, it’s still early in the recovery.

So, I would say there is still more hunger out there than we would like and it may take a little while for margins to meaningfully change within that sector. Gas processing is slightly different, but we still have a lot of great competition in the gas processing business.

So, yes, I think it would be smart to temper expectations for a hard snapback in margins..

Are you staying – maybe I will sneak one more? And are you staying pretty firm on how you are bidding things and the margin expectations you have or are you trying to fill the facilities as well?.

I would rather not go into that too much. But we – one of the key skill sets for our management teams in those big ES businesses of the United States and Canada is really looking at all those opportunities and looking at the risks of executing them and deciding on the margin that’s appropriate for the customers, the jobs, the competitive environment.

So, it’s really a day-to-day analysis that the teams do to try to maximize margin at all times. And the empty capacity amongst our competitors is a really big part of that math. So, as long as we are at the early stages of the recovery, there is going to be a lot of competitive pressures, no doubt..

Understood. Thanks for taking my questions. I will turn it over..

Thank you. Our next question will come from Cole Pereira with Stifel. Please go ahead..

Good morning, everyone. Just wanted to start with the U.S.

bookings numbers, obviously, very strong, can you just comment if there were any energy transition projects in there or does that still remain more of a 2022-2023 story?.

There is – it’s more of a 2022-2023 story. The energy transition for us where I would say, very active in the inquiry to order pipeline for energy transition businesses, in biofuels, in carbon capture, and in hydrogen and E-compression, those sort of four areas that we mentioned, more in the pipeline than in the backlog..

Okay, perfect. Thanks. And apologies, my line cut out.

So, apologies if I am re-asking, but thinking about the additional asset ownership opportunities, can you just comment on how we should be thinking about Enerflex allocating capital between BOOM assets and contract compression?.

I don’t think we have ever given a percentage that we want to send here in percentage we send there. We really like our U.S. contract compression fleets performance through the pandemic. And we are going to put an appropriate amount of growth capital into that business.

The BOOM projects that we mentioned are in the pipeline are very interesting to us as well. So, we don’t go into a ton of details about which one sort of gets more money..

Nope, that’s totally fair.

And I mean, thinking about Canada, it’s historically been a smaller piece of the ES business, but with the strong activity outlook and in particular, strong natural gas prices, do you see it becoming a bit more of a contributor? And are you happy with your current footprint in the region?.

I am more optimistic about the outlook for Engineered Systems and AMS in Canada today than I have been maybe for the last 3 years or 4 years. And it’s our – the customers in Canada are – they have gone through a tough period, they have got their balance sheet squared away, they got their overhead structure squared away.

The gas prices they are realizing in the WCSB are healthier than they have been for a long time. And so the discussions we are having with clients are really positive. I am very happy with our footprint in Canada and not just the shop, but our people.

We have worked really hard to make sure we have prioritized of keeping the human capital that we really need to serve our customers going forward. That’s the engineers that understand gas processing and compression, carbon capture, electric compression, all of those things that our Canadian customers are engaging with us today.

So, I am optimistic about the outlook. We have got the people on the shop that we need to capitalize on what I think will be a healthy, three to five, maybe even longer up-cycle in the Canadian market..

Okay, great.

And just one last one for me, as activity continues to increase, are you concerned at all about labor availability in North America?.

We are for sure the labor – like labor, so for hourly employees. Good field technicians are always a very hot commodity and are core to our success. And so we have been paying attention to the labor markets really, for the last six months, as we have seen the macro pick up upstream and the rig counts increased and gas and oil prices increased.

We knew the day was coming that our field service people and our shops would get busier. So, we have been as proactive as we can be to make sure that we have the best talent strategy as possible..

Okay, great. That’s helpful. Thanks. I will turn it back..

[Operator Instructions] Our next question will come from Tim Monachello with ATB Capital Markets. Please go ahead..

Hey, good morning guys. Most of the questions had been answered. But I am just curious about I guess lead times, a lot of commentary in the market from your peers in the U.S., especially about Cat engines and delays to get those. But it strikes to me that your inventory levels are still pretty high.

Do you think that that’s going to be a headwind on deliveries for the new bookings you are getting in the second half of the year and what will lead times look like today?.

I don’t know. Tim, it very well, could be a headwind. We will have to see what happens from that point of view. I am not feeling that it’s going to be a really acute significant impact on our Engineered Systems business. Our lead times today are in the 20 plus week range.

And Caterpillar and Ariel, two of our main suppliers, Waukesha is another key supplier. They are looking very closely at their supply chains and trying to ramp up and again, we are still in the early phases of this. So, I am not that concerned about it today..

Okay, is your inventory has a significant piece of it, there would be those critical components?.

For sure. It does..

Okay..

And we are working on it. A lot of that inventory will be reduced in the coming quarters based on the big bookings quarter we had..

Okay, got it. And then just, I guess the geographical basis is, the commentary coming into the quarter, I would have expected U.S. probably not to be as strong as it was. And you are just about how strong your outlook is for Canada.

How would you make the three markets in terms of current activity levels, in terms of I guess bookings increase?.

The bookings in the quarter were very close to a third, a third, a third between Canada and United States and rest of the world. So, that’s pretty broad based, pretty evenly split. The pipeline of opportunities are equally positive in all three regions. The Engineered Systems opportunity set in Canada and United States are both very healthy.

And in the U.S., it’s multiple basins around the country. In Canada, it’s almost all Montney shale business. And international, a lot of the activity level is really based on our BOOM projects in the rest of the world segment. So it’s broad based, we are really happy with what we are seeing in all the regions..

Okay. And then just last one for me just on the energy transition conversations that you are having.

Are these typical counterparties for you, are these mostly E&P and midstream companies that you are talking to? Are you getting a more broad based industrial client base coming to you?.

To know what really I am excited about in energy transition is the fact that we are talking to both existing customers that we have great relations with and brand new customers that we didn’t really know before. They are our industrial users in the post and pre-combustion space for carbon capture.

When we look at biofuels, that’s a lot of new customers, when we look at other carbon capture utilization and storage projects, we are working really closely with traditional E&P customers and midstream customers in Canada and the United States.

So, it’s really, it’s like three dimensional, the number of folks and projects and ways we are looking at the different projects. It’s really exciting, frankly, I mean, we have got, over 30 carbon capture opportunities we are currently looking at in various stages.

And those are in the United States, they are in Canada, they are with midstream companies or with E&P companies or with industrial companies. So it’s a lot of fun, the stuff we see coming into the pipeline right now..

Yes. I guess one more question, here.

Just to follow-on with the typical size of those projects?.

They are the size that would be great for modularization. And the tons per day number I don’t have at the top of my head.

But a lot of the work we have been doing with the energy transition team over the last six months, is saying, listen, where do our modular equipment, where does that expertise, where is that best applied to carbon capture and storage.

And not surprisingly, it covers a pretty big percentage of all the capture opportunities that are out there would be well solved with the modular solution. We have a number that sort of modular solutions are really appropriate up to an X ton per annum capture facility. I just don’t have that, but it’s a big percentage of the overall opportunity set..

Okay, got it. Thanks a lot. I will turn it back..

Thank you. I am showing no further questions in the queue at this time. I would now like to turn the call back over to Mr. Marc Rossiter, for any closing remarks..

Well, thank you operator. Since there are no further questions, I would like to once again thank you for joining us on the call. We look forward to giving you our second quarter results in November – third quarter results in November..

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect..