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. If anyone should require assistance during the conference, please press star then zero to reach an operator. As a reminder, this call is being recorded. I will now turn the call over to Blair Goertzen. You may begin.
All right. Thank you, operator. 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 30th, 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 investor section. During this call, unless otherwise stated, we will be referring to the three months ended June 30th, 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 CAD 373 million represented Enerflex's second strongest quarter for bookings since 2014. This was driven primarily by the U.S.A. segment, which continues to see significant activity across numerous resource basins in the region and for a variety of product offerings. Enerflex's backlog in Engineered Systems in the U.S. had a total of CAD 749 million, a 12% increase compared to backlog at the end of 2017. This provides good visibility for Engineered Systems revenue throughout 2018. Subsequent to the end of the quarter, the company recorded bookings of approximately CAD 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 U.S.A., the company continues to grow the rental fleet, expanding on the U.S. 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 contribute to increasing recurring revenues for this segment. During the quarter, Enerflex invested CAD 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 a 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 investment in the country. The new president has expressed his desire to make Pemex more productive, which may be positive for the market, since compression service is 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 remains 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 CAD 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 strategy of geographic diversification has significantly lessened the impact of the challenges of the Canadian market, and Enerflex is not solely dependent on the Canadian activity to drive growth and 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 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 CAD 0.095 a share, which is CAD 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 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 U.S.A., 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 U.S.A. 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 CAD 72 million compared to CAD 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 CAD 44 million compared to CAD 45 million. The slight decrease of CAD 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 CAD 20 million, or CAD 0.23 per share, compared to net earnings of CAD 21 million or CAD 0.24 per share in 2017. Adjusted EBITDA was CAD 51 million versus CAD 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 an 11% decrease year-over-year compared to 2017, with lower bookings in Canada and rest of world segments, partially offset by CAD 302 million of bookings in the U.S.A. segment. Enerflex saw a CAD 78 million increase in backlog compared to December 31st, 2017, due to strong bookings in the U.S.A. and lower Engineered Systems revenue recognized in the quarter.
Backlog remains strong at CAD 749 million, which provides good visibility for this product line through 2018. Subsequent to the end of the quarter, Enerflex received a partial ruling related to the Oman Oil Company Exploration & 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 $30 million U.S. 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 U.S.A. segment, Enerflex's bookings of CAD 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 CAD 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 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 the world, the CAD 24 million of bookings include CAD 17 million for a power generation project in Australia. This segment's bookings are typically larger in nature and as a result, are less frequent. Backlog of CAD 85 million at June 30th, 2018, decreased by CAD 18 million relative to December 31st, 2017, due to Engineered Systems revenue outpacing bookings. Revenue in the rest of world segment for the second quarter was CAD 117 million. This increase of CAD 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, while 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 CAD 11 million represents a CAD 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 CAD 47 million, a decrease of CAD 74 million compared to the same period in 2017. While lower than the comparative period, it should be noted that this quarter's bookings were CAD 30 million higher than the bookings from the first quarter 2018, and the company continues to see healthy inquiry levels, which was reflected in booking subsequent to the quarter, totaling CAD 160 million.
Revenue in Canada was CAD 69 million as compared to CAD 100 million in the second quarter of 2017. This CAD 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 CAD 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 the liquidity, the company has access to a significant portion of its bank facility for future drawings to meet the company's future growth targets. As at June 30th, the company held cash and cash equivalents of CAD 306 million and had drawn CAD 175 million against the bank facility, leaving it with access to CAD 538 million for future drawings. The company continues to meet its bank facility covenant requirements with a bank-adjusted net debt-to-EBITDA ratio of less than 1, and an interest coverage ratio of greater than 11 times to 1. With sustained pricing gains, Enerflex is optimistic that customers will increase capital spending and production, translating into increased demand for Enerflex's products and services.
We anticipate increases in activity levels in the U.S. 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 this strategy in the U.S. 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 9th press release. We will now be happy to take any questions. Operator?
Ladies and gentlemen, if you'd like to ask a question, please press star then one. If your question has been answered and you wish to remove yourself from the queue, you may press the pound key. Once again, to ask a question, please press star then one. 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.
Thanks.
Couple quick ones here. On the subsequent wins, the CAD 294 afterwards, you mentioned CAD 160 million was in Canada. Can you give us any color on what the other CAD 130 was like? Is that predominantly U.S., rest of the world, widely diversified, focused?
Yeah, no, it was pretty much split roughly 50/50 between the other two segments, Greg, for the booking subsequent to the quarter. 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, it 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? What can you do in terms of revenue per quarter, I suppose, for Engineered Systems? When would you have to expand your capacity, and then what would that expansion look like?
Yeah, Greg, it's a great question because it's been part of our thought process here for the past six months. Not getting into what we do have for capacity, but we are expanding our Houston facility as we speak by about 100,000 sq ft. That's going to give us an opportunity to
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%. That's going to have some meaningful impact on our ability to de-bottleneck 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 and what we needed in the queue as well. 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 facility and also our supply chain around some of these long lead items.
That's interesting. That capacity increase, is that underway now? When would we expect it to be, I suppose, commercially live?
Yeah, it'll be ready to go early Q1.
What's the total cost of that, Blair? Is that included in your announced capital budget or incremental?
Incremental.
Yeah, that would be incremental.
Yeah. Single digit million, tens of millions, hundreds of millions? Just order of magnitude.
Yeah. It's about CAD 18 million-CAD 20 million is what we've budgeted.
Great. 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%. We see an industry growth rate of around 10%, implying that you're taking quite a bit of market share. Could we expect this kind of growth rate to continue if we project on into late 2018 into 2019, 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. I think we are getting our fair share of the market. I think that there could be some modest market share increase for ourselves. 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. We're probably even tempering some of our growth given the fact that we want strong service support for this equipment when it hits the field. We don't see any reason to, at this point, back off on that sort of 30% growth over what we've seen in the last 12 months.
Okay, that's fair, and that makes sense. I guess just lastly from me, kind of comes up every conference call, 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?
Yeah, 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, we would expect that to get stronger by a couple of percentage points here into Q3 and Q4.
James, is that because of pricing power, or is that because of product mix?
It'll be a little bit of both, Greg, for sure.
Got it. That's it for me. Thanks a lot.
Once again, if you'd like to ask a question, please press star then one. Our next question comes from Jon Morrison of CIBC. Your line is open.
Morning, all.
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? Is line of sight in the U.S. Rockies starting to look better just given some of the emerging gas take-away issues that we're seeing in that market?
Yeah. From our standpoint, we like to see diversity in the bookings across multiple resource basins, 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. If we compare bookings activity in 2017, roughly 65%-70% of it was concentrated in the Permian. For the same period in 2018, the first six months, that's dropped down to about 35%-37% Permian, 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. We have seen a lot more diversity, as I said.
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?
No, 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 a backlog standpoint, Blair 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? 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 midstreaming activity, which is consistent with what we've said on the Q1 calls relative to the inquiry levels that we're seeing in Canada right now. 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.
James, would it be fair to say that you likely believe that this is an inflection point in Canada? Realistically speaking, based on both the bookings that you've 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 would be fair to say that from a booking standpoint, we've definitely hit an inflection point and a backlog standpoint. We've seen multiple or sequential declines in backlog and the activity we saw to begin Q3 is going to shift that. I want to be careful in terms of when that starts contributing materially, though, to Canadian results. It would be fair to say that we'll probably get some contribution in Q4 from these projects, but the lion's share of these bookings will be recognized in 2019 within the Canadian segment.
Okay. That's very helpful. There's obviously, or there was some issues in the International segment last quarter. There's 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. You touched on it. We didn't recognize any further margin erosion on that project.
Okay. Positive to see the OOCEP ruling 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? 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 come through it where it's at, it could actually be higher in the coming period?
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. Both parties obviously agreed to advance through the ICC arbitration court. As a result of that, the ruling is considered binding. That's the answer to the first part of your question. The second part of your question, yes, there is a third part to this, which will deal with costs that we've incurred with respect to this process. There's going to be another round of submissions to the tribunal to make an argument for cost recovery. We would expect that decision to be tabled by the end of this year, based on the guidance that we're getting.
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, while I realize that you say that you're adding square footage, 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's obviously a crunch across the U.S. supply chain, even in terms of outsourcing carbon steel welding. This expansion is to debottleneck some of that. 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 an opportunity to meet faster schedules. It all works in concert together. We've got good supply chain on carbon steel welding, now it's to really accelerate our ability to package and do processing and spools.
Perfect. Last one, just for me, how active is U.S. rentals bidding right now in terms of new opportunities? Can you give any sort of a magnitude of what you have on your radar screen from an aggregate value or horsepower perspective that you might be bidding on?
Yeah, it's very active for the U.S. rentals business at the moment. Again, the platform that we acquired was gas lift, which is smaller horsepower. That's pretty active at the moment. 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 active, primarily in the Permian Basin, but it's not limited to the Permian either.
Is it more active than it was three or six months ago, Blair?
I'd say it would be relative to what was happening three to six months ago. Clearly, even out into next year, there is significant opportunities.
Appreciate the color. Good quarter. I'll turn it back.
Thanks, John. Thank you.
Our next question is a follow-up from Greg Coleman 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'm 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.
Yeah.
I just want to get an opportunity to talk about it.
Yeah, no, appreciate the follow-up question. We've been pretty clear about 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. As contracts obviously come up for renewal, we have been trying to push those increases through. We wouldn't expect any material margin erosion as a result of that. Obviously, it's just steel prices with the tariffs that we've been very careful to manage and are going to be managing aggressively on future bids. Those are the two areas that we've been focused on. I wouldn't expect material margin erosion arising out of those two matters.
Great. Good to know. Finally, just on Saudi Arabia, given the current news, I'm sorry, I might have missed this with Mike's questions. I don't think he touched on it, though. Could you remind us what your exposure to Saudi Arabia is right now and also in the backlog?
Yeah, there is no impact at this point for our business with the Saudi Arabia-Canada political issue.
Great. That's it for me. Thanks very much.
Thanks, Greg.
There are no further questions. I'd like to turn the call back over to Blair Gertsma for any closing remarks.
All right. Thanks, operator. 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.