Good day, and welcome to the SNC Lavalin Third Quarter twenty nineteen Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Dennis Jasme. Please go ahead, sir.
Good morning, everyone, and thank you for joining us today. Our earnings announcement was released this morning, and we have posted a corresponding slide presentation on the Investors section of our website. If you are not using today's webcast, please open the presentation as we will refer to it during this call. The recording of today's call and webcast will also be available on our website within twenty four hours. With me today are Ian Edwards, Confirmed President and Chief Executive Officer Sylvain Girard, Executive Vice President and Chief Financial Officer and Nigel White, Executive Vice President, Project Office Site.
Before we begin, I would like to ask everyone to limit themselves to two or three questions to ensure that all analysts have an opportunity to participate. You are welcome to return to the queue for any follow-up questions. Please note that comments made on today's call may contain forward looking information. This information, by its nature, is subject to risks and uncertainties, and as such, actual results may differ materially from the views expressed today. For further information on these risks and uncertainties, please consult the company's relevant filings on SEDAR.
These documents are also available on our website. And now I'll pass the call over to Jan O'George. Jan?
Thanks, Denis. Good morning, and thank you for joining us. As you know, this is the first quarter since we announced our new strategic direction, which is designed to reduce business risk, generate consistent earnings, and cash flow. Our goal is to position SNC Lavalin for long term sustainable success by simplifying the business, focusing on what we do best in the high growth potential, high margin areas of the business where we are strongest and operate as a tier one player. To that end, looking at slide four, our strategy includes a number of components, beginning with the decision to exit lump sum turnkey contracting.
The volatility and the unreasonable risk associated with LSTK projects have been the root cause of the company's financial underperformance. By exiting this contracting model and running off the LSTK project backlog as efficiently as possible, we will be be able to significantly reduce risk while optimizing free cash flow generation from the higher performing parts of the business. To focus those efforts, I also made the decision as part of the new strategy to recognize SNC level into two distinct business lines, SNCL Engineering Services and SNCL Projects. SNCL Engineering Services focuses on our high margin, high performance segments, which include EDPM, nuclear, infrastructure services, and capital. SNCL project is comprised of the LSTK projects for the resources and infrastructure segments and the remaining parts of the resources business.
We also announced that we're exploring all options for our resources segment, particularly our oil and gas business, including transitioning it to a service based business or divestiture. Turning to slide five. While it's early days, this quarter demonstrates that we're moving in the right direction. Our third quarter results were solid and considerably improved over previous quarters. We generated a net income of $2,800,000,000 mainly due to the sale of the 10% of four zero seven.
The proceeds of this were used to to to reduce our leverage and strengthen our balance sheet. Adjusted net income from E and C was up 33% year over year. We had a very strong performance from S and CL Engineering Services, generating year over year and quarter over quarter improvements in backlog, revenue, segment EBIT, and segment EBIT ratio. In contrast, the company did register a loss in SNCL projects in Q3 due to a combination of factors. However, performance did improve compared to the last three quarters.
As we quickly work through the resources backlog, the remaining backlog will be mostly Canadian light rail contracts where we have historically performed well. In summary, we had a solid showing in q three that demonstrates that the strategy is beginning to deliver results. Moving to slide six, in terms of ex exiting LSTK and focusing on efficiently completing projects, the backlog was reduced to 3,200,000,000.0 from 3,400,000,000.0 last quarter, and we remain on track to run off the vast majority of the backlog by the 2021. We have introduced a series of measures to strengthen project oversight, which is being spearheaded by our new EVP, Nigel White, and we are seeing marked improvement in project reforecast. On slide seven, in terms of our focus on SNCL Engineering Services, the high growth potential, high margin parts of the business, we saw significant momentum this quarter.
Each of our
segments, EDPM, Nuclear, Infrastructure, and Capital performed well with some notable EBIT and revenue increases. The EDPM business grew across the board in terms of revenue, segment EBIT, and segment EBIT ratio on a year over year basis. Nuclear revenue was on par with last year, and it delivered strong EBIT margin of 18.5%. The infrastructure services segment generated the most significant growth with revenue increasing 43% compared to last year, mainly due to the contribution from LinxOn. I'm pleased to say that we have also increased our backlog in SNCL engineering services by approximately 1,000,000,000 year over year.
Our book to bill ratio for the nine month period is 1.2 as we continue to win high quality work for SNCL Engineering Services, securing a number of new contract wins over the past quarter. That momentum and the opportunity to work on some of the world's leading engineering projects is what has allowed us to retain our top global talent. Despite the challenges of the company has had in the past year, staff voluntary turnover across the entire company has increased less than a percent year over year, which has not had any impact on the operation of the company. Within former Atkins, for example, turnover actually decreased year over year. And in the last nine months, more than 650 new new graduates joined SNC of Admiral.
Moving to the balance sheet on slide eight, we decreased our debt by 2,400,000,000.0, and our net recourse debt to EBITDA ratio sits within our covenant. As we improve our EBITDA and keep and and free cash flow generation, our goal is to reduce our leverage ratio. This brings me to slide nine, which outlines our plans for the resources segment. We're undertaking a number of actions to derisk and optimize the business, including running off the resources LSTK backlog, which is the root cause of the volatility in this business. Exploring all options for our midstream oil and gas fabrication facility, including a combination of potential divestitures and closures.
And lastly, rightsizing overhead and assessing a possible transition to services for certain components of the mining and methodology and oil and gas business. We continue to make progress, and we will provide updates as decisions are made. Having reviewed our strategy and how we're executing against it, I'd like to now move to slide 10 to talk about where we see the future of the business. That future is with SSCL Engineering Services, And I'll start with EDPM, which has 2,700,000,000 of backlog and 2,800,000,000 of bookings year to date. EDPM is working on some of the world's most transformational projects and is positioning itself at the forefront of technologies shaping the future of engineering consulting sector.
Its value proposition lies in combining deep engineering and design expertise with cutting edge digital technology and data analytics in order to optimize each stage of the project life cycle, enhance productivity for our clients, and provide more certainty in the field. We are seeing growth across a range of sectors in the countries across the world. Key highlights by region would include the following. We were recently recognized for the best use of digital technology at the British Construction Awards for our design work on the Hinkley Point C nuclear power plant in The UK. We were awarded a services contract in the new multiuse corridors initiative in Florida aimed at upgrading highways, sewage, and water treatment and broadband connectivity as the state adapts to a growing population and influx of a 130,000,000 visitors a year.
We've also awarded a significant contract to support Australia's largest freight rail infrastructure project,
part of
the country's plans to spend tens of billions of dollars over the next decade in infrastructure. And in Canada, we're seeing similar opportunities with new infrastructure investment, including the Quebec City Tramway and the new terminal for Montreal Port. Turning to slide 11. With our industry leading position in nuclear services, we are poised to capitalize on growing demand for clean energy, the need to maintain, refurbish, and extend the commercial life of aging infrastructure. These opportunities include the support and refurbishment of the global CANDU reactor fleet in Romania, South Korea, Argentina, China, and Canada, where Ontario alone has a 26,000,000,000 refurbishment program.
The support of non dew can do fleets, including The United Kingdom, United Arab Emirates, and Saudi Arabia, and the increasing demand for decommissioning and waste management for commercial reactors, particularly in Canada, The US, Japan, UK, and Europe through our CDI joint venture accompanied with Holtec International. On slide 12, with regards to infrastructure services, we're moving forward towards lower risk projects and construction management and operations and maintenance service mandates, primarily in Canada and The US. We see significant opportunity to be an integrator on major complex projects that leverage our expertise in PMCMOM and major p three project delivery. Some examples of new business include the ongoing operations and maintenance of the new Ottawa Light Rail for the next thirty years. We're also part of consortium chosen to expand the Montreal Airport, a five year project to improve traffic flow and facilitate transit.
So I'd now like to conclude by saying just how proud I am to be CEO and president of S and C Labeling. To lead one of the top global engineering firms in the world and a great Montreal based Canadian company is something that I personally have aspired to and worked towards all my career. It's a privilege and an honor. More so, it's such a pivotal time in the company's evolution. We have an exciting opportunity to build and grow this business in a way that truly leverages our strengths and our greatest asset, which, of course, is our people.
And we're off to a promising start with a new strategic direction. The third quarter results are a step in the right direction that demonstrate the strategy is working. The future of our business, SNCL Engineering Services, is strong and growing as we continue to win work on transformational projects across the world. At the same time, we continue to actively derisk the business as we successfully run off our remaining LSTK backlog. And our balance sheet is significantly stronger with nearly a billion dollars in cash and $2,400,000,000 in debt reduction.
By generating consistent earnings and cash flow, my goal is to continue to deleverage the company and surface value for shareholders. With that, I'll now turn over to Nigel White, who joined SNC Lavalin in August as EVP of project oversight. Nigel has more than thirty years of experience in managing all aspects of civil, building, foundation, electrical, and mechanical contracts in Hong Kong, UK, and The USA. He was formally with Hong Kong based Gamma Construction about the PC company. Going forward, he will provide regular status updates on the LSTK backlog at each quarter.
Nigel? Thank you, Ian. It is a pleasure to
be here today and be able to provide you with regular updates on the oversight process and how the runoff of the LSTK backlog is progressing. As you know, I joined S and C Lavalin on August 1. And since that time, I've undertaken a review of the project business with a particular focus on the LSTK backlog and the controls in place to manage these projects. I began my mandate by meeting with all the sector presidents, project teams, and traveling around the business to get a better understanding of the management approach to the project's backlog. I then undertook a series of analyses starting with a review of the historic performance of the company's LSPK projects.
From that, there are two points that I would like to highlight on Slide 15. First, LSTK projects have historically generated slightly above breakeven returns. Within the LSTK, mining, metallurgy and oil and gas have also generated breakeven returns, while light rail projects have generated positive returns. Second, that while there could be a fairly wide range on the returns, it is very clear that the Codelco project was a significant outlier and atypical of resources LSDK historic performance. In addition to the historical review, I also conducted a sensitivity analysis of each of the projects currently in the backlog in order to get a realistic view of the best and worst case scenario for each.
With this evidence based understanding of the LSDK backlog, I am now working with the sector presidents and delivery teams to introduce a number of measures to enhance our risk management and optimize outcomes. We are establishing an oversight team and are looking to strengthen our on-site project delivery teams. And we are introducing a number of enhanced controls and strategies. Two examples of which are we we have weekly updates with the senior leadership team to ensure issues are flagged and actioned as quickly as possible. And improved cost management protocols that, for example, simplify the number of cost codes and better align with our supply chain to ensure better project results.
Slide sixteen, seventeen and eighteen provide more detail on the current status of our LSTK backlog. Looking at Slide 16, the vast majority of the remaining 3,200,000,000.0 of LSTK contracts are in infrastructure worth approximately 2,700,000,000.0 or 84%. These are composed largely of Canadian light rail projects where we've had a history of profitable performance. The remainder of the backlog, an estimated 500,000,000, is in resources. These projects are primarily in oil and gas, and the majority are expected to be run off over the next two years.
I think it is important to underscore, however, that while it is not unusual to have issues with these kinds of highly complex projects, we believe the risk is manageable. We have implemented and will continue to implement and improve a series of oversight and management measures that allow us to quickly identify issues as they emerge and deal with them effectively. I, together with the sector presidents and the team, remain laser focused on winding down the remaining backlog as efficiently as possible. Thank you. I'll now hand the call to Sylvain.
Thank you, Nigel, and good morning, everyone. Starting on Slide 20, we have recorded in Q3 a net income of $2,800,000,000 which included a net gain after tax of $2,600,000,000 from the disposal of a 10% stake of Highway four zero seven ETR. Total revenues for Q3 twenty nineteen amounted to $2,400,000,000 The SNCL Engineering Services business line totaled $1,600,000,000 an increase of 11.5% compared to Q3 twenty eighteen, mainly due to a revenue increase of 43% in Infrastructure Services, reflecting the increased level of activity in Linksan acquired in Q3 twenty eighteen as well as an increase of 6% in EVPN. E and C revenue from SNCL project business line for Q3 twenty nineteen decreased by 26% to $851,000,000 mainly due to the continuing backlog runoff of certain major LSTK Resources and Infrastructure EPC construction projects. The SNCL project business line recorded a negative EBIT totaling $45,000,000 in Q3 twenty nineteen.
This negative EBIT was mainly due to three drivers: unfavorable reforecast on certain LSTK projects in Resources continuing underperformance of our oil and gas production and processing facilities in The United States and an overhead structure within Resources that is still too high for the current level of activity. These overhead costs are currently being rightsized and part of our ongoing cost reduction program. In contrast, the SNCL Engineering Services business had a very strong quarter, performing better than prior periods. It recorded a positive segment EBIT of $253,000,000 representing a 16% EBIT to revenue ratio or 12% if we exclude capital. Corporate SG and A for Q3 twenty nineteen totaled $20,000,000 $13,000,000 for E and C only.
Note that the corporate SG and A for Q3 twenty eighteen had a recovery of $15,000,000 as it included a $16,000,000 favorable impact from revised estimates on legacy site environmental liabilities and other asset retirement obligations. Adjusted net income from E and C in the 2019 was $165,000,000 or $0.94 per diluted share compared to $124,000,000 or $0.71 per diluted share for the corresponding period in 2018. The adjusted net income from E and C in Q3 twenty nineteen included the recognition of $83,000,000 or $0.47 per diluted share in income tax recoveries on capital losses from following the disposal of a 10% stake of Highway four zero seven ETR. I will cover this in more detail on the next slide. Our backlog totaled $15,600,000,000 at the September.
SNCL Engineering Services had a backlog of $11,400,000,000 Bookings for the third quarter were almost $2,000,000,000 and totaled 5,500,000,000 for the nine months of 2019, which represents a 1.2 book to bill ratio. SNCL projects backlog had a $4,200,000,000 backlog, representing an 11% decrease compared to the 2018. As a result of our decision to cease bidding on LSTK construction projects. We expect this declining trend to continue. The company's balance sheet was strengthened during the third quarter as we were able to repay significant portion of our debt with the proceeds of the sale of a portion of our stake in Highway 407 ETR.
As of September 3039, the company had $939,000,000 of cash, dollars 1,200,000,000.0 of recourse debt and $400,000,000 of limited recourse debt. We also have $2,500,000,000 in unused capacity under the company's 2,600,000,000 committed revolving credit facility. The net recourse debt to EBITDA ratio calculated according with the terms of the company's credit agreement was 3.4x. Note that in the third quarter, the company and its lenders amended the credit agreement to extend the temporary increase of the ratio to 4x until and including the period ending December 3139. Turning to next slide, Slide 21.
On this slide, we are breaking down the tax items that are impacting our adjusted EPS from E and C. As indicated in the past, we usually target for a 20% tax rate on our E and C business. If we apply this rate to the adjusted E and C earnings before tax, the income tax expense should have been $18,000,000 and the EPS for the quarter should have been $0.41 Due to the geographic mix and other normal course of business tax items, we have recorded for the quarter a lower tax expense of $8,000,000 bringing the adjusted EPS from E and C at $0.47 In addition, this quarter, the capital gain recognized from the sale of our stake in Highway four zero seven ETR is allowing the company to recognize some capital losses within E and C from prior years, representing a tax recovery of $83,000,000 the end result being an adjusted EPS from E and C of $0.94 Turning to Slide 22. As you all know, the free cash flow was materially negative before the third quarter, mainly due to some challenging LSTK projects. This quarter, cash flows from operating activities were significantly less negative at $51,000,000 We expect this improvement trend to continue for the fourth quarter.
2019 year to date cash flows used for operating activities totaled $668,000,000 If we look at the cash flows generated by SNCL Engineering Services business line only, which will be the core of our business going forward, year to date operating cash flows, excluding capital, generated $350,000,000 representing an 88% segment EBIT conversion, while the capital segment generated $128,000,000 We can also see on this slide that the cash flows from SNCL projects are the main cause of our negative operating cash flows for the year. Lastly, as we're progressing on our cost reduction program and due to the recent reduction of our debt, we should see going forward less cash used for interest in restructuring and reduced cash flow uses from other corporate items. I won't spend too much time on the next two slides. Slide 23 details the company's cash and debt position as at September 3039. As previously mentioned, we have significantly decreased our debt balance with the Highway forty seven sale proceeds.
The only outstanding recourse debt that the company now has is three debentures for a total of $675,000,000 and a $500,000,000 term loan. We also decreased the CDPQ loan to $400,000,000 Slide 24 is our traditional slide that summarizes the result by segment. Resources recorded a loss of $47,000,000 due to the three drivers that I've previously mentioned, while all segments under SNCL Engineering Services had a strong quarter. Segment EBIT ratios increased in all segments with 10.6% for EDPM, 18.5% for Nuclear and 10.5% for Infrastructure Services. Note that the Infrastructure Services segment EBIT amount increase was mainly due to stronger performance of our O and M business.
Lastly, you will see that we have included in the appendix of this presentation the 2019 EBITDA by segment as we believe this information could be useful going forward to evaluate the company. This concludes my presentation. We can now open the line for questions. Thank you.
Thank you. We'll now take our first question from Benoit Poirier of Desjardins Capital Markets. Please go ahead.
Yes. Good morning. Congratulations for the good quarter and also for your permanent role, Ian, at SNC. Just on the Nuclear side, could you talk a little bit about the, how we should be thinking in q four and 2020 as new projects ramp up? And could you talk about the recent award in Germany?
Yeah. So I think what, you know, what we've obviously, we're not about to kind of put guidance in for the nuclear sector right now. But what we said in the past that you can expect that the business will perform in line with history in terms of of of growth and profitability. So we we have got numerous parts of the nuclear business, primarily in in in Canada, in in The US, and and in in The UK. And the new award, in in Germany, of course, is a it's kind of a, you know, an exciting award for us based from a from the the European part of the business.
So we've got active projects, as you know, in Canada on life extension, and we've got also the kind of exciting joint venture that we put together with CDI for decommissioning. So I think there are numerous parts to this business that will, that will kind of drive it forward and and keep it on a on a on a successful trajectory. If I
can add, Benoit, just just on the margin rate, I'm assuming that was also something on your mind. I mean we had a very strong quarter in Nuclear at 18.5%. I mean I wouldn't take that as your run rate for the year, but we did say that we would catch up on some of the earlier quarters, which were a bit lower.
Yes. Okay. That's very good color. And maybe one question for Nigel. Since your appointment, I was curious to get your insight and your opinion on the remaining LSA key projects and ability to manage the ramp or the ramp down, Nigel?
So just before Nigel answers that, I mean, it's Ian. I mean and I and I will hand over to Nigel. You know, we're we're we're laser focused on executing these projects, to to to get the best outcome that we that we possibly can. And I and I think Nigel's oversight is really important to ensure that that focus continues. But but there is a point that I'd like to to make, and I know we've made it already in the presentation, that the lion's share, the majority of this backlog now at 2,700,000,000.0 of the 3.2 is in Canadian contracts in light rail.
And I and I just wanna kinda make that point upfront. But Nigel, please.
Yeah. As as Ian said, the the the majority of it exists in the in the infrastructure projects in North Canada, which is 2,700,000,000.0 primarily in light light rail, and we have 500,000,000 in the resources business. That 500,000,000 in the resource business will be mainly completed over the within the next two years, the majority of which over the next, twelve to eighteen months. So the the big focus and the big risk outside of that is the EPC backlog. We're working well with the teams to support and supplement what we previously had to enhance our systems, which we're we're really focused on going for excellence in execution by enhancing the processes and controls we already have.
We did a sensitivity analysis in all these projects. And those risks that we have, we believe are manageable.
Okay. That's very good color. And maybe last one for Sylvain. Could you provide more color whether you still expect cash flow from operation to be positive in the second half? And also whether you could recoup more tax loss carryforward with respect to the tax implication around the Highway 407?
Thank you.
Yes. So we're maintaining what we said last quarter in terms of the second half cash flow performance being positive. The so that's on that. And then as it relates to the tax effect of the four sales, so we're still working through the overall planning. Just to give a bit of color, the cash tax expected right now is slightly below $100,000,000 of cash out on the 407000000 But we're still working it.
Okay. That's very good. Thank you for the time.
Thank you. We'll now take our next question from Jacob Bout of CIBC.
Good morning. Had question
on EDPM. So strong 10.6% EBIT margins. Talk about the sustainability of this and what was the driver here?
So clearly, EDPM is a is is a global business. It is the, the consultancy design, feasibility, professional services part in infrastructure that was evolved from legacy Atkins. It has a a you know, I would call it a a tier one reputation globally, for providing those services. I think the kind of exciting part of, of EDPM is its future in developing its technology arm and and producing technology solutions and digital solutions to to the market. We are on a growth plan.
Primarily, the growth geographies for EDPM are The US where we're absolutely underweight compared to our peer groups, and Australia, is, going through an infrastructure boom where, again, we we are we're we're kind of underweight compared to our our peer group. So we we do think that the, the business is sustainable, and and we do think that the, the kind of strategy we've got for that business is, is is is is will repeat what we've, historically been, been producing.
Okay. So so just to recap here, 10% plus even margins is is reasonable?
Well, towards 10% is kinda historically what what we've been producing. I mean, Sylvain, don't know if you wanna Yeah.
I think
I think you again, very strong quarter in EDPM and not clearly enough to diminish what happened. I think we do have from quarter to quarter some movement. So I would take a bit of a blend of prior quarters to get to your number, but around 10 is the number. Yes.
Okay. And then I guess in the press, there have been a number of articles about you know, the potential of WS Atkins, you know, being up for sale. Do you have any comments on that at all?
Yeah. The the the the strategy of the company is absolutely as we've defined it. SNCL, engineering services is the future of this company. And and the future of the company is absolutely EDPM, the nuclear part of the business, the infrastructure services, and capital. All those are defined part of of of the strategy and defined part of the future.
Okay. That's clear. Last question here. Just around the the DPA. So, you know, clearly, the the Liberals indicating, you know, during the the election campaign that they they wanted to pursue this.
Did it surprise you? And then any update you can provide either on, you know, court date on on the DPA or or anything on the integrity regime.
So so we kinda remain focused on, on defending ourselves through through a court process. And and that's kind of our our our key key focus right now, and and and we're we're we're kind of prepared for that and prepared that it that it goes to that. I mean, obviously, if if there were opportunities for, for settling this in another way, we'd be open to that. But we don't expect it. We're we're we're kind of we're we're we're prepared for the, for the court process.
And you figured it I think I read in in your press release sometime in 2020 is when you expect the, trial to start?
Yeah.
Yeah. But not fixed.
Thank you very much.
Thank you.
Thank We'll now move on to our next question from Derek Spronck of RBC. Please go ahead.
Okay. Thank you very much. I'm just going to drill down a little bit more on the fixed bid remaining backlog. Mean, you have 500,000,000 of remaining backlog in your resource base fixed bid projects. Now, arguably, if there is gonna be a cost reforecasted, it's gonna be on on the total project revenue versus, you know, the remaining fixed bid backlog.
Are you able to provide what the total project revenue are within the resource fixed bid backlog is?
So so on on slide 17, what what we've tried to do here is is give a little bit more transparency of the scale of the resources backlog within the the the, you know, the the the larger projects. So that the, you know, those five projects that are identified there, just to give you a little bit more information as to the the kind of size of the projects. Because, you know, a couple of them are sub 50,000,000, which will probably be burned off quite quickly and and quite small projects. So I don't know if that gives you the information that you need or does Sylvain is the
Yeah. I think we'll try to answer that as well. But if if we don't, just just just restate the question maybe. So so the backlog amount essentially represents the amount of revenues we expect to generate from those. And that's shown on page 18.
You see the phasing of how of how that runoff will happen. So those are the revenues expected from the remaining backlog. So unless unless there are scope changes on any of the projects, and you should you should not see a change to this to this amount of revenue, you might see changes in the phasing as progress can accelerate or decelerate for various reasons. And then the other thing is if there were a cost reforecast, yeah, there would be a typically a true up of your revenue, but it would just be you know, the revenue would essentially come back later. Now, obviously, with a reforecast positive or negative, your margin would move accordingly.
So I don't know if that answers the question, Derek.
Yes, that helps. And just looking at the percentage of completion, is that a relatively linear relationship relative to the remaining fixed debt backlog? Just in terms of understanding the the scale of the of the total like, at the beginning of each project, of the remaining projects that are left
Yeah. Was it entirely linear? Yeah. It's really not linear. And I think I would again, page 18 will give you that color of there's quite a bit in 2020 that's that's running off.
And and the reason it's not linear is you have different components between engineering procurement and construction, and they they tend to move in a different pace. So that that drives some, you know, some changes from quarter to quarter or year to year as the project evolves.
Okay. And and you you Nigel mentioned that he he's done some sensitivity around the both the, you know, positive and and and and a more negative scenario. Are you able to provide any details around those, you know, those two kind of outcomes?
I I think what I I can say on that is it is within LSTK style contracting, there there is all sorts of risks and issues. These are highly complex projects. So things do to change, and there are scope changes as as you go through the project. And these are these are huge prototypes that have never been built before, so expect the unexpected. What I can say about that sensitivity analysis is that is that, we believe that the risks that are are highly manageable within within that sensitivity.
Yeah.
And I and I, you know, I would just add to that that the the the smaller share of this backlog is is in results, and I know I've said this, which if you look at the table that we try to add a bit more transparency on that, you know, you could conclude from that that that there's a couple of small jobs. You know, one that's 90% complete, and then two, with any sort of significant backlog left in it. But the rest of it, the $2,700,000,000, is in, is in Canadian contracts, which, you know, I repeat of of of of can traditionally and historically for us gone well.
Okay. No. That's great. And and the and the additional disclosure all around is helpful. And then just one last one for myself.
Just just on on the Montreal REM, I mean, obviously, there's been some press releases or or information in the news that has come out. Can you provide an update and and kind of your thoughts on that project?
Yeah. For sure. For sure. I mean, the first thing I'd say is, you know, the REN project is a is a fascinating, fantastic project. Right?
The 60 odd kilometers of, of urban railway. But what you might expect with that, is, you know, multiple interfaces, whether it's, you know, the the old tunnel that we've gotta deal with or the the airport that we're interfacing with or all the communities that the railway travels through, the the existing bridge that we've gotta build across. There's there's there's these multiple interfaces. And I think what's really, really positive, which obviously was kinda missed in all the media, is the the project is ahead of schedule. So the work that was done with our client to get this project into that state is is is truly almost kind of, I wouldn't say it's unique, but it's remarkable to get it there.
Now now clearly, there's some challenges. There's challenges with any complex project like that, and and we've gotta work through those challenges with our client to optimize the best results, for for the project. And that and that's and that's what we're doing.
Okay. And that's that's great. Thanks for the color, and congratulations, Ian, on the appointment.
Thank you.
Thank you. We'll now take our next question from Mark Neville of Scotiabank. Please go ahead.
Hi, good morning. First, Ian, congratulations. Maybe if I can just start with the resources. There was additional reforecasts this quarter. Maybe just a little more color on that, if it was one particular project or multiple and one that project or projects may finish.
So, I mean, I think we said it in the script, but I'll give a bit more color both from myself and Sylvain. I mean, I I think what it's disappointing. Okay? So so the first thing I'd say is that the the the number that we we got out of that was a disappointment to us. What is interesting is it comes from three components.
And the three components are some reforecasts on some projects that are nearing completion. There's losses attributed to the fabrication facility, which we're in the process of either divesting or closing down. And there's losses due to the, the need to right size the overhead as we reduce the activity on the the lump sum turnkey part of the business. So the way I look at that is is two of those components are really fixable, and we will fix. I mean, Sylvain, if you have
Yeah.
What I what I said specifically on the reforecast, it is a smaller component of the three. It is spread across a number of projects. It's not a single one. And and you had some positives and you had negatives. This quarter, it was a net negative.
But we're working through the remaining of the backlog and obviously try to contain this and hopefully get some positives as well in there.
Good. Yeah. In your again, in your remarks, you've talked about sort of advancing a number of alternatives for the business. Is there anything more detail you can give us as maybe just trying to handicap sort of what happens here or when something may happen?
Well, yeah. I mean, clearly, you know, we're ex I mean, the biggest component, let's exit the LSDK, burn that off, and put that behind us. We're we're absolutely looking to to to move away from the fabrication midstream fabrication facility that we've got. I mean, now that we're not in the lump sum turnkey business, it really doesn't complement, you know, our business going going forward. So that leaves really the the services side of mining and metals and the services side of the oil and gas business.
And and we we just wanna be really sure that this is, you know, gonna produce the the kind of the kind of cash flows and earnings that we want in the business going forward. And we're we're doing a lot of analysis around that now to, to to understand if, if if that's what we want as part of the future.
Okay. Maybe just on the cash flow. Sylvain, just I think you said you're reiterating what you said last quarter in terms of the cash flow. Can you just remind us exactly what that was?
I think what I said last time was that the operating cash flow of the second half would be positive, but that Q3 would be negative.
So if I understand, again, there's quarter to quarter sort of volatility, lumpiness and just like there's some projects you're working through and maybe some claims outstanding. But is there a line of sight for us sort of when it sort of becomes like normalized or like just maybe a little more consistent? Yes.
Well, it should. I mean, if you look at this year, the big issue or the set of issues we face with the cash flow has been the the losses in the project side of the business, which these losses have translated into cash. And we started the year with, you know, $250,000,000 of cash out expected out of Codelco, which the P and L impact was taken in our 'eighteen results. So you get already bit of an EBITDA cash difference and a drag. And then we had you know, further we had other issues as well as as we closed last year, but we had more of the same in q one and especially q two.
So that's that's creating a bit of a something not normal in the profile of the future. So as as of now, you you you could start to expect things to start normalizing as as we burn off the source of these this volatility. So that's Yeah. You know, q three being an example and then q four continuing, and hopefully, we carry it on 2020.
Yes. I guess that was my question. So if you book these losses, you're still working through the project, but it sounds like as we sort of finish this year, that sort of resolves itself?
For the most part.
Right. Okay. And sorry, just on the 04/2007, did you say $100,000,000 cash tax associated with the sale? That was your expectation?
That's kind of what for that's basically we've been asked the question a number of times, and we're still working for the cash tax planning around it. And that's where we are right now, and that's continuing to evolve.
Okay. Sorry. Just maybe one last one then. Just the leverage, 3.4 x on the covenant. I'm just doing some math.
And if it's right, I guess, it looks like the debt as per that calculation would be about €1,300,000,000 which would mean EBITDA in and around $375,000,400 million euros But in the EBITDA, there would be roughly $400,000,000 of losses that would not have been adjusted for, again, excluding the Codelco. Is that are those numbers about right?
Don't Mark, why don't we take this offline? You can call me and I can go through the numbers exactly with you.
Sure. Will do. Thank you.
Thanks, guys.
Thanks, Mark. Thank
you. We'll now take our next question from Yuri Lynk of Canaccord. Please go ahead.
Hey, good morning,
Good morning, Good
Just looking to get a bit of a better idea of what's going on in the oil and gas business outside of of the lump sum turnkey. I mean, was, most of that work was, you know, cost reimbursable maintenance work. Sorry. Pretty pretty recurring. So are are you still bidding work in that section of of Kents, we'll call it?
And and how is that business performing? And then are you able to retain people in in this environment?
Okay. Yeah. So, yes, we are bidding. And and I think in the in the wins in the quarter, there was at least one, win. So the there's there's there's kind of a couple of components there in the current oil and gas business that were services.
Some were actually legacy Atkins, out of The UK, and some of it, as you say, was the the services part of of Kent and and to some extent, the the legacy S and P. So primarily, those kind of services parts of the business, such as design services, you know, feasibility, some commissioning type work, and some sort of closure type closure of of asset shutdown type kind of work. And it's kind of spread between The Middle East, some of it in The UK, and and and North America. So, yeah, absolutely, we're continuing to bid, and, and and we are, we are picking up work. Oh, sorry.
To add to that also is the, the services part of the mining and metal business, which was the the the kind of SEC level and legacy mining and metal business, which, again, we're we're bidding kind of services work or or or ECTM type work, but not obviously, not any, any any lump sum construction.
Okay. That's helpful. Just a a a a following up on another question as we look towards the, you know, the start of the trial next year. I was just curious what proportion of engineering services revenue is is generated in in Canada?
The we'd have to answer that. The the EDPM, which is mostly an EDPM Canada, I think you're referring to, that's that's in the range of 400,000,000, but that's spread across many, many projects. I I think in what we've said in the past when you were asked is Canadian federal revenue, it was more like half a billion, was what we had, and most of that being Champlain.
But if you if you if you think of our business kinda going forward, our engineering services business would be it would be unlikely that we would be working directly for the federal government. Unlikely, because we'd be working for a consortium that was working for the federal government. So by kind of, exiting the lump sum turnkey model, it kinda de risked our exposure to the federal government. Not not not eliminated, but but reduced.
Right. But could you give me a, like, a a go forward rough percentage of of engineering service revenue from from Canada, all sources, nuclear, everything?
Directly, no. I mean, other than what we said. Right? So EDPM is about 400 in total. The in the past, the biggest exposure we had was Champlain.
And if you exclude that directly to federal, it's not it's not that much.
Okay. Last one for me. Just any update on on capital allocation priorities and and how you're thinking about m and a. You mentioned being underweight in Australia, The US versus buybacks. Updated thoughts on that now that the the balance sheet is in better shape.
I'll turn it over. Thanks.
All of our of our intent right now is deleverage.
Thank you. We'll now take our next question from Chris Murray of AltaCorp Capital. Please go ahead.
Thanks. Good morning. So there maybe if you can take Just this for looking at your provisions line, I guess there's a few moving parts in there and we don't get the disclosure on the interims that we do on the full year. But I'm just wondering if you can give us some breakdown of what's left in terms of cash outflows for contracts that are in loss positions. And along with that, I don't know who wants to take this one, Can you also give us an idea of what the agreement with Codelco actually implies on a cash basis for you?
So
I mean, I won't answer in great details, but just to give you maybe some color, when you look at page 17 and you have the list of projects, on that list, within resources, you you essentially have the the first project that is a project at loss. And and that's the one that will have a net cash out because of that loss. Now that project is got less than $200,000,000 to go. So so that's that's something we should expect. Then then at the bottom of the page in the infrastructure where we had some you know, the last two were were at loss, a slight loss on on the LRT.
But but, basically, those have already had most of the cash out to be expected from being at loss because they're basically in operation at the moment. Overall, for LSTKs, you know, we are expecting the runoff to be still a positive event, is what I'd say. Now on Fidelco, I'm not going to say more than what we said in the press release. It was not material from an EBIT nor a cash perspective.
Okay. All right. I'll leave it there. That was my only question. Thank you.
Thank you.
Thank you. We'll now take our next question from Frederic Bastien of Raymond James. Please go ahead.
Hi, good morning. My questions relate to the Infrastructure Services business, which saw a big jump in profitability. You did bring up some of the reasons why, but could you delve further into the explanation why we saw a big jump on the, especially on the OEM side?
Yeah. I mean I mean, I'll we'll jointly answer it with Sylvain. But, I mean, one of one of the biggest kind of, jumps compared to last year was the introduction of Linksong. So so Linksong is reported through that. That's our joint venture with ABB to provide services for the installation of, of substations.
So that's one component. I think the other component is is some, some projects coming online such as, such as the Ottawa Light Rail that that brings brings O and M in into the business.
Yeah. Just just to just to add, I think the the links on point adds, certainly adds to revenue. I think it's still in ramp up phase, so we are getting, a little bit of a pickup on on EBIT, but that's on the EBIT side, that's not the biggest driver. As we've said in my as I said in my prepared remarks, I was mainly O and M. And and as the team worked through, you know, some of those contracts, there are you know, we restate those contract as we go along, as we execute, and as we find ways to optimize the margin generation on these contracts.
So we had as we do every year, we relook at our contracts and we reassess the margin potential, and that does create some positive for reforecast on those. Well, I mean, I would add
that I mean, this is kind of, for me, a really exciting part of the business. You know, as we see some clients kinda globally moving away from lump sum thinking contracting, moving to alternative methods of procurement, this is the part of the business that's gonna, that's gonna drive that for us for ourselves.
Okay. Next question. You you did mention, or at least you, you cautioned to expect for us not to expect miracles on that cash flow in the third quarter. But you did working capital did eat up over $2,000,000 of cash. Was that largely as anticipated?
I would say yes. I'm not sure if we said don't expect miracles at the time, but we did say to expect the usage simply because of the losses recorded in in the lump sum projects. But, yeah, the quarter for us is is in line with our expectations.
Okay. And then a small adjustment to purchase price you paid for a business. Would you mind giving us a bit more color on that?
I think this was the closure of the links on you you mean purchase price adjustment? Is that what you said?
Correct. Yes.
Yeah. So yeah. So it's the completion of the links on, purchase accounting period.
And that would have been reported under infrastructure services?
Yeah. Linxon is part of the infrastructure services. Yes.
Okay. That's all I have. Thanks, and and congrats, Ian.
Thank you. Thank you.
Thank you. We'll now take our next question from Maxi Sytchev of National Bank National. Please go ahead.
Hi, good morning gentlemen.
Good morning. Hey Maxi, good morning.
Just a quick question maybe to Sylvain. First of all, the covenant increased to four times by December. Is that just a function of the rolling kind of Q4 and just the LTM EBITDA? Or how should we read into this?
Well, all there is to read is we have that covenant for the first two quarters with our banks. And early in Q3, we just proactively worked with them and agreed to just extend it through the year as we work through our deleveraging plan. So there's not much else to read into it. The the 3.4 we closed this quarter in terms of the covenant is within that. It's also within our contractual covenant of March, so that's good.
And the driver, as you well know, the driver of the CALC is is more of the the poor EBITDA of, you know, especially the last three quarters. And and as we just burn those off, you know, the covenant should get back in place. So and and and we always knew that q three would be a bit of a pinch.
So that's where we are.
And and I guess we should think
So should we expect the the leverage metric to come down in q four, especially as you allude to, generating positive OCF?
Yeah. I think we're we're basically, as I said, we have, you know, four quarters where three of them are pretty difficult within that number, and q three that we added this quarter was still a bit lower than the same quarter last year because Resources had positive EBITDA last year. As we look at Q4, we should be replacing a lower performing quarter with a better performing quarter.
Okay.
You can run the math from there.
Right. And is it fair to say I mean, obviously, as you had another provision in resources that right now you have kind of, you know, wrapped your your hands around all those projects that we should be assuming basically breakeven, on a going forward basis for LSTK kind of as a as a as an item?
Well, I don't think we wanna be definitive about where where we see the actual results, but but what we, you know, what we can say is that we have got our hands around the jobs. That historically, you know, 2,700,000,000 of those jobs have performed really well, and the 500,000,000 have performed above breakeven. So we we we we've never said there isn't zero risk in this business, but we've got a really good handle on it. I think that's that's how we're feeling now.
Right. No, that's fair enough. And actually, Ian, in terms of your commentary around the compression business, suppose you alluding to kind of
the legacy
Valaris sort of assets. Can you maybe talk about you know, what what is, the market, for for those types of, companies if, you were trying to offload it? Just, you know, trying to think if if there are actually, you know, potential buyers even if you wanted to sell this this particular piece of the business.
Well, obviously, we're in the process. So so I I don't I don't really wanna comment on the the the viability of that. But as soon as we've got a fix on it, we we will be announcing. And and, yeah, you know, obviously, you're you're right about the, the asset. I mean, and and and as I said before, I mean, it doesn't really fit with us anymore.
I mean, it's but that's not to say that it doesn't fit with other with other companies and with other owners because it is a it is a viable asset. It's just that we we, you know, we we we we got it with the acquisition of Kents. Kents had acquired it, because they are flow through from their LSTK business. And, and, obviously, that's not no longer the case for us.
Right. And is there a potential timeline that you feel comfortable telegraphing or not not at this moment specifically?
No. I don't think we could share that now, but, obviously, it's, it's, absolutely on our agenda to get this done.
Okay. Excellent. That's it for me and congrats on the appointment.
Thank you.
Thank you. We'll now take our next question from Michael Dufome of TD Securities. Please go ahead.
Thanks. Good morning. Just wanted to go back to the leverage ratio and the covenant. So then can you confirm in the third quarter, was the covenant, it was 3.75?
No. It was four. It was it was agreed yeah. It was four as well. Yeah.
Okay. So it's been it's been four all year, and this extension is just keeping it at four through the remainder of the year.
That's right. That's right. So that's exactly right. The the it was extended early '3 for the rest of the year.
Okay. I I guess I was under the impression that it was gonna be 3.75 times in the third quarter, but so maybe I'm just the fact that you got that extension in place in the early in the third quarter, did that take it from what was supposed to be 3.75 at one point in the third quarter up to four for the third quarter?
The the, I guess, the original agreement or the that we have in place is at three seventy five. And at the beginning of the year, we agreed to go to four for two quarters, and we revisit that revisited that with our bankers in q three to make to keep it at four through the rest of the year as we work through our deleveraging plan. Now it you know, you could you could argue it wasn't necessary because we closed at three point four, and the normal covenant or the the covenant would have gone back to $3.75. But but we did that proactively just because we're we're just trying to manage, you know, manage proactively our relationship with the banks.
Okay. All right. Now that makes sense. You were asked about Infrastructure Services and the strong performance there from a margin perspective. I just wanted to clarify, mean, you referenced the favorable impact of some reforecasts related to O and M contracts.
Is that a onetime benefit that would have come through and help the margin in the quarter? Or is that some sort of a sustainable benefit? And I guess the bigger question really is, what is the right way to think about margins in that Infrastructure Services segment going forward? Because they were a lot higher this quarter than anything we've seen.
So, I mean, I I I think there is a component there of of one off re reforecast. But but I think the way to think about the business is obviously, you know, looking back, and its its historical performance, which I would say is, kind of at the higher end of single digit. Right? So that's the way I think about this business. I mean, it's absolutely part of our future, and we would expect to see that growth from this sector as we move further into kind of PMCM type jobs, integrator role jobs, you know, alliance type contracting, you know, all of that as well as the the the, obviously, the the O and M business that we've been operating for for for a long time.
Yeah. Just just to add to that. I mean, in the O and M business, they have they review their contracts on an ongoing basis, and they try to optimize, the delivery of of the work. So they will have reforecast like this on an ongoing basis. And and last year, we had similar similar set of effects.
They they don't they don't come in the third quarter necessarily. They come in as these contracts are reviewed. So that's the way to think of it. Now I think what Ian said in high single digit run rate type margin is probably the way to think of it. So a bit stronger in this quarter, but that's just going to evolve quarter to quarter as contracts are optimized.
And I mean, I guess I understand the sort of outlook commentary you're providing around the margins for this business going forward being high single digits, and maybe that's the most important point. But when I look back historically, mean, I guess we only have about six quarters of history before we got the third quarter number. And the highest margin that was ever delivered was 7.5%. And more frequently, we were sort of in the high 3% or mid-four percent range. So what is it that is now allowing you to do high single digit margins in this business?
Well, I think yeah.
I think the o and m business, the long term piece of it and the additions to the contracts to the additional contracts that we're seeing in that business are contributing to a better mix within that. That's basically all I could say on that.
Okay. And and so I guess one of those was the Ottawa LRT coming on. Were there others as well?
There's been some wins, through the year in social infrastructure. I can't think of anything else specific that would would change that. And, this, you know, this this part of the business kind of got recreated in the in the strategy. So we're also in the process of obviously rightsizing the overhead for this business. But I don't think we can sort of add anything else to that.
No.
Okay. Fair enough. And I guess just on on that point with respect to the overhead rightsizing, I guess you've essentially reiterated your cost savings guidance. Can you talk about what the run rate savings level you were at was, I guess, the end of the third quarter? And how we see that progressing as we move forward?
Well, I'm not sure we are kinda looking at that way. I mean, what what what we we have to achieve is that when we get to the end of this year, that the run rate, going forward into 2020 has delivered $250,000,000 of of savings. And we're we're absolute we're on target for that. I think we also said that we would save within this year, a 100,000,000, and and we're on target for that, which obviously means that the majority of that, with only two months to go, has been done. I mean, we're pretty confident with a cheap boat.
So I think that's that's kind of how we look at it.
Okay. Just lastly, and and this goes back to something that, I believe it was Derek asked earlier, but I'm just trying to reconcile the change in the LSTK backlog to the actual revenue that you delivered. So it's a little hard in resources because there's more than just LSTK work flowing through that one. But we look at infrastructure EPC projects, the LSTK backlog is down about $155,000,000 sequentially quarter over quarter. Yet the revenue delivered in that segment in the quarter was $289,000,000 So you're doing a lot more revenue than the actual work off of backlog.
I'm not sure if this is sort of what you tried to address earlier or answer earlier, but can you just explain the variance there again?
I think most of that comes to scope changes. So then that'll be one thing as we work the burn off is if there are elements of these projects that the client is changing that that could increase the revenue for those projects. So we're not we're not bidding on new work. We're not taking on new work, but there are contractual obligations to perform. So we've had a bit of scope.
Without being too specific, there there was a couple of things that were were pretty large in terms of scope change that happened in the quarter. They were probably not typical going forward. Yeah. They they put backlog in for but but but not kind of we shouldn't kinda see that to the same extent every quarter.
Okay. Helpful. Thank you.
Thank you. Ladies and gentlemen, that's all the time we have for questions today. Mr. Dennis Jasmin, at this time, I would like to turn the conference back over to you for any additional or closing remarks. Thank you.
Thank you. Thank you. I know there's a few individuals still in the queue. I'm sorry, I apologize for that. But it's 12.593, and we'll be out to end the call.
If you have any other questions, please don't hesitate to call me. Will be my pleasure to answer any of your questions. Thank you very much, everyone, and have a beautiful day.
Thank you very much. Thank you.
Ladies and gentlemen, this concludes today's call. Thank you for your participation. You may now disconnect.