Good day, and welcome to the SNC-Lavalin third quarter 2019 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Denis Jasmin. 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 24 hours. With me today are Ian Edwards, President and Chief Executive Officer, Sylvain Girard, Executive Vice President and Chief Financial Officer, and Nigel White, Executive Vice President Project Oversight. 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 risk and uncertainty, 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 filing on SEDAR. These documents are also available on our website. Now I'll pass the call over to Ian Edwards. Ian?
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 1 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 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-Lavalin into two distinct business lines, SNCL Engineering Services and SNCL Projects. SNCL Engineering Services focuses on our high margin, high performing segments, which include EDPM, nuclear, infrastructure services, and capital. SNCL Projects 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 are moving in the right direction. Our third quarter results were solid and considerably improved over previous quarters. We generated a net income of CAD 2.8 billion, mainly due to the sale of the 10% of 407. The proceeds of this were used to reduce our leverage and strengthen our balance sheet. Adjusted net income from E&C was up 33% year-over-year. We had a very strong performance from SNCL 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. 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 Q3 that demonstrates that the strategy is beginning to deliver results. Moving to slide six, in terms of exiting LSTK and focusing on efficiently completing projects, the backlog was reduced to CAD 3.2 billion from CAD 3.4 billion last quarter, and we remain on track to run off the vast majority of the backlog by the end of 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 CAD 1 billion 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 the company has had in the past year, staff voluntary turnover across the entire company has increased less than 1% 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 graduates joined SNC-Lavalin. Moving to the balance sheet on slide eight, we decreased our debt by CAD 2.4 billion, and our net recourse debt to EBITDA ratio sits within our covenant. As we improve our EBITDA 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 are undertaking a number of actions to de-risk 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. Lastly, right-sizing overhead and assessing a possible transition to services for certain components of the mining and metallurgy 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 are 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 SNCL Engineering Services, and I'll start with EDPM, which has CAD 2.7 billion of backlog and CAD 2.8 billion 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 build. We are seeing growth across a range of sectors in the countries across the world. Key highlights by region will 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 U.K.
We were awarded a services contract in the new Multi-Use Corridors Initiative in Florida, aimed at upgrading highways, sewage and water treatment, and broadband connectivity as the state adapts to a growing population and an influx of 130 million visitors a year. We were 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 CAD over the next decade in infrastructure. In Canada, we're seeing similar opportunities with new infrastructure investment, including the Quebec City Tramway and a 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 CAD 26 billion refurbishment program. The support of non-CANDU fleets, including the United Kingdom, United Arab Emirates, and Saudi Arabia. The increasing demand for decommissioning and waste management for commercial reactors, particularly in Canada, the U.S., Japan, U.K., and Europe, through our CDI joint venture, a company with Holtec International. On slide 12, with regards to infrastructure services, we're moving forward towards lower-risk projects in construction management and operations and maintenance service mandates, primarily in Canada and the U.S. We see significant opportunity to be an integrator on major complex projects that leverage our expertise in P&CM/OM and major P3 project delivery. Some examples of new business include the ongoing operations and maintenance of the new Ottawa Light Rail for the next 30 years.
We're also part of a consortium chosen to expand the Montreal Airport, a five-year project to improve traffic flow and facilitate transit. I'd now like to conclude by saying just how proud I am to be CEO and President of SNC-Lavalin. 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 at 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. 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 de-risk the business as we successfully run off our remaining LSTK backlog. Our balance sheet is significantly stronger, with nearly CAD 1 billion in cash and CAD 2.4 billion in debt reduction. By generating consistent earnings and cash flow, my goal is to continue to de-leverage the company and preserve its 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 30 years of experience in managing all aspects of civil, building, foundation, electrical, and mechanical contracts in Hong Kong, U.K., and the U.S.A. He was formerly with Hong Kong-based Gammon Construction, a Balfour Beatty 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. 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 undertook a series of analyses, starting with the review of the historic performance of the company's LSTK projects. From that, there are two points that I would like to highlight on slide 15. First, LSTK projects have historically generated slightly above break-even returns.
Within the LSTK, mining and metallurgy and oil and gas have also generated break-even returns, while light rail projects have generated positive returns. While there can be a fairly wide range on the returns, it is very clear that the Codelco project was a significant outlier and atypical of resources LSTK 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 LSTK backlog, I'm 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.
We are introducing a number of enhanced controls and strategies. Two examples of which are we have weekly updates with the senior leadership team to ensure issues are flagged and actioned as quickly as possible, and improve cost management protocols that, for example, simplify the number of cost codes and better align with our supply chain to ensure better project results. Slides 16, 17, and 18 provide more detail on the current status of our LSTK backlog. Looking at slide 16, the vast majority of the remaining CAD 3.2 billion of the LSTK contracts are in infrastructure worth approximately CAD 2.7 billion, 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 CAD 500 million, 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. Good morning, everyone. Starting on slide 20, we have recorded in Q3 a net income of CAD 2.8 billion, which included a net gain after tax of CAD 2.6 billion from the disposal of a 10% stake of Highway 407 ETR. Total revenues for Q3 2019 amounted to CAD 2.4 billion. The SNCL Engineering Services business line totaled CAD 1.6 billion, an increase of 11.5% compared to Q3 2018. Mainly due to a revenue increase of 43% in infrastructure services, reflecting the increased level of activity in Linxon, acquired in Q3 2018, as well as an increase of 6% in EDPM. ENC revenue from SNCL Projects business line for Q3 2019 decreased by 26% to CAD 851 million, mainly due to the continuing backlog runoff of certain major LSTK resources and infrastructure EPC construction projects. The SNCL Projects business line recorded a negative EBIT totaling CAD 45 million in Q3 2019.
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 U.S., 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. The SNCL Engineering Services business had a very strong quarter, performing better than prior periods. It recorded a positive segment EBIT of CAD 253 million, representing a 16% EBIT to revenue ratio, or 12% if we exclude capital. Corporate SG&A for Q3 2019 totaled CAD 20 million, CAD 13 million for ENC only.
Note that the corporate SG&A for Q3 2018 had a recovery of CAD 15 million, as it included a CAD 16 million favorable impact from revised estimates on legacy sites' environmental liabilities and other asset retirement obligations. Adjusted net income from ENC in the third quarter of 2019 was CAD 165 million, or CAD 0.94 per diluted share, compared to CAD 124 million, or CAD 0.71 per diluted share for the corresponding period in 2018. The adjusted net income from ENC in Q3 2019 included the recognition of CAD 83 million, or CAD 0.47 per diluted share, in income tax recoveries on capital losses from following the disposal of a 10% stake of Highway 407 ETR. I will cover this in more detail on the next slide. Our backlog totaled CAD 15.6 billion at the end of September. SNCL Engineering Services had a backlog of CAD 11.4 billion.
Bookings for the third quarter were almost CAD 2 billion and totaled CAD 5.5 billion for the nine months of 2019, which represents a 1.2 book-to-bill ratio. SNCL Projects backlog had a CAD 4.2 billion backlog, representing an 11% decrease compared to the end of Q3 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 30th, 2019, the company had CAD 939 million of cash, CAD 1.2 billion of recourse debt, and CAD 400 million of limited recourse debt. We also have CAD 2.5 billion in unused capacity under the company's CAD 2.6 billion committed revolving credit facility.
The net recourse debt to EBITDA ratio, calculated according with the terms of the company's credit agreement, was 3.4 times. Note that in the third quarter, the company and its lenders amended the credit agreement to extend the temporary increase of the ratio to four times until and including the period ending December 31st, 2019. Turning to next slide 21. On this slide, we are breaking down the tax items that are impacting our adjusted EPS from ENC. As indicated in the past, we usually target for a 20% tax rate on our ENC business. If we apply this rate to the adjusted ENC earnings before tax, the income tax expense should have been CAD 18 million, and the EPS for the quarter should have been CAD 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 CAD 8 million, bringing the adjusted EPS from ENC at CAD 0.47. In addition, this quarter, the capital gain recognized from the sale of our stake in Highway 407 ETR is allowing the company to recognize some capital losses within ENC from prior years, representing a tax recovery of CAD 83 million. The end result being an adjusted EPS from ENC of CAD 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 CAD 51 million. We expect this improvement trend to continue for the fourth quarter. 2019 year-to-date cash flows used for operating activities total CAD 668 million.
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 CAD 350 million, representing an 88% segment EBIT conversion, while the capital segment generated CAD 128 million. 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 use for interest and 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 30th, 2019.
As previously mentioned, we have significantly decreased our debt balance with the Highway 407 sale proceeds. The only outstanding recourse debt that the company now has is three debentures for a total of CAD 675 million and a CAD 500 million term loan. We also decreased the CDPQ loan to CAD 400 million. Slide 24 is our traditional slide that summarizes the result by segment. Resources recorded a loss of CAD 47 million 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&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. Ladies and gentlemen, if you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star one to ask a question. 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 how we should be thinking in Q4 and 2020 as new projects ramp up? Could you talk about the recent award in Germany?
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 growth and profitability. We've got numerous parts of the nuclear business, primarily in Canada, in the U.S., and in the U.K. The new award in Germany, of course, it's kind of an exciting award for us based from the European part of the business. We've got active projects, as you know, in Canada on life extension. We've got also the kind of exciting joint venture that we put together with CDI for decommissioning. I think there are numerous parts to this business that will kind of drive it forward and keep it on a successful trajectory.
Okay.
If I can add, Benoit, just on the margin rate, I'm assuming that was also something on your mind. We had a very strong quarter in nuclear at 18.5%. 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.
Yeah. Okay. That's very good color. Maybe one question for Nigel. Since your appointment, I was curious to get your insight and your opinion on the remaining LSTK projects and ability to manage the ramp-down, Nigel.
Just before Nigel answers that, it's Ian. I will hand over to Nigel. We're laser focused on executing these projects to get the best outcome that we possibly can. I think Nigel's oversight is really important to ensure that that focus continues. There is a point that I'd like to make. I know we've made it already in the presentation, that the lion's share, the majority of this backlog now at CAD 2.7 billion of the CAD 3.2 billion, is in Canadian contracts in light rail. I just want to kind of make that point up front. Nigel, please.
As Ian said, the majority of it exists in the infrastructure projects in North Canada, which is CAD 2.7 billion, primarily in light rail. We have CAD 500 million in the resources business. That CAD 500 million in the resource business will be mainly completed within the next two years, the majority of which over the next 12 to 18 months. 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, and we're truly focused on going for excellence in execution by enhancing the processes and controls we already have. We did a sensitivity analysis on all these projects, and those risks that we have, we believe are manageable.
Okay. That's very good color. 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? Also whether you could recoup more tax loss carry forward with respect to the tax implication around the Highway 407. Thank you.
Yeah. We're maintaining what we said last quarter in terms of the second half capital performance being positive. That's on that. As it relates to the tax effect of the 407 sale, 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 CAD 100 million of cash out on the 407. We're still working it.
Okay. That's very good. Thank you for the time.
Thank you. We will now take our question from Jacob Bout. Please go ahead, of CIBC.
Good morning.
Good morning.
Had a question on EDPM. Strong 10.6% EBIT margins. Talk about the sustainability of this and what was the driver here.
Clearly, EDPM is a global business. It is the consultancy design, feasibility, professional services part in infrastructure that was evolved from Legacy Atkins. I would call it a tier 1 reputation globally for providing those services. I think the kind of exciting part of EDPM is its future in developing its technology arm and producing technology solutions and digital solutions to the market. We are on a growth plan. Primarily the growth geographies for EDPM are the U.S., where we're absolutely underweight compared to our peer groups, and Australia, which is going through an infrastructure boom, where again, we're kind of underweight compared to our peer group. We do think that the business is sustainable, and we do think that the kind of strategy we've got for that business will repeat what we've historically been producing.
Okay, just to recap here, 10% plus EBIT margins is reasonable.
Well, towards 10% is kind of historically what we've been producing. I mean, Sylvain, I don't know if you want to, yeah, I think, again, very strong quarter in EDPM. Clearly not to diminish what happened. I think we do have from quarter-to-quarter some movement. I would take a bit of a blend of prior quarters to get to your number. Around 10 is the number. Yeah.
Okay. I guess in the press there have been a number of articles about the potential of Atkins being up for sale. Do you have any comments on that at all?
Yeah. The strategy of the company is absolutely as we've defined it. SNCL Engineering Services is the future of this company. 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 the strategy and the defined part of the future.
Okay. That's clear. Last question here, just around the DPA. Clearly the Liberals indicating during the election campaign that they wanted to pursue this. Did it surprise you? Any update you can provide either on court date on the DPA or anything on the integrity regime.
We kind of remain focused on defending ourselves through a court process. That's kind of our key focus right now. We're kind of prepared for that and prepared that it goes to that. I mean, obviously, if there are opportunities for settling this in another way, we'd be open to that. We don't expect it. We're prepared for the court process.
You figure, I think I read in your press release, sometime in 2020 is when you expect the trial to start?
Yeah. Not fixed.
Thank you very much.
Thank you.
Thank you. Ladies and gentlemen, if you find that your question has been answered, you may remove yourself from the queue by pressing star 2. As a reminder, to ask a question, it is star 1. 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. I mean, you have CAD 500 million of remaining backlog in your resource base fixed bid projects. Arguably, if there is going to be a cost reforecast, it's going to be on the total project revenue versus the remaining fixed bid backlog. Are you able to provide what the total project revenue are within the resource fixed bid backlog is?
On slide 17, what we've tried to do here is give a little bit more transparency of the scale of the resources backlog within the larger projects. Those five projects that are identified there, just to give you a little bit more information as to the kind of size of the projects, because a couple of them are sub CAD 50 million, which will probably be burnt off quite quickly and quite small projects. I don't know if that gives you the information that you need or does Sylvain, is that?
Yeah, I think, we'll try to answer that as well, but if we don't, just restate the question maybe. The backlog amount essentially represents the amount of revenues we expect to generate from those. That's shown on page 18. You see the phasing of how that runoff will happen. Those are the revenues expected from the remaining backlog. Unless there are scope changes on any of the projects, you should not see a change to this amount of revenue. You might see changes in the phasing as progress can accelerate or decelerate for various reasons. The other thing is if there were a cost reforecast, yeah, there would be typically a true-up of your revenue, but it would just be the revenue would essentially come back later. Now, obviously with a reforecast, positive or negative, your margin would move accordingly.
I don't know if that answered the question, Derek, there.
Yeah, that helps. Just looking at the % of completion, is that a relatively linear relationship relative to the remaining fixed backlog? Just in terms of understanding the scale of the total. At the beginning of each project, of the remaining projects that are left.
Yeah.
Was it previously-
It's not entirely linear. Yeah, it's really not linear. I think I would, again, page 18 will give you that color of, there's quite a bit in 2020 that's running off. The reason it's not linear is you have different components between Engineering, Procurement, and Construction, and they tend to move in a different pace. That drives some changes from quarter to quarter or year to year as the projects evolve.
Okay. Nigel mentioned that he's done some sensitivity around both the positive and a more negative scenario. Are you able to provide any details around those two kind of outcomes?
I think what I can say on that is within LSTK style contracting, there is all sorts of risks and issues. These are highly complex projects, so things do change and there are scope changes as you go through the project. These are huge prototypes that have never been built before, so expect the unexpected. What I can say about that sensitivity analysis is that we believe that the risks are highly manageable within that sensitivity.
Yeah, I would just add to that the smaller share of this backlog is in resource, and I know I have said this, which if you look at the table that we try to add a bit more transparency on that, you could conclude from that there are a couple of small jobs, one that is at 90% complete, and then two with any sort of significant backlog left in it. The rest of it, the CAD 2.7 billion, is in Canadian contracts, which, I repeat, have traditionally and historically for us, gone well.
Okay. No, that's great. The additional disclosure all around is helpful. Then just one last one for myself, just on the Montreal REM, obviously there's been some press releases or information in the news that has come out. Can you provide an update and kind of your thoughts on that project?
Yeah, for sure. The first thing I'd say is, the REM project is a fascinating, fantastic project, right? There's 60 odd kilometers of urban railway. What you might expect with that is multiple interfaces, whether it's the old tunnel that we've got to deal with or the airport that we're interfacing with or all the communities that the railway travels through, the existing bridge that we've got to build across. There's these multiple interfaces. I think what's really, really positive, which obviously was kind of missed in all the media, is the project is ahead of schedule. The work that we've done with our client to get this project into that state is truly almost kind of, I wouldn't say it's unique, but it's remarkable to get it there. Now, clearly there's some challenges.
There's challenges with any complex project like that, and we've got to work through those challenges with our client to optimize the best results for the project. That's what we're doing.
Okay. That's great. Thanks for the color and congratulations, Ian, on the appointment.
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 reforecast this quarter. Maybe just a little more color on that, if it was one particular project or multiple and when that project or projects may finish.
Yeah. I think we said it in the script, but I'll give a bit more color, both from myself and Sylvain. I think it's disappointing. Okay? The first thing I'd say is that the number that 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 reforecast 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. There's losses due to the need to right size the overhead as we reduce the activity on the lump sum turnkey part of the business. The way I look at that is two of those components are really fixable, and we will fix. Sylvain, if you have-
Yeah, 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. You have some positives, and you have negatives. This quarter, it was a net negative. We're working through the remaining of the backlog and obviously try to contain this and hopefully get some positives as well in there.
Again, in your remarks, you've talked about sort of advancing a number of alternatives for the business. Is there any more detail you can give us as maybe just trying to handicap sort of what happens here or when something may happen?
Well, yeah. Clearly, the biggest component, let's exit the LSTK, burn that off, and put that behind us. We're absolutely looking to move away from the midstream fabrication facility that we've got. Now that we're not in the lump sum turnkey business, it really doesn't complement our business going forward. That leaves really the services side of mining and metals and the services side of the oil and gas business. We just want to be really sure that this is going to produce the kind of cash flows and earnings that we want in the business going forward. We're doing a lot of analysis around that now to understand if that's what we want as part of the future.
Okay. Maybe just on the cash flow. Sylvain, 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-.
Okay
would be positive, but that Q3 would be negative.
Okay. If I understand, again, there's quarter to quarter sort of volatility, lumpiness, and just there's some projects you're working through and maybe some claims outstanding, is there a line of sight for us, sort of a when it sort of becomes normalized or just maybe a little more consistent? Yeah.
It should. If you look at this year, the big issue or the set of issues we face with the cash flow has been the losses in the projects side of the business, which these losses have translated into cash. We started the year with CAD 250 million of cash out expected out of Codelco, which the P&L impact was taken in our 2018 results. You get already a bit of an EBITDA cash difference and a drag. We had other issues as well as we closed last year, but we had more of the same in Q1 and especially Q2. That's creating a bit of something not normal in the profile of the future. As of now, you could start to expect things to start normalizing as we burn off the source of this volatility.
That's Q3 being an example, and then Q4 continuing, and hopefully carries on 2020.
Yeah, I guess that was my question. If you book these losses, but 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, sorry, just on the 407, did you say CAD 100 million cash tax associated with the sale? That was your expectation?
That's basically, we've been asked the question a number of times, and we're still working through the cash tax planning around it. That's where we are right now, and that's continuing to evolve.
Okay. Sorry, just maybe one last one then. Just to leverage 3.4x on the covenant. I am just doing some math, and if it is right, I guess it looks like the debt as per that calculation would be about CAD 1.3 billion, which would mean EBITDA in and around CAD 375 million, CAD 400 million. In the EBITDA, there would be roughly CAD 400 million of losses that would not have been adjusted for, again, excluding the Codelco of that. Are those numbers about right?
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 of Canaccord. Please go ahead.
Hey, good morning, guys.
Morning.
Morning. Just looking to get a bit of a better idea of what's going on in the oil and gas business outside of the lump sum turnkey. I mean, most of that work was cost reimbursable maintenance work. Sorry, pretty recurring. Are you still bidding work in that section of Kentz, we'll call it, and how is that business performing? Are you able to retain people in this environment?
Okay. Yeah. Yes, we are bidding, and I think in the wins in the quarter, there is at least one win. 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 U.K., and some of it, as you say, was the services part of Kentz and to some extent, the Legacy SNC. Primarily, those kind of services parts of the business are just doing design services, feasibility, some commissioning type work, and some sort of closure of asset shutdown kind of work. It's kind of spread between the Middle East, some of it in the U.K. and North America. Yeah, absolutely, we're continuing to bid and we are picking up work. Oh, sorry.
To add to that also is the services part of the mining and metal business, which was the kind of SNC-Lavalin legacy mining and metal business, which again, we're bidding kind of services work or EPCM type work, but obviously not any lump sum construction.
Okay, that's helpful. Following up on another question as we look towards the start of the trial next year, I was just curious, what proportion of engineering services revenue is generated in Canada?
We'd have to run to that.
Yeah. The EDPM, which is mostly in EDPM Canada, I think you're referring to. That's in the range of CAD 400 million, but that's spread across many, many projects. I think in what we've said in the past when we were asked is on Canadian federal revenue, it was more like CAD half a billion, was what we had, and most of that being Champlain.
If you think of our business kind of going forward, our engineering services business, 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. By kind of exiting the lump-sum turnkey model, it kind of de-risks our exposure to the federal government. Not eliminated, but reduced.
Right. Could you give me a go forward, rough percentage of engineering service revenue from Canada, all sources, nuclear, everything?
Directly, no. I mean, other than what we said, right? EDPM is about CAD 400 in total. In the past, the biggest exposure we had was Champlain, and if you exclude that, directly to federal, it's not that much.
Last one from me. Just any update on capital allocation priorities and how you're thinking about M&A. You mentioned being underweight in Australia, the U.S. versus buybacks. Updated thoughts on that now that the balance sheet's in better shape. I'll turn it over. Thanks.
All of our intent right now is de-leverage.
Thank you. We'll now take our next question from Chris Murray of AltaCorp Capital. Please go ahead.
Thanks. Good morning. Maybe if you can take this for you. Just 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. 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. 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?
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 essentially have the first project that is a project at loss. That's the one that will have a net cash out because of that loss. That project has got less than CAD 200 million to go. That's something you should expect. At the bottom of the page in the infrastructure, where we had the last two were at loss, a slight loss on LRT. 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, we are expecting the runoff to be still a positive event. That's what I'd say.
On Cadalso, 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 will now take our next question from Frederic Bastien of Raymond James. Please go ahead.
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, especially on the OEM side?
Yeah. We'll jointly answer it with Sylvain. One of the biggest kind of jumps compared to last year was the introduction of Linxon. Linxon is reported through that. That's our joint venture with ABB to provide services for the installation of substations. That's one component. I think the other component is some projects coming online, such as the Ottawa Light Rail that brings O&M into the business.
Yeah, just to add, I think the Linxon point certainly adds to revenue. I think it's still in ramp-up phase, so we are getting a little bit of a pickup on EBIT, but on the EBIT side, that's not the biggest driver. As I said in my prepared remarks, it was mainly O&M. As the team worked through some of those contracts, we restate those contracts as we go along, as we execute and as we find ways to optimize the margin generation on these contracts. As we do every year, we relook at our contracts, and we reassess the margin potential, and that does create some positive reforecast on those.
I would add, this is kind of, for me, a really exciting part of the business. As we see some clients kind of globally moving away from lump sum turnkey contracting and moving to alternative methods of procurement, this is the part of the business that's going to drive that for ourselves.
Okay. Next question. You did mention, or at least you cautioned for us not to expect miracles on the cash flow in the third quarter, working capital did eat up over CAD 2 million 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 a usage simply because of the losses recorded in the lump sum projects. Yeah, the quarter for us is in line with our expectations.
Okay. Then a small adjustment to the 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 Linxon. You're meaning purchase price adjustment? Is that what you said?
Correct, yes.
Yeah. It's the completion of the Linxon purchase accounting period.
That would have been reported under infrastructure services?
Yeah, Linxon is part of infrastructure services. Yes.
Okay. That's all I have. Thanks, and congrats to you.
Thank you.
Thank you.
Thank you. We'll now take our next question from Maxim Sytchev of National Bank Financial. Please go ahead.
Hi. Good morning, gentlemen.
Good morning. Hey, Maxi.
Just a quick question maybe to Sylvain, first of all. The covenant increased to four times by December of this year. 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 had that covenant for the first two quarters with our banks. Early in Q3, we just proactively worked with them and agreed to just extend it through the year as we worked through our deleveraging plan. There's not much else to read into it. The 3.4 we closed this quarter in terms of the covenant is within that. It's also within our contractual covenant of 3.75. That's good. The driver, as you well know, the driver of the calc is more the poor EBITDA of especially the last 3 quarters. As we just burn those off, the covenant should get back in place. We always knew that Q3 would be a bit of a pinch. That's where we are.
Right.
I wouldn't read anything else.
Should we expect the leverage metric to come down in Q4, especially as you allude to generating positive OCF?
Yeah, I think we're basically, as I said, we have four quarters there. Three of them are pretty difficult within that number in Q3 that we added. This quarter was still a bit lower than the same quarter last year because resources had positive EBITDA last year. 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. Is it fair to say, obviously as you had another provision in resources that right now you have kind of wrap your hands around all those projects that we should be assuming basically break even on a going forward basis for LSTK kind of as an item?
I don't think we want to be definitive about where we see the actual results, what we can say is that we have got our hands around the jobs. Historically, CAD 2.7 billion of those jobs have performed really well, and the CAD 500 million have performed above break even. We've never said there isn't zero risk in this business, we've got a really good handle on it. I think that's how we're feeling now.
Right. No, that's fair enough. Actually, Ian, in terms of your commentary around the compression business, I suppose you alluding to kind of the legacy of Valerus sort of assets. Can you maybe talk about what is the market for those types of companies if you were trying to offload it? Trying to think if there was actually potential buyers, even if you wanted to sell this particular piece of the business.
Well, obviously we're in the process, so I don't really want to comment on the viability of that. As soon as we've got a fix on it, we will be announcing. Yeah, obviously, you're right about the asset. As I said before, it doesn't really fit with us anymore. That's not to say that it doesn't fit with other companies and with other owners, because it is a viable asset. It's just that we got it with the acquisition of Kentz. Kentz had acquired it because they are flow-through from their LSTK business, and obviously that's no longer the case for us.
Right. Is there a potential timeline that you feel comfortable telegraphing or not at this moment, specifically?
No, I don't think we could share that now, but obviously 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 Dufour of TD Securities. Please go ahead.
Thanks. Good morning. Just wanted to go back to the leverage ratio and the covenant. Can you confirm in the third quarter, was the covenant, it was 3.75?
No, it was four.
It was four then.
It was agreed. Yeah, it was four as well. Yeah.
Okay. 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 exactly right. It was extended early part of Q3 for the rest of the year.
Okay. I guess I was under the impression that it was going to be 3.75 times in the third quarter. Maybe the fact that you got that extension in place 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?
Yeah. I guess the original agreement that we have in place is at 375. At the beginning of the year, we agreed to go to 4 for 2 quarters, and we revisited that with our bankers in Q3 to keep it at 4 through the rest of the year as we work through our deleveraging plan. Now, you could argue it wasn't necessary because we closed at 3.4 and the normal covenant or the covenant would have gone back to 375. We did that proactively just because we're just trying to manage proactively our relationship with the banks.
Right. No, that makes sense. You were asked about infrastructure services and the strong performance there from a margin perspective. I just wanted to clarify, you referenced the favorable impact of some reforecast related to O&M contracts. Is that a one-time benefit that would have come through and helped the margin in the quarter, or is that some sort of a sustainable benefit? 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.
I think there is a component there of one-off reforecast. I think the way to think about the business is obviously looking back at its historical performance, which I would say is kind of at the higher end of single digit. That's the way I think about this business. It's absolutely part of our future, and we would expect to see the growth from this sector as we move further into kind of PCM/CM type jobs, integrator role jobs, alliance type contracting, all of that, as well as obviously the O&M business that we've been operating for a long time.
Yeah, just to add to that. In the O&M business, they review their contracts on an ongoing basis, and they try to optimize the delivery of the work. They will have reforecast like this on an ongoing basis, and last year we had a similar set of effects. They don't come in the third quarter necessarily, they come in as these contracts are reviewed. That's the way to think of it. I think what Ian said in high single-digit run rate type margin is probably the way to think of it. A bit stronger on this quarter, but that's just going to evolve quarter to quarter as contracts are optimized.
I guess I understand the 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. When I look back historically, I guess we only have about 6 quarters of history before we got the third quarter number, and the highest margin that was ever delivered was 7.5%. More frequently, we were sort of in the high 3% or mid 4% range. What is it that is now allowing you to do high single digit margins in this business?
Well, I think. I think the O&M business, the long-term piece of it, and the additions 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. 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 change that. Obviously, this part of the business kind of got recreated in the strategy. We're also in the process of obviously right-sizing the overhead for this business. I don't think we can sort of add anything else to that, no.
Okay. Fair enough. I guess just on that point, with respect to the overhead right-sizing, 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, at the end of the third quarter, and how we see that progressing as we move forward?
Well, I'm not sure we are kind of looking at it that way. I mean, what 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 CAD 250 million of savings. We're on target for that. I think I also said that we would save within this year, CAD 100 million, 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 we'll achieve both. I think that's kind of how we look at it.
Okay. Just lastly, this goes back to something that, I believe it was Derek asked earlier, I'm just trying to reconcile the change in the LSTK backlog to the actual revenue that you delivered. It's a little hard in resources because there's more than just LSTK work flowing through that one. If we look at infrastructure EPC projects, the LSTK backlog is down about CAD 155 million sequentially quarter-over-quarter. Yet the revenue delivered in that segment in the quarter was CAD 289 million. 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?
Yeah, I think most of that comes to scope changes. That will be one thing as we work the burn-off is if there are elements of these projects that the client is changing, that could increase the revenue for those projects. We are not bidding on new work, we are not taking on new work, but there are contractual obligations to perform.
Yeah, without being too specific, there was a couple of things that were pretty large in terms of scope change that happened in the quarter that were probably not typical going forward.
Yeah.
They put backlog in. We shouldn't kind of 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. Denis 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. I know there's a few individuals still in the queue, and sorry, I apologize for that, but it's 12 minutes past 9:30, and we really have to end the call. If you have any other questions, please don't hesitate to call me. It'd be my pleasure to answer any of the 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.