Good day, and welcome to the SNC Lavalin Second 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. Denis Jasmin. Please go ahead, sir.
Thank you. Good morning, and thank you for joining us today. Our earnings announcement was released this morning, and we have posted a 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 Iain Edwards, Interim President and Chief Executive Officer and Sylvain Girard, Executive Vice President and Chief Financial Officer. 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, and 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 Iain Edwards. Iain? Thanks, Denis. Good morning, everyone. Welcome to S and C Lavalin's second quarter twenty nineteen conference call, and thank you for joining us today.
So as you know, this is my first quarter as leader of S and C Leveling since being promoted seven weeks ago. You may also remember that I was promoted to Chief Operating Officer in January. So during my time as COO, I had the opportunity to spend several months traveling the company to visit all of our business segments, many of our offices and many of our projects across the globe. Having had the opportunity to do that has given me a deep understanding of the business, the capability of the company and the extent of the talent in our people, but also an understanding of the risks contained in the business and the projects. And the first thing I want to make clear is that I'm actually really proud to be leading this company, which has dropped strong capabilities embedded in many parts of the business.
For example, we are a Tier one operator in many segments of the industry, including our EDPM and Nuclear business. This could not have been accomplished without the talented and dedicated employees around the world, the relationships we've built and the support of many stakeholders who we appreciate and value. However, there is no question that S and C Leveling is experiencing some difficult challenges. In recent quarters, we have provided guidance on our financial results that we did not deliver. This is unacceptable, and it's unacceptable to me.
And it is unacceptable for our stakeholders who place trust in the company to do what we say we will do. This is why in the past seven weeks, I've taken decisive action and will continue to do so for the long term success of the company. On the July 22, we announced the first step in a new strategic direction geared towards creating a simplified and more predictable business with a lower risk profile. I believe this new direction will position the company for sustainable success as well as more consistent earnings and cash flow generation. To achieve this, we have taken several measures, most notably exiting lump sum turnkey construction and reorganizing the company into two clear separate lines of business.
One additional aspect is exploring all options available for our Resources business, especially the Oil and Gas business, including a transition to a services based business or divestitures. Our revised business focus is based on four key pillars that allow us to concentrate on what we do best and leverage our strengths to grow from a solid foundation. The four pillars are focus, simplify, grow and right size. We will focus and reduce risk throughout our business by no longer bidding on lump sum turnkey construction projects in order to allow the strong parts of our business to reach their full potential. Secondly, we will simplify the organization into two parts: SNCL Engineering Services to become a leading global integrated professional services and project management company, while SNCL Projects will focus on the successful completion of our LSTK projects, fulfilling all of our obligations to our stakeholders and managing risk to ensure a successful outcome.
Third, we will grow the business where we already operate as a strong Tier one company, specifically in EDPM and Nuclear segments by focusing on key market positions and maintaining capital segment strong performance. And finally, we will continue to rightsize the company by delivering on our current $250,000,000 cost out saving program. In addition, we will look at reducing our geographic footprint by exiting unprofitable geographies and concentrating on our growth areas. We will also be focusing on the recovery of claims receivables with dedicated teams being allocated to execute this. Our decision to exit lump sum turnkey construction projects was a decision I made after my strategic review of the business.
Looking at our results, it's clear that volatility and unfavorable cost reforecast stemming from LSTK construction projects were the root cause of the company's financial underperformance. And thus, I took the decision to exit this type of project and contracting model. Generally speaking, large LSTK construction projects have been value destructive in our industry. Over the past five years, firms have in our peer group with a greater percentage of EPC work have generally shown a lower total shareholder return and generally poor financial metrics. We're seeing the industry as a whole moving away from this contracting model.
While we're taking action to reduce risk and simplify our business, we will remain a leading global international professional services and project management company, and we will continue to provide high quality services to our clients, covering the full spectrum of the asset life cycle. We've provided a list on Slide 10 of the accompanying presentation just to illustrate the types of contracting structures we will continue to apply while limiting our financial exposure and risk. These include consulting services, design and engineering services, fee for service contracts, framework agreements, target cost and alliance based contracts, management services such as project management and construction management and operation and maintenance. In addition to the above, there are some unique profitable low risk standardized solutions that we operate in, for example, district cooling plants and substations through the Linksong joint venture that will also remain part of the SNC Lavalin service offering. In further detail, for SNCL Engineering Services, we will now it will now encompass our high performing businesses and high growth areas, including EDPM, advisory design and project management services nuclear services, including life extension, decontamination, decommissioning and remediation infrastructure services, which includes operation and maintenance and links on and capital, provision of ownership of infrastructure assets in Canada.
Examples of where we hold a market leading position would be in the light rail and transit market, where we believe there will be significant growth globally. Another example would be our well established position in Nuclear, including holding the exclusive license to CANDU technology. This portfolio includes CANDU related services and nuclear products as well as a leading capability in nuclear power life extensions and decommissioning. We see a very strong market in the nuclear sector, both from an ongoing need for clean energy and the need for environmental remediation. SNCL projects will now house our lump sum turnkey construction contract business, which represents less than onethree of our growing backlog and was clearly the root cause of our performance issues.
On Slide 13, you can see the backlog for SNCL Engineering Services is strong, totaling approximately 11,100,000,000 at the June 2019, which included $1,800,000,000 of bookings in the 2019. The contract bookings for SNCL Engineering Services amounted to $3,700,000,000 for the first six months of twenty nineteen, 1,800,000,000.0 of that in EDPM segment and $1,400,000,000 of that in the Infrastructure Services segment. We continue to win high quality work for for SNC Lavalin services. And earlier this month, we launched our new services based contract for the construction management of the future renovation of Montreal Trudeau International Airport. In the quarter, we also won a design contract with Network Rail in The UK.
And in the Resources space, we've also shown our strength in services work with a master of service agreement with Emirates Gold Aluminum and an engineering design subcontract for a floating production unit in Australia. Slide 14 provides some more details surrounding the revenue breakdowns for each separate business, while the simplified streamlined structure of the business will result in lower top line revenue, it will be more consistent, profitable and cash flow generating. Also, you can see this newly reorganized business model also better manages our geography risk, and the revenue breakdown gives you a sense of which geographies we will operate in and how much revenue each geography accounts for. As I said, the root cause of our past performance has been in the execution of LSTK contracts. In addition to this, we've had exposure to geopolitical risk in The Middle East.
I believe our new strategic direction significantly reduces the risk in both of these areas. As I mentioned, by ceasing to bid on large lump sum construction projects, we will see our backlog in these projects decrease over time as projects are completed. Our lump sum turnkey construction projects totaled $600,000,000 in resources backlog and $2,800,000,000 in infrastructure backlog as at June 19. To put the remaining LSTK backlog into context, it is contained within six infrastructure projects and five resources projects. This is a low number compared to the past as a number of projects have been completed during the first half of this year.
Over 80% of this backlog will be executed before the 2021, including all the resources projects. And I think what I'd really like to note here is that $2,500,000,000 of the $2,800,000,000 of backlog in infrastructure is in light rail projects where S and C Lavalin's historical performance has been strong. The successful execution of the remaining backlog here is of paramount importance to all our stakeholders and ourselves. We will be applying all focus necessary to achieve this through dedicated leadership and teams. The Project Oversight Group formed in March earlier this year and led by the newly appointed Executive Vice President, Nigel White, will provide an independent oversight of this execution.
Nigel will report directly to me. A full breakdown of our lump sum turnkey construction projects in backlog is shown on Slide 18. Also, the time line of the expected phase out schedule is shown on Slide 18. This shows us completely exiting lump sum construction projects by 2024. Slide 19 gives even further detail on this.
Turning to geographical risk on Slide 20. Our revised business focus significantly reduces Resources segment's exposure to Middle East and Latin America. So lastly, on Slide 21, which relates to guidance. As you know, on July 22, we announced a withdrawal of 2019 guidance. As I mentioned earlier in the call, in the past, we've provided guidance that we simply did not meet.
However, the performance of SNCL Engineering Services business line is not and will not be impacted by the reorganization and is expected to deliver segment EBIT margin consistent with prior periods. Before I turn the call over to Sylvain, I want to add that this was a really tough and disappointing quarter. In my view, however, it also marks a turning point for S and C Lavalin, one that I'm committed to be part of to create the long term sustainable success of the future. The challenges we announced and the decisions I've made are necessary to build a stronger S and C Lavalin. We are building towards being a company with sustainable predictable earnings.
This new strategic direction allows us to focus on cash flow while simultaneously working to reduce risk. I'd like to turn the call over to our Chief Financial Officer, Sylvain Girard, who will provide more detail on our second quarter twenty nineteen financial performance. Sylvain?
Thank you, Ian, and good morning, everyone. Before I get into the financial details, just a quick note on the changes we made this quarter to our segment disclosure. The segment disclosure note in the company's financial statements now reflect the reorganization that we have announced on July 22. We have split the company into two separate business lines being SNCL Engineering Services and SNCL Projects. We have also split Infrastructure in two segments Infrastructure Services and Infrastructure EPC projects.
This will allow us to differentiate the financial performance of each business line going forward as we complete the lump sum turnkey construction project with the last one expected to be completed in 2024. For your information and ease of comparison, we have included in the appendix of this presentation the comparative restated numbers for the new segment disclosure by quarter, for the full year 2018 and for the 2019. These changes have no impact on the overall EBIT of the company. Now turning to Slide 23. As disclosed in our July 22 press release, we have recorded in Q2 a $1,800,000,000 noncash goodwill impairment charge and an intangible asset impairment charge of $73,000,000 relating to the Resources segment.
Total revenues for Q2 twenty nineteen amounted to $2,300,000,000 The SNCL Engineering Services business line totaled $1,600,000,000 an increase of 11% compared to Q2 twenty eighteen due to revenue increases ranging between 4% to 37% across all of its segments. E and C revenues from the SNCL project business line for Q2 twenty nineteen decreased by 36% to $710,000,000 mainly due to a 40% decrease in the Resources segment and a 28% decrease in the Infrastructure EPC Projects segment. The decrease in revenue from the Resources segment is mainly due to the completion or near completion of certain major lump sum turnkey oil and gas construction projects, the termination of a major mining and metallurgy project and challenges in replenishing the revenue backlog. The decrease in revenue from infrastructure EPC projects was mainly due to the completion or near completion of certain major construction and clean power projects. The SNCL project business line, which includes the Resource and Infrastructure EPC project segments, recorded a negative segment EBIT totaling $3.00 $8,000,000 in Q2 twenty nineteen.
This negative segment EBIT was mainly due to the unfavorable reforecast on certain major lump sum turnkey construction projects for a combined net unfavorable impact totaling approximately $280,000,000 This was mainly due to higher forecasted cost to complete on two infrastructure lump sum turnkey construction projects, namely the Ottawa LRT and Champlain Bridge, both of which have now reached substantial completion as well as on two oil and gas and one mining and metallurgy lump sum turnkey construction projects in The Middle East. In contrast, the SNCL Engineering Services business line recorded a positive segment EBIT of $193,000,000 representing a 12.2% EBIT to revenue ratio or 8.2% if we exclude capital. Adjusted net loss from E and C in the 2019 was $300,000,000 or 1.71 per diluted share compared with an adjusted net income from E and C of $114,000,000 or $0.65 per diluted share for the corresponding period in 2018. The adjusted net loss from E and C in Q2 twenty nineteen was due to a negative segment EBIT for the SNCL project business line. The increase in the financial expenses in the 2019 compared to the 2018 was mainly due to a $34,000,000 charge related to the amendment of the CDPQ loan in connection with the agreement to sell 10.01% of the shares of Highway forty seven ETR as well as increased level of indebtedness.
Our backlog was $15,700,000,000 at the June, with a backlog of 11,100,000,000 for SNCL Engineering Services and $4,600,000,000 for SNCL Projects. Q2 bookings for SNCL Engineering were $1,900,000,000 representing a 1.2 book to bill ratio. SNCL projects backlog decreased by 7.4% compared to the end of Q2 twenty eighteen, and we expect this trend to continue as we are exiting lump sum turnkey construction contracts. As of June 3039, the company had recourse debt of $3,000,000,000 and $1,000,000,000 of limited recourse debt as well as $1,100,000,000 of unused capacity under the company's $2,600,000,000 committed revolving credit line credit facility. The net recourse debt to EBITDA ratio calculated according with the terms of the company's credit agreement as amended was 2.5 times.
Note that our covenant and ratio calculation with our lenders has been temporarily increased to four times. Also note that the Q4 forecasted loss on the Chilean mining and metallurgy project is considered as a non recurring item up to a maximum of $310,000,000 and the $3,000,000,000 proceeds from the sale of the 10.01 of the shares of the Highway four zero seven ETR are considered on a pro form a basis. As we await the completion of the four zero seven transaction, the company and a group of financial institution entered into a new secured unsecured bridge facility in the amount of $300,000,000 with a maturity of one year. The proceeds were used to repay part of the revolving facility. The new bridge facility is payable in full upon receipt of the proceeds from the sale of the 10.01% interest in Highway four zero seven.
Turning to Slide 24. The operating cash flows for the 2019 were negative, totaling $368,000,000 This was mainly due to disbursement of approximately $152,000,000 on the Chilean mining project, timing of milestone payments, cost overruns on large infrastructure projects as well as certain delays in claim settlements on some oil and gas projects. If we compare to Q2 twenty eighteen, the increase in cash outflows was mainly driven by lower EBIT from E and C segments, an increase in restructuring costs and interest paid, partially offset by lower income tax paid. In order to allow the company to strengthen its balance sheet while implementing its new strategy, we decided to reduce the company's quarterly dividend from $0.10 per share per quarter to $02 per share per quarter. Now moving to the last slide, 25.
When looking at the segments within SNCL projects, Resources had a negative segment EBIT of $182,000,000 This was mainly due to a net unfavorable reforecast on certain major projects totaling $150,000,000 from higher forecasted costs and partial descoping, primarily from three lump sum
in oil and gas and mining and metallurgy in The Middle East. Infrastructure had
a negative segment EBIT of $126,000,000 which was mainly due to a net unfavorable reforecast on certain major projects totaling $130,000,000 from higher forecasted costs, primarily on two lump lump sum sum turnkey projects nearing completion and smaller Clean Power projects. With regards to the SNCL Engineering Services business line, all segments performed in line with expectation despite a decline in the EBIT margin percentage. Our EDPM, Nuclear and Infrastructure Services segments are strong and stable businesses, as evidenced by the new segmentation financial numbers provided in the appendix. The SNCL Engineering Services business line is expected to perform in line with prior periods. This concludes my presentation.
We can now open the line for questions. Thank
you.
Our first question comes from Yuri Lynk of Canaccord Genuity. Please go ahead.
Hi, good morning.
Morning. I'm trying to get an idea of when these the projects that hit the quarter, when they're going to run off. And I just want to make sure that the ones in Resources, are they in fact listed on Slide 18? So that one is 85% finished, one is 25%, one is 50%?
Yes, that's correct. Yes.
Okay. That helps. You're talking about achieving margins in Engineering Services similar to prior periods. Can I assume that that's code for the 10% that you achieved in 2018?
Not code, but yes, I think the performance from a dollar perspective and where we see these businesses from a percentage of EBIT margin is consistent with what we've performed in 2018.
But
your half year margins are 7.6% down from 10% in the half year of 2018. So what happens in the back half to make up that delta?
Yes. There might be
I mean, there might be a bit of leakage as we close the year. I think generally speaking, those businesses should perform in line with what you've seen in the last trailing twelve months. I think there's a bit of seasonality when you look at the first half in the results when you compare first half this year to first half last year that's that a lot of that will get resorted into the second half. I mean we had a lower Q1, for example, in Nuclear. I think we see that continuing to improve as we close the year.
Okay. So you think you can approximate the 10% on a full year basis?
We might be a bit underneath that because of where we closed the first half, but the trend is positive towards that.
Okay. And then what should we be assuming for corporate overhead to get to a consolidated EBIT figure for the business?
I think for yes.
Was going say it's GBP million? Yes. I think that's a fair assumption.
Dollars 70,000,000 for E and C and 28,000,000 for capital?
Yes.
Fair assumption. Okay.
Thanks. I'll turn it over.
Thank
you. Our next question comes from Mark Neville of Scotiabank. Please go ahead.
Hi, good morning. I just want to dig in a bit to the strategic review and sort of what's happening there. Sort of appreciate everything you've done so far, again, the reorg, exiting lump sum turnkey work. But I'm just sort of, again, curious sort of next steps. The winding down of businesses can obviously it can be costly, it can take some time.
So just is there anything sort of you're considering or anything you can do to sort expedite the derisking? I mean you're talking about potential divestiture of resources, any expressions of interest there? Anything you can do in infrastructure, again, to expedite the derisking, I guess?
Yes. I mean, for sure, as I said, for the Oil and Gas business, we're looking at all options. I mean, we haven't got anything specific to add to that at this time. But of course, as soon as we land on something, we'll be communicating that straight away. So that's in progress.
That's something which is pretty high on the next steps in terms of going forward. I mean, working through the infrastructure backlog is clearly important for us. But as I would stress, the majority of that backlog going forward is in light rail projects where we're in multi JVs, consortiums, and we, you know, we feel that we'll run that backlog off under kind of normal circumstances. Two of the six in infrastructure are almost at completion, is Ottawa and Champlain, which I'm sure you're aware of. And clearly we've got a clear line of sight to the end of those.
So I think the other parts of the strategy that are really important going forward is real focused effort on claims receivables, which we've undertaken and focused with a new team and allowing our SNCL Engineering Services, as we call it now, to actually to grow and flourish. I mean, clearly, the issues of the past
are
distracting from focus of allowing the better parts of this business to reach their potential. So I know that doesn't specifically answer the question, but that's where we're at.
Okay. Maybe just on sort of cash flow generally, like you've booked these losses in Q2. I assume there's going to be some cash coming out in the second half related to this. And sort of just thinking if you've got sort of all these losses or everything's fully captured, sort of how we think about cash flow over the next three, six months and then even into 2020?
Yes. So like you said, first half, we had the negative reforecast. We also had a lot of cash out from the Chilean project. We also had cash out related to this lower performance. There is some more to come in Q3 as we work through the losses and the cash out.
Overall, second half should see a positive cash flow, however. So that's good. So we see a turning point happening during the second half of the year. And those should these losses that we recorded should pretty much be all worked through by the time the year is over, positioning us for next year where with the engineering services, which has been providing positive cash flow all of last year and so far this year, contributing more favorably to the bottom cash flow line basically.
So operating cash flow second half will be positive even with cash coming out related to these losses in Q2 and I guess maybe even Q1 to some of these projects?
That's currently the expectation, yes.
Okay. Maybe just one last one before I get back in queue, on the four zero seven, just maybe some timelines. I know it's not in your control, maybe some timelines or sort of what's just a quick update there. Thanks. I'll get back in queue.
Yes. Well, as you say, Mark, it's not in our control. I think we're still awaiting for the court decision. I mean, entered into an expedited process back in June with the hearing towards the I think it was June 21 or the June 20. So we're just waiting for the decision at this point.
It's taken a bit longer than what we expected, but it should materialize hopefully soon.
Our next question comes from Derek Spronck of RBC. Please go ahead.
Thank you. Part of your cost reforecasting and the EBITDA impact, will that carry forward in subsequent quarters? When should that kind of follow the commentary that you talked about the cash flow impacts and the cadence there?
No, it wouldn't. I mean the way we account for these reforecasts and like we do every quarter, but clearly this quarter, we had a number of projects impacting as we look at everything we know about these projects and we make an assessment of what needs to be recorded, and that's what we do. So based on everything we know at the moment, as we close the quarter, we've recorded the appropriate level of costs and provisions into the project forecast. Forecast. So we don't out of what we know, we don't expect new reforecast of that.
Now obviously, things evolve in these projects, good or bad, and we restate these projects on an ongoing basis.
Okay. And just moving on to the write down. It seems like effectively, it's you're writing down the resource base business to zero. Is that accurate? And is the write down largely attributable to the fact that you're planning on exiting that business?
Or was the write down an actual operational impairment of the business or maybe some combination of both?
Yes. It's a combination of both. I mean, clearly, we look at the Q2 results of the Resource segment, it created a number of impairment indicators, as we call them, basically requiring us to relook at the impairment test. So that's one item. The other item that is a big cause of the impairment as well is the new strategic direction.
So the five year plan the future plans that we've had in the resource sector over time over the past years have been predicated on being an EPC player or a lump sum turnkey player doing the construction work and full EPC type on a fixed price basis projects. With the due decision to exit that, a large chunk of the addressable market was removed from the resource sector as well as then impacting future backlog, future revenues, etcetera. And then when you take that into account, it also affects the impairment model quite significantly.
Okay, great. And then just one last for myself. Your leverage ratio is at around 2.5 times. It sounds like incrementally in the back half of the year, you're going to be it's not going be a free cash flow negative period. When the sale of the four zero seven does occur, proceeds of that sale arguably you might be in a relatively decent position.
And you have enacted on your NCIB. Any potential using some of those proceeds towards your NCIB in the near future?
Right now, the answer is no. I mean, right now, the focus on the use of proceeds is deleveraging the balance sheet.
Okay. Did you feel comfortable that you'll be able to maintain that 2.5x ratio over the next few quarters?
Yes. So what we have in the ratio what we're going through right now with the ratio is essentially we had a few bad EBITDA quarters, right? And we had cash outflow as well increasing to that. But one of the big driver of the ratio right now is the fact that we had difficult quarters. So it's creating a bit of a pinch.
It is manageable, and we're continuing to manage pretty tightly our inflows and outflows and just improving the performance of business. So I think at this point, we're just working through bad quarters. Once we get beyond that, I mean, are just going to get back to a more normal level, especially with the sale concluding. I mean, it's already reflected in the ratio, as we say in the remarks. But I think it will just also just generally lower the debt levels, which will be good.
Okay. Thank you for the additional color.
You.
Next question comes from Michael Tupholme of TD Securities. Please go ahead.
Yes. Thank you. I just want to follow-up on that on the last question there about the leverage ratio and the balance sheet. So you've talked about negative cash outflows in the third quarter, albeit improving, I guess, in the fourth quarter to get you to positive for the second half. But when we look at the balance sheet and the leverage ratio over the next well, I guess, over the next couple of quarters, any concerns vis a vis the covenants and the credit agreement and needing to seek further relief?
Well, think at this point, we're like I said in the prior question, the pinch comes from the lower EBITDA that we've had in Q4, Q1 and this last Q2. So it is creating a bit of pressure on the covenant rate. We have a lot of levers, however, to address that as we go through Q3, and that's what we're working on. We have a good relationship with our banking syndicate. So if it comes to that, I think we'll be able to work on something there.
But at the same time, we have a number of settlements that are being worked on. We and then we see a recovery as well in the performance. I mean Q2 is quite unusual in our mind in terms of the number of reforecasts that we've had. So we see a turnaround from that situation, especially as a lot of the reforecasts were on projects that are really at the end of their completion. I mean, we had two out of three resources are near the end or done, one is done actually.
And then the on the infrastructure, the two of them are our Rancho Champagne, which are also done.
Just so just a clarification or addition on that. The sort of two parts. Are you adding back any of the losses you incurred in Q2 as you did with the losses on the Codelco project to get to this 2.5x ratio? And then secondly, how important is the company's investment grade credit rating for the business going forward? Or is it important to maintain an investment grade credit
rating?
So we're not adding back any of the reforecast losses in other than the mining one, okay, which we're adding back since the end of the big year last year. So that's the first question. On the investment grade, I mean, we do value our investment grade rating. And from a use of proceeds, that's exactly why we're so focused on deleveraging. We believe that once we do that, we'll be close to what we believe is our optimum debt level, maybe a little bit more deleveraging to come, pretty close to where we'd like to be.
The investment grade impact, it has a per the credit agreement, it does have a 25 bps increase on our financing costs if both ratings are below investment grade. So that's more of the immediate impact that would come from that. But as we work through this, our intentions would be to maintain our investment grade.
Question about the margin performance in the EDPM segment. It was 8.4% in the quarter. That was not materially different from what we saw in Q1, but it was down from 10.8% in the prior year's second quarter. I know you've talked about sort of the margins for the Engineering Services business as a whole being comparable to the prior year. But maybe just what is it that's pressuring the margins a little bit in EDPM?
And what is it you see happening that's going to cause those to come back up?
So there's a couple of specific things which create seasonality around the fourth quarter. One of them is the EDPM has had a long program of bringing about 300 graduates on board in the second half of the year. And those efficiencies hit the fourth quarter and have always improved the profitability in the fourth quarter for and
that's
a trend from a number of years. And then there is there's another specific around the way that they provision their cost and the charge out of the salaries, which also has a seasonal effect in the fourth quarter. So I'm sure you can probably point to that from previous years.
Okay. And then just one last one on the lump sum turnkey projects. I guess sort of two parts really. You do have some lump sum turnkey work in the Nuclear segment. Wondering if you can just talk a little bit about that.
Is that all related to the Nuclear project where you've had some higher forecasted costs in the first half of the year? Or are there other lump sum turnkey nuclear contracts as well beyond what you've been experiencing some higher costs on in the first half? And then separately, beyond the projects that caused some additional costs this quarter and the second quarter, when we look at the lump sum turnkey backlog, are all of the other projects still in a profit position? Or are they have they also experienced losses? And are they therefore breakeven at this point?
So you want to take the first one? Yes. Yes. There's two projects in the nuclear sector. One which is approaching completion, which I think you're referring to, there was an adjustment made in Q1, which is project D2O.
And that project's coming to completion. So the other is the Bruce Power, which is in part lump sum. It's actually, there are elements of it which target cost. And while an element of it, which is lump sum, which is already in the backlog that needs to be executed. The model going forward, and for the majority of the backlog in Nuclear is under target cost arrangement, which basically the downsides are capped.
Therefore, they're absolutely not what we would call lump sum turnkey construction projects and they're not where the root cause of our issues have stemmed from.
So on the second question relating to the LSTK backlog and whether those are still in a profit position. For infrastructure, for the ones that are not complete or near complete, they are, and they're performing. And we are obviously very intent to maintain that from an execution standpoint. On the resources side, the one listed on Page 18 are except for the mining one, which I cannot tell you really which one that is. But among those, there's one at a loss in there.
Thank you.
Yes. I mean I would just add that from the six in infrastructure, as I said, two of them are almost at completion. And the other four contracts are healthy contracts, primarily in the LRC space.
Our next question comes from Devin Dodge of BMO Capital Markets. Please go ahead.
Thanks. Good morning, guys. What
options are available to SNC to reduce or transfer risk on some of the lump sum infrastructure projects to other parties? And have other consortium partners shown a willingness to absorb some of SNC's roles on these projects?
So our focus right now, as we've said, is to really look at the oil and gas business and look at how we might divest parts or all of that business or how we might reinvent it as a services business that could add value to the overall S and TL engineering services part of the company. Specifically on the four ongoing infrastructure projects, they're obviously in consortium with other partners. We wouldn't rule out looking at other options. But currently, the plan is to execute those successfully.
Okay.
Look, with you guys exiting the fixed price business, both in oil and gas and infrastructure, are there measures that need to be taken to kind of efficiently wind down this business? Just thinking that employee turnover seems like it could be set to rise here just given the limited line of sight on activities for within SNC. I guess are there measures that you're doing to kind of maintain the workforce and ensure official wind down of that business?
Yeah, for sure. For sure. I mean clearly the majority of the people are actually on the projects. The people that work on projects see themselves as project people. They're working in consortiums and their kind of identity is to the consortium even though they're seconded from ourselves.
And they all have specific arrangements specific to the project. So we're less concerned about that, but we obviously have overhead and support staff that support projects. And we have taken specific measures to make sure we retain those staff that support it.
Okay. That's helpful. And maybe just a couple of quick questions. Just the JV with Holtec, what contract types are those?
So they're a capped downside contract. So they're projects and we're obviously in the process of setting this open secure in the first one of these. So I can't give you the actual kind of specifics. But the intent is that there'll be a capped downside contract model without time penalty. So in effect, they're absolutely not on LSTK contract.
Okay. And then just a question for Sylvain. The Carlyle Group, I think you had $100,000,000 commitment into one of their funds. Have you seen any capital calls on this? And are there opportunities to back out of the commitments that would would that provide maybe a because I don't believe you're going to be going after those kind of projects anymore.
Just any update there would be helpful.
So far in that entire program, we funded about $10,000,000 of the 100,000,000 and we don't see at the moment the remaining funding happening this year. As it relates to our exit and how that impacts the program itself or our involvement in the program, I think it's too early to say.
Okay. Thank you.
Our next question comes from Chris Murray of AltaCorp Capital. Please go ahead.
Thanks. Good morning, folks. Ian, as you went through your process of looking at your strategic review, I'm just wondering as you enter as you exit the lump sum turnkey projects, how does that play into your thoughts around the longevity of the capital business? Historically, a lot the projects you've done create those assets to build that pool. With the sale of four zero seven, should we be thinking about that business essentially kind of winding down over time?
No. Because where we would position ourselves in the P3 market going forward is to provide services on the design, which is the place we already play on all of the P3 jobs. And we would provide services in the operation and maintenance through the thirty year ongoing kind of life cycle operation. So in doing that, we would also look to form our place in the concession and apply the capital group to that. In actual fact, I think the expertise that we've got kind of goes beyond just providing capital injection.
It goes to the whole process of kind of getting to through the modeling and through bringing the various components of the concession together. So I think we have a pretty unique capability in bringing this all together on P3 jobs, especially in Canada. So the only part that we exit is the lump sum turnkey construction bit in the middle.
Okay. Fair part. And then my next question is, what's the projects that are still left and the runoff on them? You've taken the cost reforecast. I think as you've said, you've got the one that will probably still show some negative margin.
But from a cash flow perspective, and you mean if you can also talk a little bit about your expectations for recoveries in this. As these projects run off, what's your expectation for the, call it, the net cash flow impact before these are all these projects are all run down?
Yes. I mean, most of the projects are positive margins, right? I think there's one I mentioned in the resource sector that is not. So and then we also have, as we run off, we have a number of claims receivable on a few of those projects as well, which we'll be working on collecting. So overall, that should be positive over the run off.
So I mean, is it fair to think, I mean, when we looked at your 2018 number just on some of the numbers, you were basically kind of at a very low kind of level of margin in those projects. Is it fair to think that that I mean and I appreciate what you're saying about the earnings profile, but I'm thinking more about the cash position and the cash profile. Is it fair to think that the earnings profile actually turns into kind of a cash profile over the runoff period? Is that the best way to think about it?
For some of the projects, absolutely, yes. Okay. Just a comment on the loss making project, I think you said something just to make sure everybody is clear. The one that's at a loss, we when a project is at a loss, we record the entire loss of that project in the P and L. Then obviously the cash out happens as the project gets complete.
Yes. But I guess my point is what I'm trying to do is from this point forward is how to understand what, call it, the net cash flow impact of winding down that those projects. I understand, I think, if I've got this correctly, your position is that they actually should be modestly positive through the end of their life.
Okay. Thank you.
Our next question comes from Frederic Bastien of Raymond James. Please go ahead, sir.
Hi, good morning. Just wanted to go back to SNCL projects. Have you had any indication of interest for that side of the business? Are you are you really operating with the assumption that you'll be overseeing the execution of the backlog all the way to completion?
For the infrastructure part, we're working on the assumption that we will oversee the backlog to completion. And obviously, said for the resources part, all options are open.
Okay.
Thanks for the clarification. And Ian, you have spent the bulk of your career in the construction sector, but as you steer the company now towards an engineering services business only, What lessons can you take with you as you affect the change?
Yes. I mean, actually, I think that my background ideally places me to understand what to avoid because there's so many procurement models within this industry that we will still participate in and we will still apply our capability to. The real issue here is avoiding the contract models where the risk reward is not equitable any longer. Personally, I think I'm best placed to lead that and to lead the company to the place where we can actually apply our capability, please supply to our customers, but more importantly, provide predictability in the business and provide predictability in our earnings and cash flow.
Okay. Thanks for that and good luck.
Our next question comes from Maxim Sytchev of National Bank Financial. Please go ahead.
Hi, good morning.
Hey, Maxim. I
just wanted to come back to kind of the execution of the on the legacy EPC contracts. I mean, obviously, we have a number of provisions in the last couple of quarters, but what exactly are you doing? I mean, can you provide a bit of a playbook in terms of making sure that we don't have the same type of surprise in a couple of quarters? If yeah. Any color, please.
So it might be a reasonably long answer so bear with me. I mean for me it's different in the resources and infrastructure. I mean the infrastructure the resources sector, despite projects there, they're not large projects. Most of them are past the halfway point or at the halfway point. We have got a clear line of sight on the risks within those.
We have got a new leader in the resources business and we have applied a fresh kind of approach to the teams that lead it and the expectations that we put upon the close down of that part of the business. And in infrastructure, I mean, kind of repeat that 2,500,000,000.0 of the $2,800,000,000 of backlog is in LRT where we've been successful. And these projects are in multi joint ventures with Canadian and international players that we've played with for a long time successfully. We expect that business to be run off in a normal kind of way, in a normal environment. But what we've also kind of put upon this, as we've said, is we have not only looked at all of these projects, we have peer reviewed some of these projects where we see the higher risk and we've created this project oversight function which really reports to me to give me an absolute independent lens in real time of the health of these projects.
And I think with all of these measures together, we've really strengthened our ability to successfully execute from where we see them today to the end. Is that helpful, Mattson?
Yes. No, absolutely. Is there also maybe a question for Sylvain then? Is there a component of the new IFRS accounting rules which kind of complicates the revenue and the profitability recognition on these projects? Or there was something truly kind of structural issues on these ones?
Well, for sure, the IFRS 15 has increased the threshold of recognition of variable revenues. So when you're in a claim position, you have to have a higher probability of recovery than we had before the implementation of this new guideline, right? So that's causing some volatility, and then we've seen that. And what you'll see as well is on the project that we've been taking reforecast since the beginning of the year, a number of those are in claim situation, whether recognized or not recognized, they're on the claim situation. I'd probably have to cover a bit, but it's too early to make a call on Yes.
But I'd probably add to that, though, that our revenue recognition policy and it's the devaluing. It's pretty prudent. So moving through to IFRS 15, whilst the barrier of the threshold is higher, we kind of operated at that anyway.
Right. And then your comment around positive operating cash flow in the back half, are you banking on some clawbacks or claims to come through? Or those are externalities that you don't need to make up the numbers?
There is some settlements baked into that, especially as we complete projects. I mean, we expect those things to be able to resolve themselves. I mean, the problem during the life of a project is oftentimes the client don't want to fully resolve things until the project is complete. So I think we have assumed a number of
conclusions on some of those. Is it fair to say that Champlain is going be one of them in the back half?
Well, we don't comment something that specific, Maxim, so sorry.
Okay. Fair enough. And then maybe looking out a little bit, let's call it medium term, thinking about the appropriate leverage for this business on a going forward basis, how are you guys thinking about those metrics?
For E and C, which over time, we're talking about engineering services, we're looking at a one to 1.5 gross debt to EBITDA ratio.
Okay. And then has there been some thought given to allocating, I don't know, some sort of capital from your balance sheet? Because I mean, it's the same balance sheet that you're going to need to finance kind of both sides of the business to make sure that we have a better understanding in terms of the free cash flow generation on the part of engineering versus the legacy EPC contracts. Any thoughts there?
Yes. So we're thinking through it. I mean I realize that by creating two business lines, there's a number of items that are kind of falling in middle, whether we talk about corporate type costs or taxes or interest. So that's still something we're thinking about how far down right now we're at EBIT level, how far down we go. So it's under reflection.
And just to go back to your prior question, just to be clear, the I spoke about the E and C leverage and then on the capital side, so to speak, you could look at the we consider the $400,000,000 that would be left over after the fourseven sales, so the 400,000,000 left over with CDPQ as being outside of that ratio I just quoted you.
Yes, right. Fair enough. And then just two quick ones on EDPM, you don't mind. So in terms of retention there, have you seen any employee departures so far?
No. No. I mean the short answer is no. Obviously, we're looking at voluntary turnover pretty closely across the whole company. And we break that down into levels within the organization and businesses within the organization and geographies.
So the answer is actually no.
Okay. And last question on EDPM. Just in terms of I want to get the language right. So are you calling for EBIT margin to be stable or for the absolute EBIT to be stable on a like for like basis versus 2018?
I think we're making we're not making a precise guidance statement in what we said when it would be consistent. So I don't want to be pegged to the exact number. I think if you look at the last trailing twelve months and you consider that as a number, I think you'd get pretty close to the answer.
And in the first half of the year, what is the organic growth rate for EDPM? Because I mean like we've seen a number of reshufflings, right?
Yes. Overall, we were talking about 11 for the entire engineering services, EDPM. I don't know if you have that offhand in the Just while we're talking? It's in the segment and there's very little FX. So it's 9% and with negligible FX impact.
Okay. Okay. Thank you very much.
Our next question comes from Michael Tupholme of TD Securities. Please go ahead.
Thanks. Just a couple of clarifications. Just first of all, when you talk about cash flow being positive in the second half, Sylvain, we're talking about cash flow from operating activities after changes in working capital?
Yes.
Okay. And then I think one of the earlier questions I asked was just about the profitability of some of the remaining lump sum turnkey projects. And on the if I understood correctly, I think what you suggested was on the in the Resources segment, there's only one that is in a loss position, the mining project. Yet if I look at this quarter, the second quarter, there were three projects called out as having contributed to the losses in the quarter. And I know some of this may relate to warranty, but can you just sort of square that for me?
I'm having trouble understanding how there were three that were called out in the quarter, yet only one is in a loss position of the five. Yes.
One is complete. So that one is at a loss, presumably it's complete. The other one, there's one in there that has the reforecast and it's at a loss. And the other one had a reforecast, but it's still not at a loss.
Okay. And then I wanted to ask you about warranty thoughts on warranty exposure. So I recognize that we've talked about some of these projects nearing completion, some are already complete. But how do you feel about the warranty risk and exposure on projects that are near or even complete?
So our warranty provisions are forecasted into the forecast.
Okay. So that's not something that would be I mean, that be to say that we shouldn't be overly concerned about that going forward or?
No. No. I mean we've had a couple smaller headwinds in the quarter linked to that, that you're probably picking up on language maybe in the MD and A. But it's not a major item. Yes.
Great. Thank you. And then just lastly, again, I'd asked about this earlier, but when we look at Nuclear in the $162,000,000 of LSTK, I think you mentioned it was split between one project that's underway now and then the rest is on Bruce. Is there any way to sort of break that down and correct that the Bruce piece has not yet started?
Well, we won't split it, but the one that incurred the losses is So almost the bulk of what you see there would be Bruce and Bruce has started.
Yes, okay.
The contract format that has led you to have some portion of Nuclear and LSTK, is this something you expect to continue to contract basis under that kind of a model going forward? Or were these somehow unique and we shouldn't expect you to be entering into these kinds of contracts going forward?
So clearly, that's already in the backlog, and we will fulfill all our obligations to our client to execute that. But it wouldn't be a model going forward, no. We'd be looking to execute the nuclear work under a different model. The market is there and expects that also clearly because of the kind of risks associated with the life extension and remediation of nuclear projects. There's not a lot of desire for clients to put that under cost and time pressure.
Thanks for the clarifications.
As there are no further questions at this time, I would like to hand the call over to Mr. Denis Jasmin for any additional or closing remarks.
Thank you very much for joining us today. If you have any further questions, please don't hesitate to contact me. Thank you very much, and have a good day, everyone.
Thank you.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.