Good morning, and welcome to the Dexterra Group third quarter results conference call. All participants will be in listen-only mode. Should you need assistance, please signal our conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch-tone phone. To withdraw from the question queue, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Drew Knight, CFO. Please go ahead.
Thank you, Kate, and good morning. My name is Drew Knight, and I am the Chief Financial Officer of Dexterra Group Inc. With me today on the call are John MacCuish, CEO, and our Board Chair, Bill McFarland, who will provide some brief introductory comments. The format of this conference call will be the same as our past calls. After a brief presentation, we will take questions, with the call ending by 9:15 A.M. Eastern Time. We will be commenting on our Q3 2022 results with the assumption that you have read the Q3 earnings, press release, and MD&A and financial statements. The slide presentation which supports today's comments is posted on our website, and we encourage participants to access the slides and follow along with our presentation. Before we begin, I would like to make some comments about forward-looking information.
In yesterday's news release and on slide two of the presentation that we have posted to our website, you will find cautionary notes in that regard. I won't read the content of the cautionary notes in their entirety. We do claim their protection for any forward-looking information that we might disclose on this conference call today. I will now turn it over to Bill McFarland for his introductory comments.
Thank you, Drew, and welcome. Q3 was a solid quarter with good revenue growth and improved earnings. As our regulatory filings noted, we also took steps in Q3 to strengthen our foundation in each of our business units. These actions position us to adapt to the challenging business environment and uncertainty that all businesses face today with high inflation, rising interest rates, and challenges in attracting and retaining people. Our actions also included completing the transition and integration of the IFM acquisitions completed earlier in the year, executing on the four-point improvement plan in the modular business unit, proactively managing inflation, and strengthening our senior management team. Our financial position is also strong, and this will allow us to take advantage of opportunities in the market in the future. To be clear, Dexterra's goals have not changed. Our focus is on building a profitable, long-term, sustainable business.
In the short term, we are and will continue to take actions to proactively manage inflationary pressures, improve margins, and drive profitable revenue growth. I will now pass it over to John MacCuish to provide some more details on our results and actions.
Thank you, Bill. Good morning. Our Q3 revenue was CAD 260 million, and adjusted EBITDA was CAD 20.1 million. Revenue increased CAD 57 million or 28% compared to the same quarter in 2021. All three business units had good revenue growth year-over-year. Additional revenue of CAD 25 million was generated through the IFM acquisitions in Q1 of this year. Continued high activity levels in natural resources benefited the WAFES business, and we had greater throughput in the modular business. Inflation, recent disruptions to supply chain, and hiring and retaining talent continue to be our most important challenges. Inflation over the quarter on food was 6%, janitorial supplies 10%, building materials 5%-20%, subcontractors up to 30% increase. What steps have we taken?
Our supply chain team have increased the number of approved vendors and consolidated spend to drive improved volume discounts. Our culinary team are active in menu management, ensuring high-quality meals with the best cost inputs. Our operations teams are engaging clients to ensure inflation clauses and contracts are enacted, as well as collaborating on service and delivery levels that meet client affordability. In the services business, IFM and WAFES's inflation cost us roughly 2 points of margin. On the people front, we continue to have strong employee engagement driving retention. Our employee referral program is active and successful, and we have significantly reduced the number of vacant positions. We are also executing the business improvement plan for our Modular Solutions business unit, resulting in a return to profitability for the business during Q3, with further margin improvements expected in upcoming quarters.
Margins are expected to normalize by mid-2023 as we work out the backlog of existing fixed-price contracts. I'll now dive into some more details by business unit. Starting with IFM, this business unit increased revenue from CAD 39 million to CAD 71 million in Q3 2022 compared to prior year. This increase is largely related to the Q1 acquisitions but also includes new business wins that contributed CAD 5 million of revenue in Q3. That's CAD 20 million annually. Our airport business also saw an uplift from prior quarters, and the IFM team renewed several contracts, including the Greater Toronto Airports Authority, which is a significant contract and a strategic partner for Dexterra. Last quarter, we announced the appointment of Sanjay Gomes as the President of our IFM business.
Sanjay has conducted reviews of the two IFM acquisitions completed in Q1 2022, completed transition plans, which include bringing them on our systems, reducing overhead costs, reviewing and acting on non-profitable contracts. With that review completed, those businesses will have strong margins. Dana Hospitality also had lower margins due to the seasonality of education business in the summer months. This business has fully rebounded this fall to post-pandemic levels. The IFM business also has a good pipeline of opportunities, and the ongoing focus is winning new work that is profitable and with contractual terms to deal with inflationary pressures. Moving over to WAFES. Q3 2022 revenue grew to CAD 132.6 million, which is up 12% compared to the same quarter in 2021.
WAFES revenue performance was strong due to the CAD 7 million increase in catering infrastructure installs and rental activities in Western Canada, which resulted in increased occupancy utilization across all services and a CAD 7 million increase in energy services revenue, mostly from higher Access Matting activity. The overall increase was achieved despite a CAD 4 million reduction in fire support activity in 2022. This growth reflects our strong brand and high service levels of WAFES and included CAD 10 million of revenue from forestry's seasonal activity in Q3. The Modular Solutions business grew Q3 2022 revenue to CAD 54.5 million, compared to revenue of CAD 45.1 million in the same quarter in 2021, and exceeded Q2 levels. During the quarter, we also announced the appointment of Robert Johnston as our new President of Modular Solutions.
We're very excited to have Rob join our executive team. Rob's wealth of project and construction industry expertise and business acumen are valuable additions to the team. He is focused on expanding the modular client base through product and end market diversification. The four-point plan had an initial goal of returning the business to profitability in Q3 2022, and that was achieved. U.S. destination supply projects now represent 15% of the total revenue for the business unit also help utilize our plant capacity and generate growing revenues in Q3. This product diversification reduces our revenue concentration risk. However, social affordable housing will continue to be an important part of the business, especially as governments continue to support funding of these projects. Our modular backlog is over CAD 200 million.
The backlog increase of CAD 30 million from Q2 2022 is associated with the growth of our U.S. supply-only business, which will also benefit from the strengthened U.S. dollar. I'll now turn it to Drew for comments on our financial position.
Thank you, John. I'll discuss the EBITDA by business unit, our financial position, and some other general comments, as John has already taken you through revenue. Starting on slide 10, our IFM EBITDA margin was 4% for Q3 2022. The decrease in margin is primarily a result, as John explained, of completing the transition and integration plan related to the IFM acquisitions and includes the impact of the seasonality in Dana's education sector. These activities had a CAD 1.5 million impact or about 2 points of margin. IFM also encountered continued inflationary pressures for which there is a lag in passing on costs to the customer. A number of significant contracts reached their anniversary dates to pass costs on later in the quarter. Margins are expected to improve significantly in Q4 of 2022.
The WAFES business had adjusted EBITDA in Q3 2022 was CAD 20.9 million, which is up by CAD 4.6 million compared to Q2 2022, and was consistent with Q3 2021. The revenue increase in Q3 2022 when compared to Q3 2021 is primarily due to contract wins during 2021 and 2022, which were profitable but were offset by lower forestry and fire support business in 2022 and the impacts of inflation. Management continues to manage the inflation impacts on this business unit, but there are timing delays in our ability to pass costs on to customers. There was also strong profitability in energy services from higher mat volumes and install work in Q3. The 2021 results also included some sales of excess camp equipment, which contributed to its profitability.
The Modular Solutions business had an adjusted EBITDA of CAD 0.9 million compared to a loss of CAD 3 million in Q2 2021, and a profit of CAD 2.8 million in Q3 2021. The Q3 improvement was the result of the execution of the business unit turnaround plan with contract pricing adjusted for inflation where possible, better project management and higher plant efficiencies. New contracts have terms to manage inflation risk. We had planned for a return to profitability in Q3 and expect gradual margin improvements in upcoming quarters, with normal margins expected to return by mid-2023 as older fixed-price contracts are completed. Looking at slide 11, the corporation's financial position and liquidity remain strong, with debt reduced to CAD 111 million, and Dexterra has CAD 77 million of unused capacity on its credit lines at September 30th, 2022.
The debt reduction was assisted by a significant reduction in working capital. This reduction is expected to be sustainable as we worked actively with clients to reduce days sales in receivables. Leverage is down significantly over the past two years, and we continue to manage our debt levels in this uncertain business environment. The conversion of EBITDA to free cash flow for 2022 is expected to exceed 50%. Dexterra Group also declared a dividend for Q4 2022 of CAD 0.0875 per share for shareholders of record at December 31st, 2022, to be paid on January 16th, 2023. I will now return it back to John for closing comments.
Thank you, Drew. As we look to the future, the focus of the IFM business is on our organic, profitable growth and margin improvements. Margins will increase with contract pricing adjustments and cost management initiatives for labor and material, which will be realized in upcoming quarters. We are also looking opportunistically at tuck-in acquisitions. WAFES is expected to remain strong and will be buoyed by solid natural resource activity levels in upcoming quarters, with high demand for goods and services in our energy services division. The Crossroads Lodge in Kitimat, BC, had limited occupancy in Q3. We do not expect a significant increase in its occupancy levels in Q4 2022. We continue to proactively monitor the situation with LNG Canada, and we're looking to increase occupancy via other regional clients. In Modular, it's all about executing the business improvement plan and bringing our margins back to normal levels.
Overall, Dexterra's management team is focused on the hiring and retention of people, as people are our most important asset. Proactively managing inflation and maintaining our strong financial position will provide us with flexibility to take advantage of opportunities as we manage in these uncertain business environment. In conclusion, we have lots of positive momentum, and we're well positioned for the future. This concludes our prepared remarks for today. At this time, I'll turn the call back to our operator for the Q&A portion of the call. We ask that you begin by limiting yourself to two questions. If we have time at the end, we will circle back for additional questions. Thank you for joining us today. Please go ahead, operator.
We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you're using a speaker phone, please pick up your handset before pressing the keys. To withdraw from the queue, please press star then two. Our first question is from Aaron MacNeil of TD Cowen. Please go ahead.
Hey, morning all. Thanks for taking my questions. What are your updated views on sort of the cyclicality of your energy-weighted businesses, you know, energy services and matting in particular? What sort of expectations do you have looking into 2023? I mean, do you see the continued strength in the energy sector as an opportunity to, you know, divest of these businesses to fund your acquisition strategy in IFM?
Well, I think, Aaron, the energy business is strong as you note. You know, we see volumes continuing to be strong through 2023 and for the foreseeable future. Certainly, we're well aware of the cyclicality of the business, and we are focused on acquisitions for IFM, as you know. But at the moment, we're not actively looking to market any of these businesses.
Just switching gears to IFM, I guess. Can you walk us through what a recession might mean for IFM, you know, on the revenue side? How resilient do you think the revenues are to broadly reduced economic activity? On the flip side, do you see a potential for, you know, a recession to act as an opportunity for some relief from inflationary and wage pressures?
Okay, I'll try that on, Aaron. Look, we're very strong on the IFM business. I think, revenue-wise, the inflationary environment we're in does cause clients to rethink how they deliver certain services in their buildings, in their infrastructure. We're not anticipating any dullness around the revenue at all. In fact, there may be opportunities to deliver a better solution for clients. Obviously on inflation, I mean, there's a body of knowledge out there that indicates, you know, this could go on for a while. No one really knows. You know, we're just going to continue to do the things that I talked about.
We're gonna focus on our contracts and make sure that the terms in any new contracts are contemplating inflation at a, you know, at a brisk rate. You know, we're gonna continue with our client engagement to ensure that, you know, we're meeting a scope that works for them and their affordability. Of course, obviously, strategic supply chain will continue to be a strong initiative for us. You know, I think we're well-positioned to work through these inflationary times. Still lots of uncertainty, but we feel we're equipped to carry on in that environment successfully.
Yeah. Aaron, I think I'd add to that. You know, our IFM business is a very resilient business, and a recession, you know, certainly would be concerning, but it's not a huge impact on our IFM business. We don't expect. It's nothing like COVID was, a couple years ago, right?
The next question is from Chris Murray of ATB Capital Markets. Please go ahead.
Yeah. Thanks. Good morning, folks. Drew, you made the comment that you thought that margins in IFM would be materially higher, I guess, in Q4 or and into 2023. Can you talk a little bit about, and maybe go back just so I understand, you know, what's the bridge between where you were for Q3 to, you know, what you think it would be materially higher? And I guess maybe to frame this maybe a different way, does materially higher get you back into that 7%-8% range that you've historically talked about for IFM?
Yeah. Chris, I think you'll see in the material and in the script, we mentioned there was a CAD 1.5 million charge in the quarter, and that really bridges us back to pretty close to those historical rates. You know, the education sector, one of the acquired businesses was a big impact in July and August. We did a lot of work to remediate that business and we're expecting a big bounce back. It seems like, you know, the education sector in 2021 wasn't back to pre-COVID levels, but 2022, it's back to pre-COVID levels, like all the residences are back, all the private schools are back, and that's a big piece of the acquired business.
All right. There's nothing getting us back to where you guys had talked about, you know, in that range. John, just in terms of contract structure, is there a chance to put CPI inflation or anything like that, kinda mid-year into these contracts, or is this something that's only revisited annually? Can you just kinda maybe walk us through the structure of how you're gonna get some of this cost recovery?
Right. Historically, the CPI or inflationary clauses were annually. You know, we've been living for the last 12 years in a different environment. I think when I say the client engagement, that's exactly what I'm talking about. Annual isn't enough right now, and it's that client engagement, whether it's in the contract or not, we're making overtures to clients, sharing the facts, co-opting them into the discussion. You know, take an example, you know, in IFM, labor is a big component, a big input to cost. You know, clients know in their facility that employees are feeling the pinch of inflation and affordability for their own families.
You know, clients are willing to talk about how we might deliver our fund, you know, pressures on wages. Clients have the same issues we have, so it's not like we're trying to introduce a new dimension here. They're living with it in their own business, and they're quite, you know, aware of what we're all dealing with. To be honest, you know, we have great client relationships, and thank goodness we do because this is the time when you need to rely on those relationships. I hope that answers the question.
The next question is from Zachary Evershed of National Bank Financial. Please go ahead.
Morning, everyone. Thanks for taking my questions.
Hey, Zach.
The backlog increase in Modular of almost CAD 31 million from Q2 is associated with continued federal funding for rapid affordable housing. You say that may be impacted by large projects. Can we get clarification on that phrasing? Like, what's the implication of may be impacted by large projects?
Yeah, I guess it's just a lumpy thing. You know, to be honest, we weren't expecting growth in the backlog in the current timeframe, but a couple of contracts came through that were, you know, over CAD 20 million for the coming periods, and that impacts that backlog pretty significantly. You know, if there's not those big lumps coming through in the future, the backlog will oscillate up and down. You know, and also the U.S. business has been strong for us. I think, you know, we mentioned, though most of our contracts are in Canadian dollars, we do benefit from the exchange rate, even if it is in Canadian dollars when we're selling. That's been helpful for the last nine months or so.
Got you. Thanks. Do you still believe EBITDA margins for the modular segment can reach 3%-4% in the back half of the year? Is normalized EBITDA by mid-2023 still around 6% in your mind?
Yeah, I think, we're looking at gradual improvements, and the EBITDA for Q3 was about 2 points for modular, and we're thinking it's gonna add 1 point every quarter as we go forward, and then by mid-2023, we'll be back to that 6%-7% range.
Again, if you have a question, please press star then one. The next question is from Frederic Bastien of Raymond James. Please go ahead.
Drew, you partly answered some of those questions, but there's obviously confidence in your ability to bring margins back to or to have the margins normalized by the middle of next year. Can you remind us exactly what normal margins look like by segment? I think it was 7%-8% in facilities management. What are the other two?
Yeah, sure. IFM, yeah, we're targeting to be a little over 7%. Modular is really north of 6% and could be over 7%. Then the WAFES business usually sits around 15%. That's generally where we're at.
Okay.
We are watching inflation in all those businesses. It, you know, it does with those timing delays that we articulate, it does fluctuate by a point or two till we get that stuff digested. That's it.
Understood. Can you discuss the occupancy delays at the Crossroads Lodge? Obviously, you were pointing to, I think, a faster ramp up. What's behind the delays? Is it client driven? Just curious what if you could provide more color.
Yeah. It's, you know, something outside of management's control, but maybe I'll let John take it.
Yeah. Yeah. I just to give you color around this, obviously it is associated with our big client for this camp would be LNG Canada. You know, it's impacted by ramp up on the project, labor shortages, et cetera. We're staying very close to that client. We don't know, you know, we're not in total control of this. You know, we are active around other regional opportunities. The key here is Crossroads continues to be an opportunity and an upside for us.
Yeah. Like, Crossroads was essentially break even in Q3 this past quarter. You know, we're looking at other regional players, and there are a few other regional players that'll give us upside from our Q3 results. You know, anything that comes from the construction of the LNG facility is upside as well.
The next question is from Jonathan Goldman of Scotiabank. Please go ahead.
Hey, good morning, guys.
Morning, John.
Just a clarification question. Good morning. The CAD 1.5 million impact in IFM on profitability, were there three causes to that or two? I think I'm just trying to clarify between the script and the press release.
Yeah. It was mostly fixated on the two acquisitions. As we integrated and transitioned those businesses, there were some costs getting them onto our systems and getting the accounting straight for all the transactions and activities, and then also taking a look at their contracts. You know, they were sort of getting new information as they adapt to the way we run our businesses, and data is powerful. We see that we saw some contracts that were underwater. In a post-COVID world, some of those contracts just never really came back to where they were before. It caused us to get them to talk to their clients and either adjust the contract or potentially walk away from some business.
You know, in the summer months, especially in that education sector, there were some big losses in July and August that now we've reconciled and fixed. I think the CAD 1.5 million is a non-recurring thing that should come back.
Okay, that makes sense. Just I guess along those lines, I guess if you were to normalize for that 1.5 IFM margins, I guess from my math would be 6%. I guess some more pass-throughs are gonna kick in in Q4. Would the 6% be a good baseline to then model some improvement on top of that going through the back half or rather the last quarter of the year?
Yeah, you hit the nail on the head. That's the way we're viewing it in the short term, in the next couple of quarters, but we are targeting to get back north of 7%, in a few quarters from now.
The next question is from Trevor Reynolds of Acumen Capital Partners. Please go ahead.
Morning, guys. You guys walked through some of the inflation numbers that you guys have seen, and just wondering, have those levels moderated in Q3 or into Q4? What are you seeing on that front across the board?
Yeah. Look, Trevor, this whole inflation situation is very fluid. It's driven by all kinds of influences. We've seen up, we've seen down, we've seen building supplies skyrocket up, you know, six months ago and then come back down a bit and then only to go back up again. We are monitoring everything as closely as we can. The actions we're taking are the things that we have control over. We have control over our client contracts and our engagement with clients around recovery. We have control over our strategic supply chain so that we can consolidate spend with fewer approved vendors and drive better volume discounts. We can, you know, control our inputs.
That's why I spoke about our culinary team doing, you know, menu management so that we make the best of the situation. Hard for me to answer that. I think, you know, we don't expect it to be larger. Let me say that.
Okay. That's fair. Obviously subcontractors is a big portion of that. Are you getting enough labor that you're seeing that the amount of subcontractors that you have to use come down or where does that sit?
Yeah, I wouldn't say that we're at that point because look, to be honest with you, these are trades positions. Our subcontractors are licensed HVAC technicians and other tradespeople. You know, just read the literature out there. There's a lot of demand and a lot of shortage. We're being very attentive to this. We're actively recruiting. We've got a higher referral bonus inside the company for tradespeople to kind of entice our employee network to attract people. We're constantly looking at the value of self-delivery versus subcontractor. We're hoping that as we get our staffing to higher levels, we'll be able to be less dependent on subcontractors.
The next question is a follow-up from Zachary Evershed of National Bank Financial. Please go ahead.
Hey, just a quick follow-up on the integration costs in the quarter, the CAD 1.5 million. Were those in line with your expectations, and what were they attributable to? What integration activities were they for?
Yeah. Hi, Zach. You know, we knew we had issues coming up. It was probably similar with what our plans were, but you know, it was mostly getting both of those businesses onto our systems, you know, getting them used to certain business administration practices like issuing POs, et cetera, and also getting their contracts buttoned down. You know, there's a lot of contracts that have been changed in a post-COVID world. You know, the way hospitals operate is tremendously different. You know, it hasn't really come back from COVID the way the rest of the world has. Some of those contracts are in a very challenged position.
We've more data from our systems than maybe the businesses were flying blind a little bit. They realized there's a few contracts that were underwater, and now we've had to reconcile those contracts, go back to the client, and either restructure or jettison. We do think it's a one-timer.
That answers my next question. Thanks very much.
This concludes our question and answer session and today's conference. Thank you for attending today's presentation. You may now disconnect.