Q3 2022 SNC-Lavalin Group Inc Earnings Call
Thank you for standing by this is the conference operator, good morning, and welcome to <unk> third quarter 2022 results Conference call. As a reminder, all participants are in listen only mode and the conference is being recorded.
After the presentation there'll be an opportunity to ask questions to join the question queue. You May Press Star then one on your telephone keypad should you need assistance during the conference call you May signal, an operator by pressing Star then zero I would now like to turn the conference over to Denny Jasmine Vice President Investor.
Relations. Please go ahead.
Thank you good morning, everyone and thank you for joining the call our Q.
Q3 earnings announcement was released this morning, and we have posted a corresponding slide presentation on the investors section of our website.
Recording of todays call and the transcript will also be available on our website within 24 hours.
With me today are unit words, President and Chief Executive Officer, and Jeff Bill Executive Vice President and Chief Financial Officer.
Before we begin I would like to ask everyone to limit themselves to one or two questions to ensure that all analysts reports and feedstock space. You are welcome to return to the queue for any follow up questions.
I would like to draw your attention to slide two comments made on today's call may contain forward looking information. This information by its nature is subject to risks and uncertainties and as such actual results may differ materially from the views expressed today.
For further information on these risks and uncertainties. Please consult the company's relevant filings on SEDAR. These documents are also available on our website.
During the call we may refer to certain non <unk> measures and ratios. These measures and ratios are defined calculated and reconciled with comparable <unk> measures in our MD&A, which can be found on SEDAR and our website management believes that these non <unk> measures provide additional insight into the company's financial results and certain <unk>.
They may use this information to evaluate the company's performance from <unk> and now I'll pass the call over to you in other words.
Thank you Tony Good morning, everyone and thank you for joining us today I want to start as I do every quarter by taking a minute to recognize the tireless efforts of our 33000 employees worldwide.
Also want to officially welcome the new employees that joined in the quarter.
Nice to have you in the S&P level and it sounds like.
Core purpose is engineering, a better future for our planet and its people.
Only able to do this through the hard work and dedication of our employees, whose contributions help us achieve our long term growth aspirations.
Appreciate everything that they do.
With that let's start on slide four during the third quarter. We saw a continued uptick in topline performance as total revenues increased four 5% year over year to $1 $9 billion driven.
Driven by the continued acceleration of our engineering services business.
During the third quarter, our SDK projects backlog declined further by $164 million.
From the second quarter to $664 million.
As we approach the completion of these projects with the two Ontario projects on track to be largely physically complete by the end of the year, we remain confident in our.
Financial risk estimates that we outlined earlier this year.
NPL services revenues were up eight 2% over Q3 of last year to $1 6 billion.
Excluding the impacts of foreign currency, we achieved a robust organic growth of 12, 6%.
Segment, adjusted EBIT was $153 million and represented a nine 3% margin.
We're especially pleased by the continued execution in our engineering services business, which achieved a record high backlog for the second consecutive quarter results. These past two quarters further highlight our ability to execute are pivoting to growth strategy and expand into our tool geographies.
Which continue to demonstrate resilience and growth.
Total backlog for engineering services rose to $4 6 billion.
Which represented a 20% increase year over year with a further strong growth in the U S.
We've been intentional in our pivot into specific core geographies in our chosen markets.
Seth This this quarter further emphasize the strengths of our pivoting to growth approach.
On our growth opportunities are unfolding as we planned.
We continue to believe this strategy put in place represents the best opportunity for S&P level, and we expect to continue to deliver on our stated goals.
While the macroeconomic environment is challenging and is projected to be so for the foreseeable future.
<unk> model remains resilient and this is driven by public sector focus on sustainable infrastructure and long term energy solutions.
Turning to slide five our engineering services business continued its momentum from the last few quarters delivering strong results during the third quarter.
Business remains robust in our core geographies as evidenced by our 18, 3% year over year organic revenue growth to approximately $1 2 billion.
Our sustained improvement quarter over quarter highlights our ability to capture market share and provides a clear roadmap for the growth prospects for sustainable infrastructure demand.
Segment, adjusted EBIT margin and segment adjusted EBITDA was the net revenue margin was eight 3% and 14, 5% respectively.
Our target ranges on.
On an absolute basis segment, adjusted EBIT grew $5 million year over year.
Before discussing key wins I want to highlight how proud of them all of our teams for the quick response to assist the U S. Emergency relief from program set up by FEMA to help those floridians and need following hurricane Ian we send best wishes to all of those continuing to be affected by this disaster.
During the third quarter, we continued to realize significant wins across our core geographies. The U S. The UK and Canada, but we also saw increase in demand in the middle East, where we continue to secure project wins and sustainable building development to support increased population growth in the region.
Strong backlog increase in the U S was achieved through several government contract wins, notably with the department of transport for infrastructure development in Florida, Georgia, Colorado and Texas.
These wins in addition to those elevated our backlog to $4 6 billion, another record level and 20% higher than where we stood as of September 32021.
Looking forward, we remain optimistic of the long term potential for our engineering services business. Our pipeline remains robust and we are well positioned to continue growing capturing market share from increased governmental focus on sustainable infrastructure and renewable power alternatives were.
Also believe that the global energy transition that we are currently witnessing is positive for us and C level and not only for our nuclear and infrastructure sectors, but also for our mining and our industrial sectors, which have seen a significant increase in demand for our services such as studies for new minerals extraction processes as well.
As engineering for new electrical vehicle battery plants.
Yeah.
I'd like to now move on to slide six and the results for our nuclear business.
During the third quarter nuclear revenues and segment adjusted EBIT was similar to prior year with slightly lower revenue being offset by slightly higher segment adjusted EBIT margin.
We continue to make progress across our Canadian refurbishment projects at Darlington and Bruce power.
And we're also seeing growing demand for life extension work for the can do reactor fleet around the world.
As countries continued to make commitments connect zero, we're seeing this as a positive catalyst for nuclear as a low carbon way to produce electricity and Martin and increased focus on newbuild opportunities to deliver baseball baseload power into an evolving and green power grid. We are also well.
Positioned to capitalize on major upcoming Newbuild projects and small modular reactors, where we are dedicating a greater number of our highly skilled engineers to billable projects as we position our newbuild business for growth.
We are offering large reactor technology support and continue to partner with Rolls Royce for small modular reactor work.
The opportunity to participate in nuclear projects is robust including size, we'll see in the U K and the potential for Cerner voting units three and four in Romania.
Looking at the pipeline for potential growth in this arena is very strong over the past three months, we've added significant amount of new opportunities to the pipeline across all nuclear subsectors.
Life extension and refurbishment.
Decommissioning and waste management and new builds.
These high quality prospects showed the potential growth opportunity in front of us.
Our technology and scale positions us to be market leaders in nuclear support.
Boost the long term growth potential of <unk> government.
Moving to slide seven in our O&M segment, which generated a $124 million in revenue during the third quarter and a 12, 2% organic increase year over year.
This sector continued to deliver strong segment adjusted EBIT of $60 million, representing 12, 7% EBIT margin well above our long term target of 5%.
Looking out we have highlighted several opportunities across the U K.
U S and Canada through building road infrastructure improvements with the progress we're making in our final SDK projects. We're also mobilizing for the O&M Stanhope after rent payments.
Please.
We continue to see opportunities for growth in our strategic partnership with key industry players and by leveraging our capital program to maximize bidding opportunities for future growth in core markets.
On slide eight our linked some business was impacted by supply chain and manufacturing delays during the third quarter revenues declined to $123 million, representing an organic revenue decrease of 11, 1% compared to the third quarter 2021.
Segment, adjusted EBIT totaled $2 million in the quarter Q3, and year to date margin is lower than our long term target of 46, therefore, our main focus rather than winning more profitable work on will be.
Performance improvements to ensure we meet our targets in 2023.
The pipeline of opportunities remains robust driven by significant investments across the globe towards grid infrastructure renewable energy parallel.
Our backlog ended the second quarter at $764 million.
However, new orders of $217 million have been added to the backlog year to date and we are anticipating further additions to the backlog in the fourth quarter as we secured a number of project wins subsequent to the quarter close.
Turning to slide nine and capital third quarter revenues increased $29 million and segment adjusted EBIT rose to $25 million.
Mainly due to the dividend received from highway 407, ETR. This was partially offset by the previous disposal of our investment in parallel DC, which occurred in the first quarter of 2022.
As COVID-19 restrictions in the province of Ontario continue to ease traffic patterns trends have been stronger on highway 407 with traffic now, reaching 88% of pre pandemic level.
We received a $40 million dividend during the third quarter and subsequent to quarter close we received a $24 million dividend in October .
Moving to slide 10, and the update on the LSE K projects.
Our backlog continues to decrease at a robust pace with a year over year decline from $1 $2 billion to $664 million.
Representing a 43% reduction.
Sequentially the backlog saw a 20% reduction from Q2.
Segment adjusted EBIT continues to be impacted by the macro factors that we've been managing over several quarters as we work to complete these projects, including supply chain disruptions elevated inflation labor shortages and the impact early in the quarter from an Ontario safety inspectors strike.
As we've previously explained this.
<unk> post pandemic macro economic factors in our opinion are largely recoverable under the contracts, we have with our customers.
And ongoing ongoing negotiations are in progress to recover the losses.
We continue to progress the majority of these projects to completion at our cost.
Despite the lack of payments from our customers for contractual issues for which we have a legal entitlements compensation.
Our shortfall in cash flow. This year has been significantly impacted by the failure to receive these compensation payments and we will continue to actively pursue claims for timely recovery as we move into 2023.
As you can see on slide 11, we have provided as in Q2, a more detailed update of the wind down of the other <unk> projects.
Two of the three Canadian projects Eglinton and Trillium remain on track to be largely physically complete by the end of the year, while ramp continues to progress really well and is over 70% complete as of September 32022.
We have recognized $111 million of EBIT losses year to date.
With $77 million of those losses related to the $300 million of total financial risk.
To complete the LSC K projects represented.
Represented on the chart on the right hand side of this slide.
The remaining $34 million in losses is mainly related to the overhead cost and managing these projects.
With each passing quarter.
We gain increased visibility into the completion cost of these projects.
And we remain confident that any further additional financial risk should be contained within the $300 million envelope originally projected earlier this year.
So before turning it over to Jeff I just wanted to highlight our 2021 sustainability report that we published on the 20th of 26th of September .
Helping customers reached a net zero carbon targets is fundamental.
Part of our work and we want to be recognized as a global pioneer in sustainable infrastructure.
We have proven our capabilities through a diverse track record that ranges from electrified light rail transportation nuclear energy to designing building financing maintaining projects focused on transforming the built environment for greener future.
We're investing in data driven digital innovation that we believe can unlock significant value for our customers by providing greater certainty over project timing and cost increased operational efficiencies and reduced carbon footprint.
We're helping to engineer a future by meeting the global demand for clean energy Decarbonizing, the built environment minimizing the impacts of new infrastructure and building resiliency to climate change impacts.
Helping our customers adopt clean power and renewable energy is a global effort, which is expected to require significant investment over the next 30 years.
All of this is only achieved through the hard work and dedication of our employees and we have successfully welcomed a net increase of 2400 employees across the company year to date.
And we are further investing in that Korea to grow through our global talent development program.
This is an exciting time to be a SMC loveland.
And with that I'll now turn it over to Jeff to discuss the financial highlights.
Thank you Ian and good morning, everyone.
Turning to slide 14, total revenues for the quarter increased to $1 9 billion.
Driven by SNCF services, which produced its sixth consecutive quarter of positive year over year revenue growth.
While Teekay project revenues continued to decrease as expected.
Total segment adjusted EBIT for the quarter was $134 million.
Which was comprised of $153 million for SNCF services, a 3% increase year over year $25 million for capital and negative $44 million for Alex Teekay projects.
FMC Health services adjusted EBIT margin was nine 3% in line with our targeted range of 8% to 10%.
The negative EBIT for Alex Teekay projects resulted from recognizing $31 million in the quarter up to $300 million potential financial risks disclosed in our Q4 2021 results and $13 million, primarily from the segment overhead costs needed to support these projects.
Corporate SG&A expenses from <unk> for the quarter was $25 million in line with our expectations and 43% lower than last year. As Q3 2021 included certain unfavorable estimate revisions.
We continue to expect that corporate SG&A expenses for <unk> should be about $100 million for full year 2022.
Capital had $7 million of corporate SG&A in line with last year and in line with our expectations.
<unk> net income from continuing operations this quarter was $45 million.
Compared to $19 million in Q3, 2021 and was composed of a net income from <unk> of $30 million and net income from capital.
<unk> million dollars.
The adjusted net income from <unk> and PM was up 29% to $52 million or <unk> 30 per diluted share due to the lower corporate SG&A and higher segmented adjusted EBIT from FMC health services, partly offset by higher losses analysis Teekay projects.
Backlog ended the quarter at $12 $4 billion.
Compared to $12 8 billion at the end of Q3 2021, primarily due to a decrease in Alice Teekay projects.
We continue to execute our strategy to exit the LLS teekay construction contracts, partially offset by an increase in SBC and services.
Yes in field services backlog increased to $11 7 billion at the end of the quarter, which included a 20% increase in the engineering services segment backlog, despite the weaker British pound compared to Q3 2021.
This segment was awarded $1 $6 billion of work in the quarter, representing a very strong one four book to Bill ratio.
<unk> segment also had a good quarter with a book to Bill ratio of one two and in Q3 at $859 million of backlog.
If we now turn to slide 15 at the end of September 2022, the company's net limited recourse and recourse debt was $1 5 billion.
And the net limited recourse and recourse debt to adjusted EBITDA ratio was three three times.
While this ratio was above our target range of one five to two times at the end of 2020 for balance sheet strength and financial resilience of our core financial priority and we remain confident of meeting the target at the Ellis Teekay projects complete and we continue to execute on our growth strategy.
Our day sales outstanding for Engineering services continues to be lower than the pre pandemic level due to our continuing efforts on cash collection and stood at 65 days at the end of the quarter.
However, this is higher than what we've seen throughout the last four quarters as client payment terms are returning to more normalized levels.
If we now move on to slide 16, and free cash flow.
Net cash used for operating activities was $159 million in the third quarter.
SNCF services continued to generate positive cash flow from operations was $60 million for the quarter, while capital generated 19.
After cash taxes interest and corporate items, which includes the payments for government fines restructuring and transformation costs amongst others.
You can see that the company used $16 million of operating cash flows excluding TK.
Alex Teekay projects used $143 million.
On a year to date basis, SNCF services generated $213 million and capital of $46 million of cash flow from operations, while Ellis Teekay projects had a usage of $369 million.
After cash taxes interest and corporate items total net cash usage for the first nine months of the year was $421 million.
As Ian said, despite the lack of financial payment from our clients, we continue to progress well on the remaining teekay projects.
These continued to be affected by several external challenges.
<unk> is to fund the increased cost resulting from these events.
We continue to believe that the clients are responsible for much of these additional costs and we are actively pursuing claims associated with the increased cost we've experienced.
Discussions with our LSD Quay project clients remain constructive and ongoing however, it may take some time to come to final resolution at which point the related cash received will be incrementally positive to the companys net cash from operating activities.
For the last quarter of this year, we expect operating cash inflows from SNCF services to improve compared to Q3 and.
And operating cash outflows related to LNG teekay projects to reduce.
As we are moving closer to the physical completion of two of these large infrastructure projects. We clearly expect that the cash outflows required to complete them will significantly reduce throughout 2023.
And therefore year on year cash flow to improve.
And our longer term targets haven't changed we continue to expect that by the end of 2024, our free cash flow conversion rate to adjusted net income should be between 80 and 90% as we previously disclosed.
Turning to my last slide Slide 17 for our 2022 outlook.
And we are moving closer to our year end, we're making three adjustments to our 2022 Edward.
First in line with what I, just said on cash flow. We are now expecting the full year 2022, net cash usage from operating activities to be approximately $300 million.
With positive net cash from operating activities in the fourth quarter.
Second given our robust backlog and strong performance year to date in engineering services, we are raising the SNCF services organic revenue growth outlook for full year 2022 versus 2021 to be between 5% and 7%.
Note that engineering services revenues in Q4 last year included a one time $93 million favorable income from an arbitration decision, which is not expected to repeat this year.
Our 2022 revenue growth outlook would be even higher.
And thirdly, we are tightening the <unk> services segment adjusted EBIT to segment revenue ratio outlook for full year 2022 to between eight five and 9% in line with our year to date margin.
All other companies' financial outlook metrics for full year 2022 remain unchanged.
And now I'll hand, it back to Ian.
Thanks, Jeff turning to slide 19, I'd like to conclude my remarks with a few key takeaways.
Our core business is executing well and we continue to do what we said we would do.
We are delivering strong financial performance with notable backlog expansion in engineering services and high growth potential markets and strengthening our pipeline of new business opportunities and nuclear positions us well in our core markets.
We are continuing our plan to exit our LLS TK business.
Having close conversations with our customers to recoup the total cash owed.
For the work that we have already completed.
Recent results further demonstrate the resiliency of our business and our ability to grow in the current macro environment. We remain laser focused on executing our pivot into growth strategy, while delivering sustained revenue and earnings to fuel the long term health of FSA Loveland.
We are strongly positioned with a leading presence across our core markets of Canada, the U S and the UK.
And we are deploying global capabilities locally to our clients and delivering unique end to end services across the whole lifecycle of an asset positioning us as a partner of choice.
And we create value through the breadth and depth of our capabilities by consistently delivering high quality services and solutions to our customers.
We have significant opportunities in front of us leveraging our engineering services capability to support the development of new infrastructure projects on a global nuclear expertise as public entities seek alternative to support their energy security and net zero goals.
We look forward to providing further updates on our progress of creating long term value creation for all our stakeholders through our core growth drivers.
Thank you we will now open the call for questions.
Thank you we will now begin the question and answer session to join the question queue. You May Press Star then one on your telephone keypad, you'll hear tone acknowledging your request. If you are using a speaker phone. Please pick up your handset before pressing any keys to withdraw your question. Please press Star then two.
We will pause for a moment as callers join the queue.
Our first question comes from Yuri Lynk of Canaccord Genuity. Please go ahead.
Good morning, everyone.
Good morning.
I wanted to dig in a little bit on your comments on Eglinton in Trillium.
You continue to guide to physical completion by year end, but.
They remain at 95% and 95% complete which is the same numbers at the end of June .
So what gives.
It doesn't look like they're moving.
On the percent of completion numbers at least so maybe a bit more color.
On.
When these things can can wrap up.
Sure Yes.
Actually.
We've executed $165 million of revenue in the quarter.
So Q3s is a good quarter for executing physical world.
Obviously at the backend of Soma.
Whether it's good.
So there is always some additional work that flows through as well. So that's why you see probably not in the net.
Coming down, but the important thing about these two projects is getting the physical work complete and as we've said before.
The risk assessments that we've made and the risks that we've been incurring through this year and clearly previous periods.
All of our finish in the physical world, So, they're actually going well I mean these projects both have progressed well, we will be where we said we would be at the end of the year and next year is all about getting them into operation.
Testing commissioning, obviously, finishing landscaping and things like that when the winter is over but in demand. These jobs are where we expected them to be and we're feeling good about about where they are.
And for sure.
The $300 million overall risk envelope that we've put out there is definitely we're confident that we're within that.
You may have seen and I'll add to it.
Some media about the opening date now obviously the opening date.
Very much dependent on our customers and our clients and when they want certainty. They are ready for the operation of these assets and we work closely with them to make sure that that's a smooth transition into into operation.
Okay, and you keep referencing physical completion.
Yes.
And I'm, assuming but correct me if I'm wrong once physical completion is reached.
The odds of material.
The material negative cost re forecast from that point forward are.
Minimal zero like how do we think about the tail risk on these things.
Let's say.
Reduced.
I would say.
Substantially reduced because.
The cost.
To complete these projects is really in the civil and building.
Associated with completing the jobs once we get the physical world and the main complete the risk is not zero, but it drops off.
And then it's really about professional staff testing and commissioning of the systems getting the systems up and running running the trains betting them in so the kind of the risk envelope is quite a lot different as we move into next year. So that's why we keep stressing this physical work complete on those two jobs.
Okay.
Obviously.
<unk>.
We've reported in previous.
Quarters.
Is this hyperinflation this labor shortage is that supply chain.
Those risks that have led to these cost overruns, which are associated with actually executing physical world.
Not actually testing commissioning embedding in the rail systems.
Got it.
Second and last question real quick for Jeff.
Debt to EBITDA increased half a turn sequentially I think another quarter like that and youre going to be close to or through your covenants. So.
Certainty around.
The cash that you expect to come in the door in the fourth quarter, particularly in light of your comments on your clients.
Im not paying you on these larger contracts. Thank you.
Yes.
Problem.
From our perspective.
We're well below our covenant ratios on our credit facilities.
And have a high degree of.
Confidence in terms of where we're headed in the fourth quarter.
Both in terms of the cash generation from the services business, but also in Indiana said as we come into winter and we approach the physical completion, particularly on the two Ontario projects, we start to get into a glide path with lower cash usage.
Those Alice Teekay projects so.
I'm not concerned at all of them, where our balance sheet is in our projections of cash flows from here.
Okay.
Yeah.
Our next question comes from Jacob bout of CIBC. Please go ahead.
Good morning.
Good morning.
Wanted to go back to the <unk> TK.
Perfect discussion and just.
How long do you think it's going to take to work out these claim recoveries.
Trillium I know you said the discussions are ongoing but.
When do you when how long do you think it's going to take to work out.
And really what's the bottleneck there.
Yes, I mean, clearly we're disappointed.
We have not recovered some of this loss in 2022 and that's the main driver of the.
Revised.
<unk> operating cash outlook.
We've put out.
I mean, clearly with the best ways to resolve.
These compensation payments is through negotiation.
It's not the only way.
There are other routes through dispute resolution in arbitration or even litigation, which ultimately would take longer.
So we're putting our efforts into working with our customers.
To negotiate.
It is obviously complex and.
Customers.
And the main representing government so they've got to be confident that any compensation that is paid is justified.
Correct.
So.
Whilst we're disappointed that we've not resolve that in 'twenty, two and obviously with two months ago wed like to reassess what our ability is to recover. It we are really focused on trying to get this done in 'twenty three.
Now there's always two people in two part is in negotiations so I can't give.
The guarantee the outcome and I cant give you a guarantee timeline, but we're working really hard to get this cashback.
Because obviously every client that has settled is the cash upside.
And we want to get a return to a normalized cash.
<unk> position in this company as soon as we can put in LLS teekay behind US. It is clearly part of it up.
Sure.
What's the main bottleneck here.
Well.
As the magnitude of the issue of these and these are not small numbers.
It's the complexity of the information and it's the requirement.
From government entities.
Two.
To be able to understand.
And justify to themselves.
The decisions that they make in settling these clubs.
These claims.
The right judgments in the REIT.
Settlement judgments and whilst I understand customer.
Customers' point of view this is highly frustrating for us.
Because.
All the time that it takes to settle these claims.
Is that our expense we are completing these jobs at our expense.
We're not just talking about the losses incurred in 2022, we're talking about losses incurred in prior periods as well so.
It is a frustrating process, but we've just got to keep at it.
That will get to an amicable resolution with our Ontario customers.
Okay.
And my second question is just on the engineering services sub segment.
Segment of S&P.
<unk> services book to Bill there at one four times in Q3, so it looks like Youre, gaining a lot of traction in the U S.
Just talk about what's driving this growth and our.
Are you seeing expansion into new areas within the U S.
Yes, I mean, obviously.
We're really pleased with the go forward part of this company.
We have protected it over the last years, while we've been going through this transformation.
And we went into the pivoting to growth strategy a year ago, when we presented to.
Through our Investor day.
And we're really pleased that we're delivering against it.
Six quarter.
Both year over year growth.
Q3 growth.
Engineering services of 18% I mean that is.
That's really pleasing.
The three core geographies, where we are positioning this company.
Giving us.
Very sustainable pipeline of opportunities that applies to our specific capabilities.
And we are able to win work because we're applying those capabilities to our customers and a stronger demand market.
I mean, as you say the U S. There is particularly pleasing because.
We have this very defined land and expand strategy.
Not only can.
<unk> been successful in specific states, but also to take that success to new states.
And that strategy is working and.
A good portion of the growth you've seen in the backlog in engineering services.
Our record backlog of $4 6 billion as I see come out of the U S in that strategy.
Great. Thank you.
Chip.
Our next question comes from Chris Murray of ATB capital markets. Please go ahead.
Yes, thanks folks good morning.
Ian maybe maybe thinking about going back going back to your Investor day, and you talked a little bit about.
Growth in the future.
And I appreciate you talked a little bit in your script about about the pivot to growth strategy around organic but part of this was also around M&A.
And obviously, maybe some balance sheet caution is maybe the way I'll frame it.
About maybe have any hesitant with M&A, but is there a point, where you probably can get more active in M&A and is it still as you laid out at the Investor day still looking to do either of our land and expand type strategy in the U S or tuck in in the U S.
Or is there something changing in the way Youre looking at.
At M&A growth.
No no I don't think anything's fundamentally changed in our capital allocation strategy.
And particularly to your point about our land and expand in the U S.
I mean, clearly until we're producing free cash flow.
We are only in the preparation phase, which we're actually putting quite a lot of effort into the preparation phase.
<unk>.
Yes.
These things take a lot of pre work and pre.
Kind of analysis.
I understand.
<unk> targets are available and what is going to be the most accretive for us and that we can use as a base to build upon but obviously right now.
We haven't got the free cash flow to deploy and maybe Jeff you could let me just reiterate our capital allocation priorities, yes, I mean, I think as you heard us say in the balance sheet is the first priority.
As we return to free cash flow positivity.
Down the road here and at the same time.
We'd be looking for opportunities to deploy capital.
To further accelerate.
The strategy in growth, but at the same time, we will be looking at what it means in terms of returns to shareholders.
Both in terms of whether we actually have acquisitions that are compelling enough, but I think also crude depending on where the share price of that and whether we see a significant discount to intrinsic value of the company. So.
We'll clearly be looking at both of those.
When we get to the point of deploying capital on the balance sheet.
Okay, and then is it fair to think that you are waiting.
To get past CLS teekay or at least at least maybe the Ontario projects and get some resolution before that becomes fair to think about our level would be just purely numbers driven off.
Off the cash flow statement.
In terms of M&A Chris.
Yes.
Basically yes, yes.
No I think there's some overlap here I mean, obviously visited.
Pretty significant group of people in the company that are focused on LLS teekay execution, and LST K cost recovery through the clients and that group is highly focused on that.
There's another group of people that are focused on growing the company forward in taking the company.
Forward in an M&A group and our group, particularly in the U S are looking at.
What that looks like in the future and preparing for it so a little bit of overlap there but.
But for sure we're taken everything in a kind of step by step approach.
Alright fair enough.
Other question I had is just maybe if you don't mind elaborating a little bit on a linked Sean.
Certainly when I think about.
Some of the areas that they work and I am thinking about Europe for the most part but.
You don't want to think about a part of the world that probably needs.
Energy infrastructure helped in a hurry.
Certainly comes up there.
Can you just maybe walk through.
What youre going to be able to do in the near term about.
Improving those margins.
And then any longer term thoughts around summer.
Maybe it's a war in Ukraine, and some of the other issues, there and Europe and its energy challenges how that plays into all of this.
The way I think the way I would phrase that.
As the market.
Is far larger than our capability.
The market is very strong.
And globally strong so.
North America Europe .
Middle East and even Asia.
A strong because.
Almost everybody is trying to upgrade the transmission and distribution and obviously links on cells the substation.
Service and into the upgrade.
So.
We don't.
We don't believe that we have an issue and winning work in growing the business, but as you rightly say.
Disappointed in the margin profile, we've setup and EBIT range, which we think is.
Capable EBIT range of 46%, which actually is a good EBIT range because of the amount of flow through work that goes through this business.
So we need to get in that range. So our focus will be on winning profitable work.
Primarily in Europe , and North America, so it aligns with the overall strategy of ASIC development.
And bringing those margins open then proven performance in the business.
Natural fact, we've got a we've got a real drive on that right now.
With the team.
I think and maybe.
Add to that which I think was around the second part of your question Chris.
Think of Europe , more broadly and energy security I mean, I think that very much plays into the nuclear business and the nuclear capabilities that we have there.
Both from a potential new build perspective.
And whether that helping EDF with next.
Or being a key part of EDF team as part of that next new building in the U K or indeed, our can do reactor technology, which currently has two.
Two.
Stations in Romania, and the potential for two more for me.
For which we have seen a lot of good progress on so we think theres as Ian says a lot of a lot of <unk>.
<unk> market opportunity there.
Alright Thats helpful. Thank you.
Thank you.
Our next question comes from Devin Dodge of BMO capital markets. Please go ahead.
Thanks. Good morning can you help us better understand the sequential decline in operating cash flow guidance.
From the updated thank you.
You provided back in August .
Reconciling the $200 million additional cash flow you said this year.
Yes.
I would say it's.
A small increase in that $300 million.
Max downside bucket.
Yes.
It's Jeff Kevin why don't I do that.
So there's really a couple of components you could think about it as.
Part of that is related to claims that we have been unable to negotiate with our customers.
Instead, we saw success in that in previous years, and we have been on an good constructive discussions with clients.
We just haven't been able to reach resolution.
In the year as we had expected.
Earlier in the year back in back in August and the second is that we are seeing increased cost so.
In addition to what we see in terms of the absolute losses in <unk>.
In the in the projects themselves cost have run slightly higher than that and we believe some of that we can get back and so we booked that as revenue.
But therefore, the costs are running higher as well so it kind of part of one part of the other is what has really driven into that $200 million.
Okay. Okay. Thanks for that Okay, and then maybe just sticking with the cash flow if I look at slide 16 of the deck.
Sure.
All services, having pretty meaningful working capital usage.
I mean, it's almost on par with.
The drag that we're seeing across Teekay spoke in Q3 and year to date can you talk about the drivers behind that and if you expect some of that to unwind in the coming quarters.
Yes, so so and thats been a trend we've seen over the last few quarters. The primary driver of that Devon is the fact that we are seeing.
Rising DSO off what we would consider to be an abnormally low level of <unk>. So that is coming back towards a more normalized level, which would be closer to 70 days outstanding rather than the sort of high 50%, 60% debt.
That we had been experienced over the previous quarters. The other thing thats driving into that.
It's frankly.
Really significant growth rate that we're seeing in the services business and particularly in engineering services.
And when revenue accelerates that way you do end up with a drag in working capital as that builds up in width and receivables before it actually gets built and turned into cash. So it is why.
We've guided to the point that we do expect to see stronger cash flow in Q4, including in services as we start to see some of that normalizing out and the cash.
The cash coming in.
Thanks for that I'll turn it over.
Thank you.
Our next question comes from Michael keep breath of Desjardins capital markets. Please go ahead.
Good morning.
Good morning.
Looking at what happened in Florida with Hurricane Ian given you have a couple of joint ventures in the FEMA work appraisal exposure and we expect some sort of positive contribution in the upcoming quarter.
Yes, I mean, I think some of the Q3 eight.
Uptake in the U S or in par was was the favorable that.
But we went in I mean, obviously.
This disaster relief.
The work we have to deploy people quickly.
We have to find people across the business to support FEMA and we did that and obviously that work is ongoing it will probably be ongoing.
Through Q4, and maybe even into into next year. So yeah, I think thats a fair assessment.
Perfect. Thank you for the color and maybe just on free cash flow looking at the next year or 2023 do you believe it could be a total reversal or is it more private expecting more of a gradual improvement given you don't know the timeline on when the government is good.
Negotiating team.
Yes, I think as you heard Jeff as you heard Ian and say I think it's.
It is hard for us to predict exactly when we'll be able to.
Resolve with the government or the clients different claims.
We would remain hopeful that we can do that.
In a negotiated way and do that in 2023, but we'll have to see.
Thank you.
Regardless of that as we move into 2023 as you have heard me say in the presentation.
The two Ontario projects being largely physically complete this year and moving into mostly testing and commissioning.
Next year that by by definition will reduce the cost and the quarter over quarter cash flow usage that they required.
So therefore, we do expect to see a clear improvement in cash flow over the course of 2023, just just for that fact alone as the projects complete and ultimately go into service.
Perfect. Thank you I appreciate the time thank.
Thank you. Thank you.
Our next question comes from Fredrik question of Raymond James. Please go ahead.
Hi, good morning.
<unk> seen central banks raise rates pretty aggressively in the recent past and Thats led to them.
A step change in interest you paid during the quarter.
Can you please remind us how much of your debt is fixed versus floating and sort of what the terms are around that.
Thank you Jeff.
We have taken some action.
Over the course of this year to convert what was largely floating rate debt some of it into fixed rate debt.
I'd say roughly currently.
Two thirds floating one third.
$75 25 kind of in that in that neighborhood.
So in terms of <unk>.
Every 1% increase in interest rates and we gave some disclosure as we did at the end of the year in our financial statements.
Call it $1 billion of floating rate debt.
Economically, 1% would be about $10 million pre tax.
Okay. That's helpful. That's all I have thank.
Thank you.
Thank you.
Our next question comes from Maxim <unk> of National Bank Financial. Please go ahead.
Hi, good morning, gentlemen.
Morning.
I just had a quick question in terms of engineering services.
Because I think.
<unk> EBIT margins year on year, and I'm wondering in terms of.
The moving parts, there, maybe any comments around wage inflation and.
Thank you.
Yes, Matt I think it was I think it was primarily around engineering services you were asking so there's a couple of elements in there and then maybe ill turn it over to Ian to talk a bit about wage inflation.
One was we did have an arbitration settlement last year.
Which helped the margin last year think about eight 9% last year versus eight 3% this year.
Some of that was in there.
Secondly is that.
The decrease in the pound.
<unk> has largely been offset by the strength of the U S dollar year over year, but not entirely and so there is a small amount in there where we're seeing a bit of drag from FX. So between those two that that is are they that makes up most of that difference in kind of year over year, but yes.
Yes.
Wage and wage inflation per se, particularly in the engineering services business.
Doesn't have an impact on profitability.
<unk> and margin levels and the reason for that is in demand in the engineering services business is on the short cycle. So typically the backlog is burned opened nine months on average therefore, you're constantly rebidding constantly winning work and that is also a fairly high proportion of that work which is.
Reimbursable.
Which obviously the inflation around wages has flowed through.
And and even previously the cycles of high inflation that we've seen with generally not seen.
Duration of margins. So I think it's really the other aspects that.
<unk> spoken to.
And so how should we think sort of directionally.
Dan I mean, like obviously you compressed.
<unk>.
Since previous expectations for 2022, but in terms of 2023 and kind of beyond.
Some cost initiatives optimizations.
Yes, how should we think about that on a global basis.
Yes, I think I think Max.
We normally do we will come back in Q4 to set out our guidance for 2023, similar I expect to what we've done here in 2020, we provide.
Probably better perspective than but what I would say is that we do have cost transformation programs ongoing.
And we are driving those particularly in this environment with the amount of inflation we're seeing.
A lot of focus on how do we manage the cost base, obviously, particularly firm from an overhead perspective.
And we'll continue to aspire to drive margins higher up in our range, but we'll come back and provide better perspective on that in 2023.
And a key element.
We've said a couple of times is consistency, we want to keep consistent obviously, we always aspire to.
The higher end of our ranges, but growth is key.
And our focus is around growing these businesses.
Alright, and then just one last question.
To squeeze it in terms of.
Operating cash flow and how that sort of absent flows, especially next year. So do you think we are pushing out some extra cash flow generation to 2024, then and there's no chance of that happening.
Next year, because again at that certainty of when Youre going to get paid from the government or how you guys thinking at this point of the year. Thanks.
Yes, Matt I think kind of as I said earlier with the physical largely physically complete an ENT in the interior projects end of this year early next year, we do expect that cash flow usage.
To start to clearly improve.
The projects.
Complete through certainly through the first half or so of next year.
You just look at slide 16 in the presentation.
As we reach quarters were particularly later next year.
There is little or no drag from there is little or no drag from the <unk> project the rest of the business.
Hi.
Consistent.
<unk> cash flow.
Generating business so.
I think it really is tied to ignoring whether we when we get amounts back from from government.
Really about as we complete those projects.
And we would start to believe we're entering a period of seeing free cash flow generation.
I think.
I don't think we necessarily see that as being in 2024 are having to wait that long, but we will continue on this path in 2023.
And no concern on kind of on Ram on the payment terms there.
I know that that contract is set up in a way that.
That we haven't seen the same issues that way when projects are progressing well.
Okay, Okay, that's great excellent discipline.
Thank you.
Our next question comes from Michael to pump of TD Securities. Please go ahead.
Thank you good morning.
Good morning.
Jeff can you talk about expectations for changes in noncash working capital in the fourth quarter.
Often there is a seasonal reversal, but I'm not sure if everything you're you've been describing there with respect to the <unk> projects and timing effects that this year and somehow alters that but just your thoughts on that would be helpful.
Yes, I'm not sure.
We will see a big change in noncash working capital or that trend from NLS Teekay perspective.
As Ian is here at <unk>, we continued to kind of fund the cost of these projects.
And we would expect to continue to see that trend.
Reimbursement or further reimbursement from the client. So I don't think you will see that trend, but to your point on the services side.
We do typically and historically see a reduction in noncash working capital as we come into the end part of the year and to my previous answer I can't remember who asked the question.
With the rapid increase in our revenue, particularly in engineering services that does create kind of a quarter delay in terms of converting that additional within revenue into actual cash. So we would expect to see that starting to normalize out in Q4 and into the beginning part of next year. So I would expect to see improvement in.
Noncash working capital for that reason all else being equal.
Okay. So when you put all that together for the fourth quarter.
Do you have a view as to whether or not on an overall net basis, you would you would be positive or or is that.
Yes, so as I said in the presentation based on where we are at nine mines, we are expecting to be operating cash flow positive in the in the fourth quarter, even with LST Kay.
When you look at our guidance of having a usage of $300 million overall, Okay. And then can you talk about.
How do you see.
Leverage and the leverage ratio evolving as you move forward.
I guess the end of the year, but also more specifically into into next year and any targets you have in it.
The timing on those.
Susan intact or if there's been any shifting.
Yes, I don't think I don't know.
We see any material shift in that as I said, we continue to see a very clear path.
Being in our target range of one five to two times in 2024.
I'll shift around a bit quarter by quarter and period to period.
You see that and you go back to the end of last year for instance.
So I would expect clearly overtime.
For the ratio to improve and we'll see where we are at the end of the year, but as I said continue to have a high degree of confidence in our.
In our balance sheet and our ratio at this point, it's just the impact really that the LST K losses are that we're seeing.
As we look to finish out those projects, particularly from a physical completion perspective.
Okay. That's great. Thank you.
Okay.
Our next question comes from <unk> Khan of RBC capital. Please go ahead.
Hi, This is more of a question on the operating backdrop can you comment maybe a little bit on the U K.
The government is undertaking a capital review their two different thoughts.
Yes, yes, yes for sure.
Obviously, we're watching the UK closely.
We.
We understand.
And we're trying to follow.
How this will play out however.
I think that our specific business.
As.
Resilient.
Two.
Are we still on.
Sorry.
Our specific business is it's actually quite resilient, we think to any kind of austerity measures that we might see and the reason for that is it's a very very diverse business, we've got across the UK.
We have a law.
Sort of.
Services different services that we sell to different end markets.
The markets are in the one of the two biggest areas as nuclear and transportation those rewards defense buildings in places a lot of it.
Leaning towards towards government.
But it's not all in capital projects and we think it's probably the larger capital projects, which may get delayed probably not cancel that may get delayed and.
And as we sell a lot of services into from consultancy or we sell a lot of services into the operation of assets such as water rail.
Road obviously.
Operation and maintenance of those assets has to continue and the.
Funding has to continue for that.
The other positive is the commitment for energy transition.
In particular, the energy transition into nuclear.
No.
A significant number of people on the.
On the <unk>.
Good point.
<unk> power station and then we're still very optimistic with sizable is going to be announced soon and then we have already have pre negotiated a large position on size world and that's going to fuel our business very very significantly. So all in all I think we need to keep a really close eye on that.
You'll have seen earlier this year that we on boarded by Rns Rubin the Greg Smith as a board member gives us really good insight into the market.
We think we can have a resilience kind of approach.
Any headwinds that we're going to see in the U K.
Okay, great. Thanks, very much for that.
Thank you.
This concludes the question and answer session I would like to turn the conference back over to Danny Jasmine for any closing remarks.
Thank you very much everybody for joining us today 70 further questions. Please don't hesitate to contact me at <unk>.
Great.
We can thank you very much. Thank you. Thank you.
This concludes today's conference call you may disconnect. Your lines. Thank you for participating and have a pleasant day.
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