Aecon Group Inc. (ARE) Earnings Call Transcript & Summary

Good morning. Thank you for attending today's Q2 2023 Aecon Group Inc. Earnings Call. My name is Lauren, and I will be your moderator for today's call. [Operator Instructions] It is now my pleasure to pass the conference over to our host, Adam Borgatti, Senior Vice President of Corporate Development and Investor Relations. Mr. Borgatti, please proceed.

Thank you, Lauren. Good morning, everyone, and thanks for participating in our second quarter results conference call. Presenting to you this morning are Jean-Louis Servranckx, President and CEO; and David Smales, Executive Vice President and CFO. Our earnings announcement was released yesterday evening, and we have posted a slide presentation on the Investing section of our website which we'll refer to during this call. Following our comments, we'd be glad to take questions from analysts, and we ask that the analysts keep to one question before getting back into the queue to ensure others have a chance to contribute. As noted on Slide 2 of the presentation, listeners are reminded the information we're sharing with you today includes forward-looking statements. These statements are based on assumptions that are subject to significant risks and uncertainties. And although Aecon believes these expectations reflected in these statements are reasonable, we can give no assurance that these expectations will prove to be correct. With that, I'll turn the call over to Dave.

Thank you, Adam, and good morning, everyone. I'll touch briefly on Aecon's consolidated results, review results by segment and then address Aecon's financial position before turning the call over to Jean-Louis. Turning to Slide 3, revenue for the second quarter of $1.2 billion was $44 million, or 4%, higher compared to the same period last year and is 8% higher on a year-to-date basis. Adjusted EBITDA of $17 million, a margin of 1.4%, compared to $39 million, a margin of 3.4%, last year, and operating profit of $56 million compared to an operating profit of $5 million. Diluted earnings per share in the quarter of $0.38 compared to a diluted loss per share of $0.10 in the same period last year. The improvement in operating profit and diluted earnings per share was largely due to an increase in other income of $70 million, driven primarily by a $38 million gain on the sale of Aecon's Transportation East business, or ATE, and a $31 million gain on the sale of certain property and equipment, which more than offset the $53 million negative impact of larger period-over-period margin adjustments related to legacy fixed-price projects. Reported backlog of $6.9 billion at the end of the quarter, after removing $447 million of backlog in Q2 related to the sale of ATE, compared to backlog of $6.6 billion at the end of the second quarter of 2022. New contract awards of $2 billion were booked in the quarter, compared to $1.3 billion in the prior period. Now looking at results by segment, turning to Slide 4. Construction revenue of $1.1 billion in the first quarter was $35 million, or 3%, higher than the same period last year. Revenue was higher in civil operations, driven by an increase in major projects in both Eastern and Western Canada and road-building construction work in Western Canada, partially offset by a lower volume of road-building construction work in Eastern Canada as a result of the sale of ATE in the quarter. In industrial operations, higher revenue was primarily due to increased activity on mainline pipeline work in Western Canada. And in utilities operations, higher revenue was driven by an increase in telecommunications and high-voltage electrical transmission work. Partially offsetting these increases was lower revenue in nuclear operations from a lower volume of refurbishment work and in urban transportation solutions, primarily from a decrease in LRT project work. New contract awards of $2 billion in the second quarter compared to $1.3 billion in the same period last year. Backlog at the end of the quarter of $6.8 billion compared to $6.5 billion at the same time last year. Turning to Slide 5, adjusted EBITDA in the Construction segment of negative $4 million was $38 million unfavorable compared to the second quarter of last year. The decrease was driven by negative gross profit of $31 million in the second quarter from a fixed-price legacy project in civil operations, versus a gross profit of $4 million in the same period last year from the same project, and by a negative gross profit of $50 million from 1 of the 4 fixed-price legacy projects in urban transportation solutions, compared to a negative gross profit of $33 million from one of the other fixed-price legacy projects in urban transportation solutions in the same period last year. Other than the impact of these fixed-price legacy projects in the quarter, higher gross profit in the balance of the Construction segment was primarily driven by improved results in urban transportation solutions. At June 30, the remaining backlog to be worked off on these 4 projects was $699 million, compared to $1.1 billion at the end of 2022. The 4 legacy projects comprised 13% of consolidated revenue in the second quarter and 10% of backlog at June 30, compared to 16% of consolidated revenue in the full year 2022 and 17% of backlog at December 31. Turning to Slide 6, Concessions revenue for the second quarter was $27 million, compared to $19 million in the same period last year, primarily due to an increase in airport operations at the Bermuda International Airport. Bermuda continues to operate at a reduced volume compared to prepandemic levels, but continued to recover in 2022 and into the first half of 2023 from the more severe impacts experienced in 2020 and 2021. This recovery was evidenced by the fact that traffic in the second quarter averaged 73% of the prepandemic level in the second quarter of 2019, compared to average traffic in the second quarter of 2022 being just 43% of the prepandemic level. Adjusted EBITDA in the Concessions segment of $28 million compared to $17 million in Q2 last year, primarily due to results from the Bermuda airport and an increase in management and development fees. Turning to Slide 7, at the end of the second quarter Aecon had a committed revolving credit facility of $600 million, of which $188 million was drawn and $11 million utilized for letters of credit. On December 31, 2023, convertible debentures with a face value of $184 million will mature, and we expect to repay these debentures at maturity or before. At this point, I'll turn the call over to Jean-Louis.

Thank you, Dave. The significant impacts on the 4 large fixed-price legacy projects being performed by joint ventures in which Aecon is a participant continue to be felt in our results. Aecon and our partners are working towards resolution and compensation for the impacts of these projects [indiscernible] with the respective project owners, focused on reaching fair and reasonable settlement agreements as we move towards project completion in each case. As I've said before, this will take some time, but we are on it constantly and making progress. 3 of the 4 projects are currently expected to be substantially complete by dates between late 2023 and the middle of 2024, and the fourth is currently expected to be substantially complete during 2025. Turning to Slide 9, demand for Aecon's services across Canada continues to be strong. While volatile global and Canadian economic conditions are impacting inflation, interest rates and overall supply chain efficiency, those factors have stabilized to some extent and have largely been and will continue to be reflected in the pricing and commercial terms of Aecon's recent and prospective project awards and bids. However, results have been negatively impacted by the 4 legacy projects in recent periods, undermining positive revenue and profitability trends in the balance of Aecon's business. Turning to Slide 10, with backlog of $6.9 billion at June 30, 2023, and recurring revenue programs continuing to see robust demand, Aecon believes it's positioned to achieve further revenue growth over the next few years. In the second quarter, Aecon was awarded a number of projects that were added to backlog, including delivery of the Deerfoot Trail Improvements Project in Alberta and [Technical Difficulty]

Apologies. It appears we have lost connection with Jean-Louis' [indiscernible] line. Please stand by while we try to reconnect him.

The Scarborough Subway Extension Project and the Darlington New Nuclear Project will only be reflected in backlog and a successful conclusion of the lengthy development phases. Aecon, including joint ventures in which we're a participant, is also prequalified on a number of project bids due to be awarded during the next 12 months and has a considerable pipeline of opportunities to further add to backlog over time. Coming back, [ sorry for this ], trailing-12-months recurring revenue of $1.1 billion was up 40% versus the prior period and 74% versus 2 years ago. Utilities operations and contributions from the GO Expansion On Corridor Works and Scarborough Subway Extension Project during the respective development phases were the primary drivers of this growth. Utility operations and further advancement from these projects as we continue through the development phases are expected to contribute to future growth in recurring revenue. The Concessions segment is also expected to see airport traffic in Bermuda continue its recovery in 2023 and 2024. Turning to Slide 11, Aecon continues to support the energy transition to build and operate sustainable infrastructure. In the second quarter, the Oneida Energy Storage Project achieved financial close, with Aecon Concessions as an 8.35% equity partner. Earlier this year, Aecon was awarded a $141 million EPC contract by Oneida Limited Partnership to build this 250-megawatt, 1,000-megawatt hour, advanced-stage, grid-connected battery storage project, representing the largest clean energy storage project in Canada. Projects such as Oneida Energy Storage, GO Expansion On Corridor Works, Scarborough Subway Extension and the Darlington New Nuclear Project demonstrate the path Aecon is on to embrace the opportunities linked to decarbonization, sustainability and the energy transition. Turning to Slide 12. In addition to large-scale energy projects, we continue to expand our portfolio with Aecon's green energy services through residential and commercial renewable energy projects. This also includes strategic partnerships with companies to provide electrification and charging infrastructure that enables municipal transit agencies and other corporate fleets to power their vehicles using clean energy. We continue to work towards reducing our own emissions and have been switching our operations to more sustainable fuels and piloting new technologies such as the use of hydrogen generation, renewable power on construction sites and electric equipment. Turning to Slide 13, with strong demand, growing recurring revenue program and diverse backlog in hand, Aecon is focused on achieving solid execution on these projects and selectively adding to backlog through a disciplined bidding approach that supports long-term margin improvement in the Construction segment. In the Concessions segment, in addition to expecting an ongoing recovery in travel through the Bermuda International Airport through 2023, there are a number of opportunities to add to the existing portfolio of Canadian and international concessions in the next 12 to 24 months, including projects with private-sector clients that support a collective focus on sustainability and the transition to a net zero economy. The GO Expansion On Corridor Works Project and the Oneida Energy Storage Project noted above are examples of the role Aecon's Concessions segment is playing in developing, operating and maintaining assets related to this transition. Thank you. We will now turn the call over to analysts for questions.

[Operator Instructions] Our first question comes from Frederic Bastien, from Raymond James.

Guys, we all knew there were risks residing in these 4 legacy fixed-price projects, but I'm really surprised by the extent of the losses you posted in Q2. So my question is, what changed in these short 3 months since you last reported to make you take that significant of a provision?

Frederic, I mean, you're right. Those legacy projects are a challenge and the dynamics of the negotiations, especially when we are reaching up to the end of those projects, are extremely complex. Those are not negotiations about one parameter. I mean, we tell our clients due to modifications in the condition of execution of our contract to [indiscernible] x', and the client answers, In fact, I'm going to compensate for 'y'. I mean, there's a lot of parameters about the risk taken out, about eventual modification to the PA, about the trade-off between cash and more long-term additional revenue. We also have to deal with different partners on each of those joint ventures. We are not alone. We are dealing with different clients, with different decision-making process. All this is extremely complex. And this explains that the outcome of those negotiations cannot be perfectly forecasted dollar per dollar. What is sure is that every day on those 4 projects, we are negotiating with our clients, and every day we are progressing up to the final of those projects. You have probably noticed that the backlog associated with those projects now is under $700 million. When you compare it, I mean, to our [ declared ] backlog, which is $6.9 billion, or with our quasi-backlog when you add the 3 progressive design-build projects which will give us something like $7 billion to $8 billion of additional, it has now become a very small portion of our backlog.

But that small portion of the backlog, I mean, it's a bit of a black hole. We just don't know where things will land. It's very difficult for us on the Street to figure out what future projections will be.

What is sure is that every day [ that pass ] with these projects is a victory, because we have less in our backpack to execute.

Our next question comes from Chris Murray, from ATB Capital Markets.

So maybe following on that question, maybe a different way to think about it, what you've been telling us at least for the last few quarters is that you thought you had maybe the reforecasts behind you, but would be operating at lower margins. Now, like, how should we be thinking about margins through the completion of this at this juncture? Jean-Louis, I hear what you're saying about the backlogs outside of these projects, but these projects kind of feel like they're going to be driving your margin profile for the next year or so. So just how should we be thinking about Construction margins on a go-forward basis?

So Chris, in terms of the legacy projects, the position we take at the end of each quarter is based on everything we know at that point in time. And so if those forecasts and everything we've taken into account play out the way we, as a joint venture in each case, envisage them, then the EBITDA margin effectively from those 4 projects should be 0 on a go-forward basis if they're in line with projections. And then overall EBITDA margins, if you look at our numbers for Q2 and over the last 12 months, excluding the impact of the legacy projects, you can see those margins have been progressing quite nicely. The overall margin profile of the backlog is healthy and improving over time. We've talked a lot about the fact that we're in a strong demand environment for infrastructure and construction, generally, and that's being reflected in not just the building backlog, but also the margin profile of that backlog, and you're seeing that in the numbers in the rest of the business. So we expect that trend to continue for the base business. And as I said, the legacy projects in theory should be 0.

Okay. I guess we'll have to work with that. I guess, moving on, [indiscernible] who wants to take this one, but just the Ontario government has been talking a lot and some of the other folks in Ontario about additional nuclear development, and certainly you're well positioned there. I guess a couple of questions. Can you maybe frame the scale of the opportunity that's here? And I guess, as a piece of this, I mean, if everything that everyone is talking about, additional small nuclear reactors, large reactors, I mean, if that all kind of comes into play, is there a limit to how large or how much nuclear exposure you folks can actually accommodate?

I can take this one. Nuclear is a long-term industry. It means that you don't decide on Friday that you're going to build a reactor and begin the works on Monday. I mean, the land has to be readied, all the environmental licenses. I mean, the technological licenses, the capacity to design, build and operate, everything is a lengthy process. So what we know at the moment is that you've seen that we have booked a little more than $1 billion, I mean, of new orders during the quarter for Bruce. We now have the totality of the 6 reactors under Aecon execution. At OPG, we still have 2 units to go, each unit being more or less 3 years of work, but they can interlap. Just as a signal of lessons learned and the way we are progressing, you probably noticed that the second unit at OPG, U3, was just delivered and substantially completed by [ our team ] 169 days ahead of schedule, which just saw the way we master now all this rehabilitation. Evidently, there is a decision coming about the refurbishment of 4 units at [ Pickering ]. It's probably going to come during the Q3 2023. Then there is 1 year to 1.5 years of preparation and early works, and then we will begin to work if we are awarded those jobs. All this takes time. Regarding the small modular reactors, we have enter in a 6-year alliance with GE Hitachi and SNC for the first one. You probably have noticed the announcement that there will not be 1, but 4, smaller modular reactors under OPG in Ontario. All this will be phased and will take time. So only for this, we are speaking of a horizon of something like 15 years, without even talking about the big units that can be developed at [indiscernible]. So we are not worried about a sort of ceiling in our capacity. What is more important for us is to be sure that all the teams that we have been training, recruiting, developing are going to stay with us and that they will not be all within the development of all those, I would say, nuclear programs.

Our next question comes from Benoit Poirier, from Desjardins Securities.

Was wondering if you could provide details about the potential charge to be taken in the second half, the risks behind that on those 4 legacy projects, given that historically you've been more heavy in the second half. And also, more granularity about the potential settlements that you're looking for. And maybe the remaining 40% exposure to your backlog to fixed-price, the risks behind the -- I know projects are much smaller in terms of size, but wondering if there's any risk with respect to the 40% remaining exposure to the backlog.

I mean, if you go back to my previous answer in terms of the position on each of these projects at the end of Q2, it factors in everything we know at this point in time. The write-downs in the second quarter take all of those factors into account, and they're all based on forecasts through to the end of the job. So with that positioning, it's not a case of being able to say, okay, now expect "this" or "this." If those forecasts are correct, then the impact on those projects on a go-forward basis from a profitability perspective should be 0. Having said that, as we've flagged now for a fairly lengthy period of time, there will remain risks until we get to the end of these projects. It's just the nature of the complexity of the situation, as Jean-Louis described earlier. In terms of the balance of the backlog, as you've seen, the mix of work has been shifting fairly significantly over the last 12 to 18 months away from fixed-price into more nonfixed-price work. As you know, there is still backlog in fixed-price. We're very comfortable with those projects. We've called out those 4 legacy projects for a reason. But the rest of the work that we're doing, execution is going well. And it's all reflected in the margins you're seeing over the last few quarters, which, as I said earlier, we expect that trend to continue in terms of positive margin development. So no, we don't see risk in the rest of the portfolio.

Our next question comes from Naji Baydoun, from Industrial Alliance Securities.

Can you maybe talk a little bit more about what additional compensations or measures that you're pursuing for these fixed-price projects, I understand it might take a bit of time, and how that might impact the margin outlook for the rest of this year? I think your previous commentary was that margins could potentially be up year-over-year for 2023. I'm just wondering if that's still the case.

You're speaking about the legacy projects? Your question is about those?

Correct. Yes.

We are finalizing the execution of 3 of those projects. The fourth one will go out to 2025. We are negotiating with our clients. There is no doubt with all our clients that those projects have suffered from heavy modifications and need to be compensated. Now, as I've explained, the dynamic of the negotiations are extremely complex. But I can tell you that on 2 of those projects, the amounts on the table under negotiation are quite substantial. The issues are all the parameters attached to the additional revenue, and this is where we are still working and we expect some further settlements in the future, in the near future. But they are extremely difficult and complex negotiations.

Okay. And just maybe if we sort of look at the underlying business, ex these projects, can you just maybe confirm what the revenue and EBITDA would have been on a normalized basis outside of the impact from these projects? I'm just trying to get a sense of how the rest of the Construction business is performing.

I will begin, and maybe David will give you a little more information. I mean, as you have noticed, the EBITDA without those legacy products for Q2 would have been $98 million, which is extremely strong, and the trailing-12-months EBITDA without the legacy projects would have been $375 million. And when you know the revenue we have, it's extremely high in the industry. It's probably one of the best ones. It means that we think that our strategy that we have been developing for the last 4 years is the right one, about balancing our activity, about strengthening our execution capacity. Because the underlying -- I mean, the normal business, I would say, has never been that strong. In addition, as I've already explained, we have tightened a lot everything related with the first [indiscernible] of new projects. As I said, I mean, we have $6.9 billion of backlog. We have $7 billion of additional quasi-backlog associated with our 3 progressive design-build projects: OnCorr, Scarborough and small modular reactors. We're not starving, at all. We are in a very favorable position to choose the project, the client, the partner, the timing that best fit with our capacity. This is why we are quite optimistic with all those parameters about Aecon after those legacy projects are definitely behind us.

And Naji, just to add to that, you also asked about revenue and margin impact to work out the impact on the base business. So as Jean-Louis said, the EBITDA impact was $81 million. So excluding those legacy projects, the rest of the business generated $98 million in EBITDA. Revenue attached to those legacy projects in the second quarter was approximately $150 million. So if you exclude the legacy projects altogether, then the EBITDA margin on a consolidated basis in the second quarter would have been 9.6%, as opposed to the 1.4% reported.

That's exactly what I was looking for. It seems like there's some very strong organic growth tailwinds and the margin is pretty healthy on a normalized basis. So I guess you've just got to work through these impacts over the next few quarters. Maybe just one last question for me. So you got the road building sale completed and that Bermuda minority sale coming up next. Just any updates on use of proceeds and where you expect sort of to end the year in terms of the balance sheet and the leverage profile?

So as you know, the transportation sale closed in Q2. We expect the Bermuda sale to close shortly. We've now received all final approvals. So it's just a question of paperwork, basically, backwards and forwards between lawyers. It should be closed in the next couple of weeks. So that will contribute $128.5 million in terms of U.S. dollars, approximately $170 million, $175 million, to the cash position in Q3. Obviously, we have the convertible debenture maturing at the end of the year. The proceeds from those 2 transactions give us lots of flexibility in terms of options to deal with those converts. We'll continue to monitor the market at the same time to decide if we want to do something in terms of a separate issue. But otherwise, we'll use the balance sheet to deal with those converts. So I guess in terms of leverage profile by the end of the year, it will depend to some extent whether we just pay those from existing resources or whether we do any kind of refinancing between now and the end of the year.

Our next question comes from Jonathan Lamers, from Laurentian Bank Securities.

Jean-Louis, just a follow-up on your earlier answer about settlement compensation payments on these legacy projects. Recognizing that the negotiations are complex, do you have visibility today to whether these might be received later in 2023 or 2024? And David, if they do fall into 2024, would you expect that to be a positive free cash year?

I will take the first part of the answer. We are working hard so that part of this negotiation can finalize before the end of the year and part of the payment can be done before the end of the year. It's quite [ uneasy ]. Usually, payments are phased. They are not always, I would say, bullet-paid. But all this is part of the negotiation. So it's difficult to give more precise answer. What is sure is that we negotiate with our clients every day, and we are pushing to have the right trade-off between early payments and maximizing additional revenue.

And Jonathan, in terms of if those settlements were in 2024, then, yes, I would expect 2024 to be a positive free cash flow year. Obviously, the working capital build attached to those projects has impacted cash flow over the last 18 to 24 months. But as that unwinds, that will be a contributor to cash flow, going forward.

Okay. I just have one follow-up on that. The unbilled revenue balance has also stepped up quite a bit over the first half versus last year. Do you have any visibility yet to that declining over the coming quarters?

I mean, some of that is attached to these claims settlements that we're talking about in the 4 legacy projects, and some of it is just attached to some of the timing of milestones on other projects as well as just the overall growth in revenue over the last 12 months. So it's a combination. But as we -- and we'll see some usual seasonality in that number. But as we reach various settlement agreements and as we hit milestones on some projects that are underway, then, yes, that number would -- we would expect that number to come down over the balance of this year and also into the first part of next year.