AtkinsRéalis Group Inc. (ATRL) Earnings Call Transcript & Summary

Good morning, and welcome to SNC-Lavalin's strategic divestiture of Oil & Gas and LSTK litigation matters review update. [Operator Instructions] And the conference is being recorded. [Operator Instructions] I would now like to turn the conference over to Denis Jasmin, Vice President, Investor Relations. Please go ahead.

Thank you. Good morning, everyone, and thank you for joining the call. This morning, we have announced the agreement to sell our Oil & Gas business and the results of legacy LSTK litigation matters and commercial claims review. We have posted a corresponding slide presentation on the Investors section of our website. The recording of today's call and its transcript will be available on our website within 24 hours. With me today are Ian Edwards, President and Chief Executive Officer; and Jeff Bell, Executive Vice President and Chief Financial Officer. I would like to draw your attention to Slide 2. 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. Also during the call, we may refer to certain non-IFRS measures. These measures are defined and reconciled to the nearest corresponding IFRS measures in our MD&A, which can be found on SEDAR and our website. Also, although we are today reconfirming our most recently issued guidance for the expected revenues and margin range in Q4 for our Engineering Services line of business and providing the results of the company's review of certain legacy matters with the estimated impact thereof on our 2020 financial results, we are not in a position to and will not be commenting in any way on our Q4 and full year 2020 financial results in today's call. Q4 results will be available in the coming weeks. And as usual, we will shortly issue a media advisory confirming the date on which our Q4 and full year 2020 results will be released. And now I'll pass the call over to Ian Edwards. Ian?

Thanks, Denis. Good morning, and thank you for joining us today. So the purpose of this call is to update you on some important developments as the company continues to execute on its strategic direction. We have taken a series of actions that are focused on 2 objectives: one, reducing the company's risk profile as it relates to our legacy LSTK business; and two, accelerating SNC-Lavalin's transition to a leading professional services and project management company. First and foremost, we are pleased to announce that we have reached an agreement to divest the Oil & Gas business. It's a strategic decision that significantly reduces delivery and warranty obligations attached to Oil & Gas LSTK projects and allows us to move fully focused on growing the Engineering Services business. Secondly, we have completed the review of the remaining LSTK litigation matters, as announced in Q3. The scope of this review was actually expanded to include all significant litigation matters and all commercial claims receivables. This is in order to provide a comprehensive assessment of all outstanding risk. As an update to our 3 Canadian LSTK infrastructures, they also continue to progress well. However, productivity continues to be impacted by COVID-19, and we've also reassessed these costs. And finally, we're reconfirming our previously provided financial outlook for our Engineering Services business for Q4, which continues to perform well. Moving to Slide 4 and the sale of the Oil & Gas business. As you know, we've been very focused on restructuring the Resources business, which has been a key plan really in our strategic direction. We began by closing Valerus last May. And in July, we announced the sale of the South African unit and our European fertilizer business. We developed a detailed and ambitious plan to transition our remaining Resources business to a pure services offering and bring it to profitability. Nonetheless, we kept our options open, and the benefits of this transaction are really clear. We are able to quickly and cleanly reduce our business risk by exiting Oil & Gas LSTK projects, significantly reducing delivery and warranty obligations on all outstanding contracts, divesting a loss-making business and removing the execution risk associated with further restructuring and enhancing the overall sustainability objectives of the company going forward. Moving to Slide 5. Under the terms of the sale, Kentech Holdings will take on the current backlog of approximately $745 million, representing 100% of the active Oil & Gas EPC and services contracts and 7,100 employees. This represents approximately 90% of the current Resources revenue. The transaction, which is expected to close midyear, is expected to record a net gain. Turning to Slide 6. In light of the divestiture, we have reassessed the remaining Resources business, which is mainly comprised of services projects in the mining and metals sector. We have taken a charge of $95 million to be taken in Q4 of 2020, which approximately 30% is noncash. The charge provides for the 1 remaining LSTK mining project and 3 completed yet to be commercially closed out projects. Turning to Slide 7 and the second key update. The company committed to undertake a review of all outstanding LSTK litigation matters, following the unfavorable arbitration ruling in Q3 related to a legacy Resources project. We expanded this review to include all significant litigation matters as well as all claims receivable on legacy and ongoing projects. This was a really rigorous, exhaustive process that included the latest commercial discussions with customers, updated cost re-forecast, new developments in litigation matters. This extensive internal review was led by me with senior leadership team members, operations teams, project oversight and legal teams, an external review by expert outside council in Canada, the U.S. and the U.K. And the whole process was overseen by a special risk review committee composed of independent directors, including the Chairman. Turning to Slide 8. The review, combined with the latest commercial and legal developments, identified 20 potentially significant matters with greater risk profiles. Of the 20, 7 cases were deemed appropriate to require additional provisions. The expanded review also identified a further 6 commercial claim receivables that were deemed appropriate to require reductions. As a result, we will be reorganizing the following in the Q4 financial statement: $140 million provisions related to legacy litigation matters and $155 million of reductions relating to commercial claims receivable. The majority of these adjustments are noncash. Despite how we are accounting for these matters, we plan to continue to vigorously pursue the claims that we believe are owed to us and defend our position with regards to the litigation matters. It's important to underscore that we see this exhaustive provisioning based on new and updated information as a result of an 18-month effort to derisk the business, one that is necessary to moving forward and focusing on the future and growth within Engineering Services. Turning to Slide 9 and the update on our 3 remaining LSTK projects. These projects are the REM in Montreal, Trillium in Ottawa and Eglinton Crosstown in Toronto. All 3 of these projects continue to progress well. However, due to the ongoing productivity impacts from COVID, the timing and scope of cost reimbursements remain uncertain. We continue to reassess these costs. And as a result, we will take a $90 million charge in Q4 2020. On all these projects, we are in negotiations and even litigation to recover these costs. But we are applying prudence and not recognizing any revenue on these projects until we have greater clarity on the outcomes. Turning to Slide 10. We continue to make good progress on each project, with the REM now 40% complete, a major milestones achieved, such as the test track is done and the first vehicles delivered. And we're working closely with the client to address challenges. On Trillium, we've completed the engineering design and moving to the busiest period of construction with a target of being 80% complete by the end of '21. Eglinton is the most advanced at 80% complete and we're really active in pursuing our reimbursement of claims here. Moving to Slide 11 and the outlook of our Engineering Services businesses. As you can see, our Engineering Services business, which represents the future of SNC-Lavalin, continues to perform well. Since introducing our strategic direction, revenues have remained consistent, and segment adjusted EBIT margins were robust, demonstrating the resilience of this business even through COVID and the uncertainty of COVID. Our Q4 outlook remains on track. So concluding on Slides 12 and 13. In July '19, we announced a new strategic direction that our 3 core components: exiting LSTK contracting work, reorganizing the company into 2 separate lines of business and transforming the Resources segment. The objective all along was to derisk this business and generate consistent earnings and cash flow. We have made significant progress in this regard, including the divestiture now of the Oil & Gas business and the continuous efforts to reduce the scope of legacy risk as announced today. These efforts provide a clear line of sight on the remaining risk and our risk mitigation plans, which we know is important for shareholders and allows us to fully focus on surfacing the inherent value in SNC-Lavalin. So with that, thank you, and I'll return back to Denis.

Thank you, Ian. [Operator Instructions] Let me remind you that we will not be commenting on our Q4 and full year 2020 financial results in today's call. Operator, we are now ready for the Q&A period. Could you please open the lines for the questions? Thank you.

[Operator Instructions] Our first question comes from Sabahat Khan of RBC Capital Markets.

Great. Just, I guess, on your comments earlier around the sale of the Oil & Gas business with sort of all warranties and past, I guess, call it, liabilities or just any association with those projects. I'm just thinking from investors' perspective. Does this mean that of all kind of completed projects, the buyer is now sort of responsible for what happens there and we should not expect to hear any more on past projects? Just wondering how we should think about it going forward?

Yes. I mean, with the exception of the mining business, as we outlined. Then the deal is as you would expect for a deal of this complexity with reps and warranties and indemnities. But in essence, the risk is transferred -- all material risk transferred and the benefits of the business is transferred to the purchaser.

Okay. And then I guess the review of the LSTK projects, just a follow-up there. These are -- I guess, do any of these litigation matters still remain with you? Do they go with the buyer? Or is this the amounts that you provisioned sort of part of that transaction? I just want to understand how we should think about that component.

So the legacy litigation risk review and the claims receivable review that we're referring to here and the provisions and the reductions in those are outside of this transaction. So they are nonspecific Oil & Gas. Everything within the Oil & Gas business that was legacy goes with the transaction. Everything outside of that which includes those 20 matters with potential risk. The 7 matters needing provisions and the 6 claims receivables and the adjustment for the claims receivables are all outside of that transaction.

All right. Perfect. And then just last one for me. On these Canadian LSTK projects, I guess, we've seen in the media, there's some, I guess, litigation with the government. So is the thought process that you take this $90 million charge now and then try to settle it with respective third parties or counterparties going forward and there's potential for us? Or how are you thinking about this?

Yes, precisely. Thanks for that. Yes. So you're right. I mean, certainly, it's public. So we can say on Eglinton, it's in a litigation. There's a ruling actually expected this spring on that particular job. The Trillium contract is very similar because it's in Ontario -- infrastructure Ontario contract. So we would expect Trillium to follow the same path. And we're in pretty good negotiations here in Montreal with CDPQ. What we feel is that until we see resolution of these claims with our clients, we feel, for us, it's important to recognize the cost. We don't want to build another -- we're derisking the business. Everything we're doing here is to derisk the business. So we don't want to put more risk into the business by having more claims receivable. So we're recognizing the cost, and we absolutely will pursue very, very hard the recovery. We believe we're entitled to the recovery. And that will be an upside when it's received.

Our next question comes from Mark Neville of Scotiabank.

Maybe just first on the Oil & Gas. This transaction is expected to close sort of midyear. Is there a risk that sort of over Q4 through the first half of 2021, there's a bunch -- there's incremental losses or cash outflows? Or did you try to sort of capture this in everything you did today?

Yes, it's Jeff. As I think we've given in terms of guidance before, we had moved the business to be -- on the Services side, largely breakeven in the first half of this year. And therefore, we'd expect that to be true of the business while we continue to hold it. And that's both sort of breakeven on a profit perspective and largely from a cash flow perspective as well. We have 1 LSTK business on the mining side and the retained part of the Resources we're carrying on. But again, I think we feel like we have captured the cost and everything related to that. So I think we would see it that way. The other thing I'd say is it will be -- from a disclosure perspective, this will be an asset held for sale. And we will see, at least the Oil & Gas business, shown as discontinued operations going forward until the business closes. So you'll have pretty good visibility on that as well.

Okay. But just to be clear, in the meantime, before it closes, there are these LSTK projects in Oil & Gas that you're continuing with, correct?

Well, we're pretty much -- they're pretty much wound down. There's a few that are finishing up here in the first part of the year. But there's not a significant backlog left with those. The benefit, of course, of the transaction is that the warranty periods, the delivery of that is -- it goes with the buyer.

Right. Great. Okay. That makes sense. Jeff, if my math is correct, I think if I add it all up, it's about $240 million of cash costs, all of this. Can you sort of give us an idea of sort of roughly what goes through in Q4? I guess, first, if my number is correct and then what flows through Q4 and sort of the cadence of outflows sort of over the next coming quarters and years?

Yes. I would say, my number is slightly lower than that, but you're absolutely in the right ballpark, kind of a little bit over between $240 million. But that amount is actually going to be realized over a number of years. The components of that cash, of course, some of it's related in the $90 million to the delivery of the infrastructure LSTK projects. The piece that's around additional provisions related to legal matters, of course, legal matters can take a number of years to sort out. And we have those sorts of trajectories in a number of those 7 litigation matters that Ian talked about. So the way I think about it is a little over $200 million, probably fairly evenly split over 3 to 4 years is kind of the lifespan. So $50 million to $75 million a year, and it's probably not a bad way to think about it.

Our next question comes from Yuri Lynk of Canaccord Genuity.

Jeff, just wanted to follow-up on Mark's question on the, let's call it, $240 million. With respect to the portion that pertains to the legal matters, how confident are you in the number that you were able to arrive at? And is it -- yes, I guess that's it. Just trying to wonder how -- trying to figure out how certain that number is and what you did to make sure that we don't have worse than anticipated surprises? Because I'm sure there was still some estimating to be done and stuff like that.

Yes. Let me try and picture how we're thinking about all of this. I mean -- because this is a journey that started fairly rigorously 18 months ago. I mean, this is the end of a journey is the way that I would see it. And I think we've said before that the risk in the business has really stemmed from LSTK, whether that's LSTK from a number of years ago, Oil & Gas, Resources LSTK, when we did some mining EPC jobs. And that collection of risk is -- the way we think about it is -- picture in a funnel of risk, if you like. And those are live jobs, those are litigation, those are completed jobs, those are claims receivables. And we stopped the tap. We stopped putting risk into this funnel, 18 months ago by not doing any more LSTK. And we've been working our way through this risk. Now obviously, selling the Oil & Gas business takes a big chunk away. And we're down to, what I would call a manageable level of issues that are in the bottom of this funnel now. And this review that we've undertaken, which is an incredibly extensive review that we've undertaken over the last several weeks with external help, with internal teams, with Board oversight, on a much smaller number of issues than we faced in the past, particularly divesting the Oil & Gas business, we've got to the bottom of it. And our intention here is to be absolutely confident of the provisioning that we've made against all of these risks so that we can smoothly go forward and focus on the growth of the Engineering Services business. I mean, I think, we've proved over the last 18 months, the Engineering Services business is a really, really good, consistent, highly performing business. But it's been overshadowed. We recognize it's been overshadowed by issues. Q2, we had an issue. Q3, we had an issue. We want to get beyond that now, and we want to demonstrate and surface the value out of the Engineering Services business. So to your specific question, how should you think about the risk review, it's very, very rigorous on a much smaller number of issues than we've ever seen before in the business. And we're confident in the provisioning and the positions that we're taking here.

Okay. That's fair. Just on the sale of the Oil & Gas business. I was under the understanding that you were keeping it. So is this a change from what was communicated previously? And if so, just maybe the back story there?

Yes. It is a change. It is a change. I mean, we spent a lot of time in the last 18 months restructuring this business. I mean, it was an LSTK business with some Services business in it. And we've turned this around into a Services business, that the profitability of it is clear. Now having done that and having announced that we've got to that place in Q2, actually, some interested parties came along that were interested in purchasing. And we looked at all the -- obviously, the benefits, and we looked at the options of either keeping or divesting. And we think for SNC-Lavalin and where we want to take the company in the future, our efforts are better focused on growing our successful and other Engineering Services business rather than continuing to make efforts to make this business profitable. And its home will be with a company Kentech that is wholly focused on oil and gas and nothing else. So it's probably a good option for both. It's probably a win-win and a win-win for the employees and customers as well. But absolutely, we -- this is -- it's a new decision and it's what we believe is the right decision for our future.

Our next question comes from Michael Tupholme of TD Securities.

First question just relates to the review of the legacy LSTK litigation matters. As part of this process, were you able to formally resolve and put behind you any outstanding claims? Or is this more of an exercise in adjusting some of the assumptions you were making and the accounting around that?

It's both, frankly. So we went -- I mean, in the last 18 months, everything that we've been doing is to try to solve these with the best possible outcome for SNC. But particularly since Q3, and particularly getting into this review and getting under the skin to understand at a detailed level the risk, there are a number of issues and litigations that we have actually settled. So there are a number left that we -- that I listed in how we concluded with finding 20 matters with potential risk, 7 needing provisions and then 6 claims that we had on our books that we've taken a reduction to. But absolutely, it's -- it was a process of both and a very, very detailed process at that, too.

Yes, it's Jeff. And I think I'd sort of add to that. You're absolutely right. A lot of new information in Q4. Judicial matters being arbitrated or settled, fundamental cost re-forecast, closing out commercial decisions or discussions with customers. So all of these provisions that we've taken have had new and updated activity and information in the last quarter. And obviously, some of those have -- as matters settle out, and as Ian has been saying, we've been very focused on trying to drive these to resolution, to try and put the risk behind us. Those -- as those matters settle out or we get rulings on them, that informs other projects that -- and positions we have as well. So yes, a lot of new information around all of that, that we had in Q4.

Okay. That's helpful. And then just as a follow-on to that, I appreciate the -- all the detail you included in the slide deck, including indicating 20 projects or 20 matters identified and how that broke down. But is there any way to put this into context? So I don't know if it's in the context of this '20 relative to what the overall number was or if it's in the context of the dollar amounts you gave us. But I certainly understand this is a far-reaching review, but just trying to understand if there were a bunch of projects that in your estimation did not require changes? Or does this 20% represent sort of the vast, vast majority of really what's out there?

Yes. I mean, I think, when we went into this exercise, we -- what we said in Q3 is that we would look at legacy LSTK litigation matters. And the reality is that we decided, "Let's look at everything. Let's look at all the litigations. It doesn't matter which business it's in. And let's look at all of our claims receivables and all legal matters." Now obviously, with a business like ours, 45,000 employees and entities and businesses everywhere, there's a lot of immaterial legacy issues -- I mean, the litigation, sorry, whether those are with small entities or people or -- but -- so those have all been taken out, so to speak, and reviewed. What we can say is that of the review of everything, there are '20 that kind of had some material content that could lead to an outcome of material loss. So we looked at those in a much, much greater level of detail, getting independent review over them and making adjustments where necessary or increase provisions where necessary. And that leads to the $140 million. Now of the claims receivables, the number is much smaller. I mean, we've not got that many projects left now with claims receivables on them. But there were 6 that we felt we needed to reduce our outlook on what success we could get from those claims receivables. Frankly, a couple of those were settled. And a couple of them are reasonably material, and a couple are not so material. So I think what you should take away from all of that is it's captured everything, and it's a pretty extensive, rigorous exercise.

Okay. That's good color. And then just lastly, in terms of the 3 Canadian LSTK infrastructure projects, the charge you're taking, what does that assume? Does that assume that the ongoing productivity headwinds persist throughout the entire life of these projects? Or are you simply sort of refining your assumptions around some aspects? I'm just trying to understand sort of how...

No, no, I understand. I understand the question, and a good question. So right now, we're into pretty severe lockdowns in Ontario and Montreal. And the impacts of these lockdowns has continued, obviously, hygiene, social distancing that we've talked about before. But the lockdowns are restricting the amount of personnel we can get to the projects. And we're also seeing that we're losing productivity now through contract tracing and having to isolate certain groups of -- labor on the sites, basically. So what we -- the way we've looked at this is to say, look, this lockdown, it's definitely going to go into the spring. So we -- let's assume it's going to get into the spring. And let's assume that spring and into summer is going to be similar to last year in terms of things get better, lockdowns come off a bit. But really beyond the summer, we're assuming that things get back to normal or largely back to normal. We're not kind of making the assumption, for example, that we're going to have this situation that we've got now back in autumn, and the whole thing is going to repeat itself. So that's how we've reflected that. So it's a forecast of that.

Yes. I think the only thing I'd add to that, Ian, is -- and therefore, because we forecast on sort of full life project, this is not a run rate number kind of quarter-by-quarter. It represents our reassessment based not only sort of Q4, but as Ian said, the assumptions, I would include in what we see related to COVID impacts in the next 6 months.

And I would stress on top of that as well, thanks, Jeff, that we are not taking the revenue that we believe are entitled to get. I mean, we're -- and I repeat our approach here is one of prudence because we don't want to add more risk into the business. We're trying to derisk the business. So we've taken this charge on the basis that actually, we should get recovery for this. We should get recovery for all of it, from the 3 clients. And we are pursuing that hard, as we said, through even the litigation on Eglinton.

Our next question comes from Benoit Poirier of Desjardins Capital Markets.

Jeff, could you maybe discuss about the impact on your financial leverage and the cushion you will have versus your bank covenant given all those charges?

Yes. As Denis said, I don't want to get into sort of Q4 results or anything. What I would say is that our banking covenants have clauses that specifically exclude transactions like the Oil & Gas business, where we're disposing of a business or one-off nonrecurring items like you see with our -- the LST litigation review, the claims receivables, the kind of one-off charges related to all those sort of legacy items. So what I would say is that the amount that you see today, which, of course, are largely noncash, but to the extent they affect EBITDA, it's much -- it's really around the infra-LSTK elements. And as we said at Q3, we were well within our covenant ratios. And we'll continue and we intend to operate that way.

Okay. And now could you maybe provide some color on what will be the next priorities kind of the free cash flow capabilities going forward and whether there's any other divestiture to consider, that you might consider down the road?

Our priority is absolutely in the growth of the Engineering Services business, so to get this fully transitioned to being a leading professional services and project management company. So -- I mean I, think we've always said that continuing prudence and strengthening the balance sheet is the first priority. But clearly now, as we get into our growth plan over a longer period of time, then our capital allocation plan will drop off that. I mean, we're not in a position to get into the details of that today. But absolutely, that's a priority. And that's something that we'll be communicating at the right time.

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