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Good day and welcome to the SNC-Lavalin Third Quarter 2019 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Denis Jasmin. Please go ahead, sir.
Good morning, everyone and thank you for joining us today. Our earnings announcement was released this morning and we have posted the corresponding slide presentation on the Investors section of our website. If you are not using today's webcast, please open the presentation, as we will refer to it during this call. The recording of today's call and webcast will also be available on our website within 24 hours. With me today are Ian Edwards, President and Chief Executive Officer; Sylvain Girard, Executive Vice President and Chief Financial Officer; and Nigel White, Executive Vice President Project Oversight.Before we begin, I would like to ask everyone to limit themselves to two or three questions to ensure that all analysts have question space. You are welcome to return to the queue for any follow-up questions. Please note that comments made on today's call may contain forward-looking information. This information by its nature is subject to risk and uncertainty and as such, actual results may differ materially from the views expressed today. For further information on these risks and uncertainties, please consult the company's relevant filings on SEDAR. These documents are also available on our website.And now, I'll pass the call over to Ian Edwards. Ian?
Thanks Denis, Good morning and thank you for joining us. As you know, this is the first quarter since we announced our new strategic direction, which is designed to reduce business risk, generate consistent earnings and cash flow. Our goal is to position SEC level for long-term sustainable success by simplifying the business, focusing on what we do best in the high growth potential, high-margin areas of the business, where we are strongest and operate as a tier-one player.To that end, looking at Slide 4, our strategy includes a number of components, beginning with the decision to exit lump-sum turnkey contracting. The volatility and the unreasonable risk associated with LSTK projects have been the root cause of the company's financial underperformance. By exiting this contracting model and running off the LSTK project backlog as efficiently as possible, we will be able to significantly reduce risk while optimizing free cash flow generation from the higher performance parts of the business. To focus those efforts, I also made the decision as part of the new strategy to recognize the SNC-Lavalin into two distinct business lines, SNCL Engineering services and SNCL Projects. SNCL engineering services focuses on our high margin, high performing segments, which include EDPM, nuclear, infrastructure services and capital.SNCL project is comprised of the LSTK projects for the resources and infrastructure segments and the remaining parts of the resulted business. We also announced that we're exploring all options for our Resources segment, particularly our oil and gas business, including transitioning into service-based business or divestiture.Turning to Slide 5, while it's early days, this quarter demonstrates that we're moving in the right direction. Our third quarter results were solid and considerably improved over previous quarters. We generated a net income of $2.8 billion, mainly due to the sale of the 10% of 407, the proceeds of this we used to reduce our leverage and strengthen our balance sheet. Just in the income from E&C was up 33% year-over-year. We had a very strong performance from SNCL engineering services, generating year-over-year and quarter-over-quarter improvements in backlog, revenue, segment EBIT and segment EBIT ratio. In contrast, the company did register a loss in SNCL projects in Q3, due to a combination of factors. However, performance did improve compared to the last three quarters. As we quickly worked through the resources backlog, the remaining backlog will be mostly Canadian light rail contracts, where we have historically performed well.In summary, we had a solid showing in Q3 that demonstrates that the strategy is beginning to deliver results.Moving to Slide 6. In terms of exiting LSTK and focusing on efficiently completing projects, the backlog was reduced to $3.2 billion from $3.4 billion last quarter. And we remain on track to run off the vast majority of the backlog, by the end of 2021. We have introduced a series of measures to strengthen project oversight, which is being spearheaded by our new EVP, Nigel White, and we have seen a marked improvement in project refocus.On Slide 7, in terms of our focus on SNCL engineering services, the high growth potential, high margin parts of the business, we saw significant momentum this quarter. Each of our segments, EDPM, nuclear, infrastructure, and capital, performed well with some notable EBIT in revenue increases. The EDPM business grew across the board, in terms of revenue, segment EBIT, the segment EBIT ratio, on a year-over-year basis. Nuclear revenue was on par with last year and it delivered strong EBIT margin of 18.5%. The Infrastructure Services segment generated the most significant growth, with revenue increase in 43% compared to last year, mainly due to the contribution from lifestyle.I'm pleased to say that we have also increased our backlog in SNCL engineering services, by approximately $1 billion year-over-year. Our book-to-bill ratio for the nine-month period is 1.2, as we continue to win high- quality work for SNCL engineering services, securing a number of new contract wins over the past quarter.That momentum, and the opportunity to work on some of the world's leading engineering projects, has allowed us to retain of top global talent. Despite the challenges of the company has had in the past year, staff following fee turnover across the entire company has increased less than 1% year-over-year, which has not had any impact on the operation of the company.Within former; for example, turnover actually decreased year-over-year and then in less than nine months more than 650 new graduates joined SNC-Lavalin.Moving to the balance sheet on Slide 8. We decreased our debt by $2.4 billion and our net recourse debt to EBITDA ratio sits within our [ covenant ]. As we improve our EBITDA and free cash flow generation, our goal is to reduce our leverage ratio.This brings me to Slide 9, which outlines our plans for the resources segment by undertaking a number of actions to derisk and optimize the business, including running off the resources LSTK backlog, which is the root cause of the volatility in this business, by exploring all options for our midstream oil and gas fabrication facility, including a combination of potential divestitures and closures, and lastly, rightsizing overhead and assessing a possible transition to services for certain components of the mining, the methodology and the oil and gas business.We continue to make progress and we will provide updates as decisions are made. Having reviewed our strategy and how we are executing against it, I'd like to now move to Slide 10, to talk about where we see the future of the business. That future is with SNCL engineering services and I'll start with EDPM, which has $2.7 billion of backlog, a $2.8 billion of bookings year-to-date.EDPM is working on some of the world's most transformational projects and is positioning itself at the forefront of technologies, shaping in the future of engineering and consulting sector. Its value proposition lies in combining deep engineering and design expertise with cutting-edge digital technology and data analytics, in order to optimize each stage of the project lifecycle, enhance productivity for our clients, and provide more certainty in the build. We are seeing growth across a range of sectors in the countries across the world.Key highlights by region will include the following. We were recently recognized for the best use of digital technology at the British construction awards, for our design work on the Hinkley Point C nuclear power plant in the UK. We were awarded a services contract, in the new multi-use coverages initiative in Florida. And upgrading highways, sewage and water treatment, or broadband connectivity, as the state adapts to a growing population and an influx of 130 million visitors a year.We were also awarded a significant contract to support Australia's largest freight rail infrastructure project, part of the country's plans to spend tens of billions of dollars over the next decade in infrastructure.And in Canada, we've seen similar opportunities with new infrastructure investment, including the Quebec City Tramway and the new terminal for Montreal port. Turning to Slide 11, with our industry-leading position in nuclear services, we are poised to capitalize on growing demand for clean energy, the need to maintain, refurbish and extend the commercial life of aging infrastructure.These opportunities include the support refurbishment of the global Cando reactor fleet in Romania, South Korea, Argentina, China and Canada, where Ontario alone has a $26 billion refurbishment program. The support of non-Cando fleets included the United Kingdom, United Arab Emirates and Saudi Arabia, and the increasing demand for decommissioning and waste management for commercial reactors, particularly in Canada, the US, Japan, UK and Europe, through our CDI joint venture, accompanied with Holtec International.On Slide 12, with regards to Infrastructure Services, we're moving forward towards lower risk projects in construction management, and operations and maintenance service mandates, primarily in Canada and the US. We see significant opportunity to be an integrator on major complex projects that leverage our expertise in P&C, O&M and major P3 project delivery. Some examples of new business include the ongoing operation and the maintenance of the new Waterloo light-rail for the next 30 years. We're also part of consortium chosen to expand the [ Montreal ] five-year project to improve traffic flow and facilitate transit.I'd now like to conclude by saying just how proud I am to be CEO and President of SNC-Lavalin, to lead one of the top global engineering firms in the world, and a great Montreal-based Canadian company is something that I personally have aspired to and worked towards all my career. It's a privilege and an honor. More so, it’s such a pivotal time in the Company's evolution, we have an exciting opportunity to build and grow this business in a way that truly leverages our strength and our greatest asset, which of course is our people.And we're off to a promising start with a new strategic direction. The third quarter results are a step in the right direction that demonstrates the strategy is working. The future of our business, SNCL engineering services, is strong and growing, as we continue to win work on transformational projects across the world.At the same time, we continue to actively derisk the business, as we successfully run off our remaining LSTK backlog. Our balance sheet is significantly stronger with a nearly a $1 billion in cash and $2.4 billion in debt reduction.By generating consistent earnings and cash flow, my goal is to continue to deleverage the company and surface value for shareholders. With that, I'll now turn over to Nigel White, who joined us at SNC-Lavalin in August as EVP of Project Oversight. Nigel has more than 30 years of experience in managing all aspects of civil, building, foundation, electrical, mechanical contracts in Hong Kong, UK and the USA. He was formally with Hong Kong-based Gammon Construction company.Going forward, he will provide regular status updates on the LSTA backlog at each quarter. Nigel?
Thank you Ian, It is pleasure to be here today and be able to provide you with regular updates on the oversight process and how the run-off of the LSTK backlog is progressing. As you know, I joined SNC-Lavalin on [indiscernible] and since that time, I've undertaken a review of the project business, with a particular focus on the LSTK backlog and the controls in place to manage these projects. I'll begin my mandate by meeting with all the sector's presidents, project teams and traveling around the business to get a better understanding of the management approach to the project backlog.I then undertook a series of analysis starting with the review of the historic performance of the company's LSTK projects. From that, there are two points that I would like to highlight on Slide 15. First, LSTK projects have historically generated slightly above breakeven returns, within the LSTK Mining & Metallurgy and oil and gas, have also generated breakeven returns, while light rail projects have generated positive returns. Second, while there could be a fairly wide range on the returns, it is very clear that the Delta project was a significant outlier and a typical of [ resources LSTK ] historic performance.In addition to the historical review, I also conducted a sensitivity analysis of each of the projects currently in the backlog, in order to get a realistic view of the best and worst case scenario for each. With this evidence-based understanding of the LSTK backlog, I'm now working with the sector presidents and delivery teams to introduce a number of measures to enhance our risk management and optimize outcomes.We are establishing an oversight team. I'm looking to strengthen on-site project delivery teams and we are introducing a number of enhanced controls and strategies, two examples of which, we have weekly updates with the senior leadership team to ensure issues are flagged and actions as quickly as possible, and improved cost management protocols that, for example, simplify the number of cost codes and better align with our supply chain to ensure better project results.Slides 16, 17 and 18 provide more detail on the current status of our LSTK backlog. Looking at Slide 16, the vast majority of the remaining $3.2 billion of the LSTK contracts are in infrastructure worth approximately $2.7 billion or 84%.These are composed largely of Canadian light rail projects, where we've had a history of profitable performance. The remainder of the backlog and estimated funds of the million is in resources. These projects are primarily in oil and gas and the majority are expected to be run off over the next two years.I think is important to underscore, however, that while it is not unusual to have issues with these kinds of highly complex projects, we believe the risk is manageable. We have implemented and we'll continue to implement and improve a series of oversight and management measures that allow us to quickly identify issues as they emerge and deal with them effectively.Together with the sector presidents and their teams, we remain laser-focused on winding down the backlog as efficiently as possible. Thank you.I will now hand the call to Sylvain.
Thank you, Nigel, and good morning everyone. Starting on Slide 20, we have recorded in Q3 a net income of $2.8 billion, which included a net gain after tax of $2.6 billion from the disposal of a 10% stake of Highway 407 ETR. Total revenues for Q3, 2019, amounted to $2.4 billion. The SNCL engineering services business line totaled $1.6 billion, an increase of 11.5% compared to Q3, 2018, mainly due to a revenue increase of 43% and Infrastructure services, reflecting increased level of activity in Linxon, acquired in Q3, 2018, as well as an increase of 6% in EDPM. E&C revenue from SNCL project business line for Q3, 2019, decreased by 26% to $851 million, mainly due to the continuing backlog runoff of certain major LSTK resources and infrastructure, EPC construction projects.The SNCL project business line recorded a negative EBIT totaling $45 million in Q3, 2019. This negative EBIT was mainly due to three drivers, unfavorable re-forecast on certain LSTK projects in resources, continuing on the performance of our oil and gas production and processing facilities in the United States, and overhead structure within resources that is still too high for the current level of activity.These overhead costs are currently being right-size and part of our ongoing cost reduction program. In contrast, the SNCL engineering services business has a very strong quarter, performing better than prior periods. It recorded a positive segment EBIT of $253 million, representing a 16% EBIT to revenue ratio, or 12% if we exclude capital.Corporate SG&A for Q3, 2019 totaled $20 million, $30 million for E&C only. Note that the corporate SG&A for Q3, 2018, at a recovery of $15 million, as it included a $60 million favorable impact from revised estimates on legacy sites, environmental liabilities, and other asset retirement obligations. Adjusted net income from E&C in the third quarter of 2019 was $165 million, or $0.94 per diluted share, compared to $124 million or $0.71 per diluted share for the corresponding period in 2018.The adjusted net income from E&C in Q3, 2019 included the recognition of $83 million or $0.47 per diluted share and income tax recovery on capital losses following the disposal of a 10% stake of Highway 407 ETR. I will cover this in more detail on the next slide. Our backlog totaled $50.6 billion at the end of September. SNCL Engineering Services had a backlog of $11.4 billion. Bookings for the third quarter were almost $2 billion and totaled $5.5 billion for the nine months of 2019, which represent the 1.2 book-to-bill ratio. SNCL project backlog had a $4.2 billion backlog, representing an 11% decrease compared to the end of Q3, 2018, as a result of our decision to cease bidding on electric construction projects. We expect this declining trend to continue. The company's balance sheet was strengthened during the third quarter, as we were able to repay significant portion of our debt with the proceeds of the sale of a portion of our stake in Highway 407 ETR.As of September 30th, 2019, the company had $939 million of cash, $1.2 billion of recourse debt and $400 million of limited recourse debt. We also had $2.5 billion in unused capacity under the company's $2.6 billion, committed revolving credit facility. The net recourse debt to EBITDA ratio calculated according with the terms of the company's credit agreement was 3.4 times. Note that in the third quarter, the company and its lenders amended the credit agreement to extend the temporary increase of the ratio to four times, until and including the period ending December 31st, 2019.Turning to next slide, Slide 21. On this slide, we are breaking down the tax items that are impacting our adjusted EPS from E&C. As indicated in the past, we usually target for a 20% tax rate on our E&C business. If we apply this rate to the adjusted E&C earnings before tax, the income tax expense should have been $18 million and the EPS for the quarter should have been $0.41. Due to the geographic mix and other normal course of business tax items, we have recorded for the quarter a lower tax expense of $8 million, bringing the adjusted EPS from E&C at $0.47.In addition, this quarter the capital gain recognized from the sale of our stake in Highway 407 ETR is allowing the company to recognize some capital losses within E&C from prior years, representing a tax recovery of $83 million, the end result being an adjusted EPS from E&C of $0.94.Turning to Slide 22; as you all know, the free cash flow was materially negative before the third quarter, mainly due to some challenging LSTK projects. This quarter, cash flow from operating activities was significantly less negative at $51 million. We expect this improvement trend to continue for the fourth quarter. 2019 year-to-date cash flows used for operating activities totaled $668 million. If we look at the cash flows generated by SNCL engineering services business line only, which will be the core of our business going forward, year-to-date, operating cash flows excluding capital generated $350 million, representing an 88% segment EBIT conversion, while the capital segment generated $128 million. We can also see on this slide that the cash flows from SNCL projects are the main cause of our negative operating cash flows for the year.Lastly, as we're progressing on our cost reduction program and due to the recent reduction of our debt, we should see going forward less cash used for interest in restructuring and reduced cash flow uses for other corporate items.I won't spend too much time on the next few slides. Slide 23 details the company's cash and debt position as at September 30, 2019. As previously mentioned, we have significantly decreased our debt balance with the Highway 407 sale proceeds. The only outstanding recourse debt that the company now has is three debentures for a total of $675 million and the $500 million term loan. We also decreased the CDPQ loan to $400 million.Slide 24 is our traditional slide that summarizes the results by segment. Resources recorded a loss of $47 million, this is three drivers that I previously mentioned, while all segments under SNCL Engineering Services had a strong quarter. Segment EBIT ratio has increased in all segments with 10.6% for EDPM, 18.5% for nuclear and 10.5% for infrastructure services. Note that the infrastructure services segment EBIT amount increase was mainly due to the stronger performance of our O&M business.Lastly, you will see that we have included in the appendix of this presentation the 2019 EBITDA by segment, as we believe this information could be useful going forward to evaluate the company.This concludes my presentation. We can now open the line for questions. Thank you.
Thank you. [Operator Instructions] We will now take our first question from Benoit Poirier of Desjardins Capital Markets. Please go ahead.
Yes, good morning. Congratulations for the good quarter and also for your permanent role, Ian, at SNC. Just on the nuclear side, could you talk a little bit about how we should be thinking in Q4 in 2020 as new projects ramp up? And could you talk about the recent award in Germany?
Yes. So I think we'll -- what we've -- obviously we're not about to kind of put guidance in for the nuclear sector right now. But what we said in the past is that you can expect that the business will perform in line with history in terms of growth and profitability. So we have got numerous parts of the nuclear business, primarily in Canada, and in the U.S. and in the U.K. And the new award in Germany, of course, is kind of an exciting award for us based from the European part of the business. So we've got active projects, as you know, in Canada on life extension. We've got also the kind of exciting joint venture that we put together with CDI for decommissioning. So I think there are numerous parts to this business that will kind of drive it forward and keep it on a successful trajectory.
Looking at the [indiscernible] just on the margin rate, I'm assuming that was also something on your mind. I mean we had a very strong quarter in nuclear at 18.5%. I mean I wouldn't take that as your run rate for the year, but we did say that we would catch up on some of the earlier quarters, which were a bit lower.
Yes, okay, that's very good color and maybe one question for Nigel. Since your appointment, I was curious to get your insight in your opinion on the remaining LSTK projects and ability to manage the ramp down, Nigel.
Just that before Nigel answers that, I mean -- it's Ian and I will it hand over to Nigel. We're laser-focused on executing these projects to get the best outcome that we possibly can. And I think Nigel's oversight is really important to ensure that that focus continues. But there is a point that I'd like to make, and I know we've made it already in the presentation that the lion's share, the majority of this backlog now at $2.7 billion of the $3.2 billion is in Canadian contracts in light rail, and I just want to kind of make that point up front. But Nigel, please.
Yes, as Ian said, the majority of it exists in the infrastructure projects in Canada, which is $2.7 billion, primarily in light rail. And we have $500 million in the resources business. That 500 million in the resource business will be mainly completed within the next 2 years, the majority of which over the next 12 months to 18 months. So the big focus and the big risk outside of that is the EPC backlog. We are working well with the teams to support and supplement what we previously had to enhance our systems, which really focuses on for excellence in execution by enhancing the processes and controls we already have. We did a sensitivity analysis in all these projects, and those risks that we have we believe are manageable. So --
Okay. That's very good color. And maybe last one for Sylvain: could you provide more color whether you still expect cash flow from operation to be positive in the second half, and also whether you could recoup more tax loss carry-forward with respect to the tax implication around the Highway 407? Thank you.
Yes. So we're maintaining what we said the last quarter in terms of the second half cash flow performance being positive. So that's on that. And then as it relates to the tax effect of the 407 sales so we're still working through the overall planning. Just to give a bit of color. The cash tax expected right now is slightly below $100 million of cash out on the 407. But we're still working it. So --
Okay. That's very good. Thank you for the time.
Thank you. We'll now take our next question from Jacob Bout. Please go ahead of CIBC.
Good morning. I had a question on EDPM. So strong at 10.6% EBIT margins. Talk about the sustainability of this and what was the driver here.
So clearly, EDPM is a global business. It is the consultancy design, the feasibility professional services part and infrastructure that was evolved from legacy Atkins. It has I would call it a Tier 1 reputation globally for providing those services. I think the kind of exciting part of EDPM is its future and developing its technology arm and producing technology solutions and digital solutions to the market. We are on a growth plan: primarily the growth geographies for EDPM are the U.S., where we're absolutely underweight compared to our peer groups; and Australia, which is going through an infrastructure boom where again, we're kind of underweight compared to our peer group. So we do think that the business is sustainable and we do think that the kind of strategy we've got for that business is -- will repeat what we've historically been producing.
Okay. So just to recap here: 10% plus even margins is reasonable?
Well, towards 10% is kind of historically what we've been producing. I mean Sylvain, I don't know if you want to --
Yes, I think you -- again, very strong quarter in EDPM and not -- clearly not to diminish what happened, I think we do have from quarter-to-quarter, some movement. So I would take a bit of a blend of prior quarters to get to your number. But around 10% is the number, yes.
Okay. And then I guess in the press, there have been a number of articles about the potential of WS Atkins being up for sale. Do you have any comments on that at all?
Yes. The strategy of the company is absolutely as we defined it. SNCL engineering services is the future of this company, and the future of the company is absolutely EDPM, the nuclear part of the business, the infrastructure services and capital. All of those are defining parts of the strategy, and defined parts of the future.
That's clear. Last question here just around the DPA. So clearly the liberals indicating during the election campaign that they wanted to pursue this. Did it surprise you? And then any update you can provide either on a court date on the DPA or anything on the integrity regime?
So we kind of remain focused on defending ourselves through a court process, and that's kind of our key focus right now. And we're kind of prepared for that and prepared that it goes to that. I mean obviously, if there were opportunities for settling this in another way, we'd be open to that. But we don't expect it. We're kind of -- we're prepared for the court process.
And you figure that -- I think I read in your press release sometime in 2020 is when you expect the trial to start.
Yes. But it's not fixed.
Thank you. [Operator Instructions] We'll now move on to our next question from Derek Spronck of RBC. Please go ahead.
Okay, thank you very much. I'm just going to drill down a little bit more on the fixed bid remaining backlog. I mean you have $500 million of remaining backlog in your resource base, fixed bid projects. Now arguably, if there is going to be a cost re-forecast, it's going to be on the total project revenue versus the remaining fixed bid backlog. Are you able to provide what the total project revenue are within the resource fixed bid backlog is?
So on Slide 17, what we've tried to do here is give a little bit more transparency of the scale of the resources backlog within the larger projects, so those five projects that are identified, just to give you a little bit more information as to this the kind of size of the project because a couple of them are sub $50 million, which will probably be burned off quite quickly and quite small projects. So I don't know if that gives you the information that you need for this. Sylvain, is that --
Yes, I think we'll try to answer that as well, but if we don't, just restate the question maybe. So the backlog amount essentially represents the amount of revenues we expect to generate from those, and that's shown on Page 18. You see the phasing of how that run-off will happen. So those are the revenues expected from the remaining backlog. So unless there are scope changes on any of the projects, and you should not see a change to this amount of revenue, you might see changes in the phasing as progress can accelerate or decelerate for various reasons. And then the other thing is if there were cost view forecasts, yes, they would be a -- typically a true-up of your revenue, but it would just be -- the revenue would essentially come back later. Now obviously with a re-forecast, positive or negative, your margin would move accordingly. So I don't know if that answers the questions there.
Yes, that helps. Just looking at the percentage of completion, is that a relatively linear relationship relative to the remaining fixed and backlog, just in terms of understanding the scale of the -- at the beginning of each project, of the remaining projects that are left, would the --
Yes, it's not entirely linear. Yes, it's really not linear. And I think I would -- again, Page 18 will give you that color of -- there's quite a bit in 2020 that's running off. And the reason it's not linear is you have different components between engineering, procurement and construction, and they tend to move at different pace, so that drives some changes from quarter-to-quarter, year-to-year as the project evolves.
Okay. Nigel mentioned that he has done some sensitivity around both the positive and a more negative scenario. Are you able to provide any details around those two kind of outcomes?
I think what I can say on that is within LSTK style contracting, there is all sorts of risks and issues. These are highly complex projects. So things do change and there are scope changes as you go through the project. And these are huge prototypes that have never been built before, so expect the unexpected. What I can say about that sensitivity analysis is that we believe that the risks that are highly manageable within that sensitivity.
Yes, I would just add to that. The smaller share of this backlog is in results. I know I've said this, which is if you look at the table that we try to add a bit more transparency on that, you could conclude from that there's a couple of small jobs. One that's 90% complete, and then two, with any sort of significant backlog left in it. For the rest of it, the $2.7 billion is in Canadian contracts, which I repeat of [indiscernible] traditionally and historically for us coming up.
Okay. No, that's great. And the additional disclosure all around is helpful. And then just one last one for myself just on the Montreal REM. I mean obviously, there has been some press releases or information in the news that has come out. Can you provide an update and kind of your thoughts on that project?
Yes, for sure. I mean the first thing I'd say is the REM project is a fascinating, fantastic project, right? The 60-odd kilometers of urban railway. But what you might expect with that is multiple interfaces, whether it's the old tunnel that we've got to deal with or the airport that we're interfacing with, or all the communities that the railway travels through, the existing bridge that we've got to build across. There's these multiple interfaces. And I think what's really, really positive, which obviously was kind of missed in all the media, is the project is ahead of schedule. So the work that was done with our client to get this project into that stage is truly almost kind of, I wouldn't say it's unique, but it's remarkable to get it there. Now clearly, there's some challenges. There's challenges with any complex project like that. And we've got to work through those challenges with our client to optimize the best results for the project, and that's what we're doing.
Okay. And that's great. Thanks for the color and congratulations again on the appointment.
Thank you. We will now take our next question from Mark Neville of Scotiabank. Please go ahead.
Hi, good morning. First, Ian, congratulations. Maybe if I could just start with the resources. There was additional re-forecasts this quarter, and maybe just a little more color on that, if it was one particular project or multiple, and when that project or projects may finish?
So I mean I think we've said in the script, but I'll give a bit more color, both from [indiscernible]. I mean I think what -- it's disappointing, okay? So the first thing I'd say is that the number that we got out of that was a disappointment to us. What is interesting is it comes from three components, and the three components are some reforecasts on some projects that are nearing completion. There's losses attributed to the fabrication facility, which we're in the process of either divesting or closing down, and there's losses due to the need to right size the overhead as we reduce the activity on the lump sum turnkey part of the business. So the way I look that is two of those components are really fixable, and we will fix. I mean, Sylvain, if you have --
Yes, what I said specifically on the re-forecast, it is a smaller component of the three. And it is spread across a number of projects; it's not a single one. And you had some positives and you had negatives. This quarter, it was a net negative, but we're working through the remaining of the backlog and obviously try to contain this, and hopefully get some positives as well in there.
Okay. Again in your remarks, you've talked about sort of advancing a number of alternatives for the business. Is there anymore more detail you can give us? Just maybe just trying to handicap sort of what happens here? Or when something may happen?
Well, yes. I mean clearly, we're -- the biggest component, let's exit the LSTK, burn that off and put that behind us. But we're absolutely looking to move away from the fabrication -- midstream fabrication facility that we've got. I mean now that we're not in the lump sum turnkey business, it really doesn't complement our business going forward. So that leaves really the services side of the mining and metals, and the services side of the oil and gas business. And we just want to be really sure that this is going to produce the kind of cash flows and earnings that we want in the business going forward. And we're doing a lot of analysis around that now to understand if that's what we want as part of the future.
Okay. Maybe just on the cash flow, Sylvain, just again, I think you said you're reiterating what you said last quarter in terms of the cash flow. Can you just remind us exactly what that was?
I think what I said last time was that the operating cash flow of the second half would be positive, but that Q3 would be negative.
Okay. So if I understand that, again there is quarter-to-quarter sort of volatility, lumpiness and just as -- there's some projects you're working through and maybe some claims outstanding. But is there a line of sight for us, sort of a when it sort of becomes normalized or just maybe a little more consistent?
Well, it should -- I mean if you look at this year, the big issue or the set of issues we face with the cash flow has been the losses in the project side of the business, which these losses have translated into cash. And we started the year with $250 million of cash out expected out of Codelco, which the P&L impact was taken in our '18 results. So you get already a -- there is an EBIT to cash difference in the drag, and then we had further -- we had other issues as well, as of [indiscernible] last year, but we had more of the same in Q1 and especially Q2. So that's creating a bit of something not normal in the profile of the future. So as of now, you could start to expect things to start normalizing as we burn off the source of this volatility. So that's -- Q3 being an example, and then Q4 continuing and hopefully it carries on 2020.
Yes, I guess that was my question. Sort of you book these losses, but you're still working for the project, but it sounds like as we sort of finished this year, that sort of resolves itself?
For the most part.
Right. Okay. And sorry, just on the 407, did you say $100 million cash tax associated with the sale? That was your expectation?
That's kind of what we're -- that's basically -- we've been asked this question a number of times, and we're still working through the cash tax planning around it. And that's where we are right now and that's continuing to evolve.
Okay. Sorry, just maybe one last one then just to leverage 3.4x on the covenant. I'm just doing some math and if it's right, I guess it looks like the debt as per that calculation would be about $1.3 billion, which I mean EBITDA, and then around $375 million, $400 million. But in the EBITDA, there would be roughly $400 million of losses that would not have been adjusted for, again excluding the Codelco? Is that -- are those numbers about right?
Well, Mark, why don't we take this offline? You can call me and I can go through the numbers exactly with you.
Sure, will do. Thank you. Thanks, guys.
Thank you. We will now take our next question from Yuri Lynk of Canaccord. Please go ahead.
Good morning. Just looking to get a bit of a better idea of what's going on in the oil and gas business outside of the lump sum turnkey. I mean this was -- most of that work was cost reimbursable maintenance work, pretty recurring. So are you still bidding work in that section of Kentz we'll call it, and how is that business performing, and are you able to retain people in this environment?
Okay, yes. So yes, we are bidding and I think in the wins in the quarter, there was at least one win. So there's kind of a couple of components there in the current oil and gas business that were services. Some were actually legacy Atkins out of the U.K., and some of it, as you say, was the services part of Kentz, and to some extent, the legacy SNC. So primarily, those kind of services parts of the business such as doing design services, feasibility, some commissioning type work and some sort of closure type -- closure of asset shutdown kind of work, and it's kind of spread between the Middle East, some of it in the U.K. and in North America. So, yes, absolutely we're continuing to bid and we are picking up work. Sorry, to add to that also is the services part of the mining and metal business, which was the kind of equity level and legacy mining and metal business, which again, we're bidding kind of services work or EDPM type work, but obviously not any lump sum construction.
Okay, that's helpful. Just following on another question as we look towards the start of the trial next year. I was just curious what proportion of engineering services revenue is generated in Canada?
We'd have to answer that.
Yes. The EDPM, it's mostly in EDPM Canada I think you're referring to. That's in the range of CAD 400 million, but that's spread across many, many projects. I think what we've said in the past when we were asked is Canadian federal revenue, it was more like CAD 0.5 billion was what we had and most of that being sampling.
But if you think of our business kind of going forward, our engineering services business would be -- it would be unlikely that we would be working directly for the federal government, unlikely because we'd be working for a consortium that was working for the federal government. So by kind of exiting the lump sum turnkey model, currently risks our exposure to the federal government, not eliminated, but reduced.
Right. But could you give me like a go-forward rough percentage of engineering service revenue from Canada, all sources, nuclear, everything?
Directly, no. I mean other than what we said, right? So EDPM is up $400 million in total. In the past, the biggest exposure we had was Champlain, and if you exclude that, directly to federal it's not that much.
Okay. Last one for me: just any update on capital allocation priorities and how you're thinking about M&A? You mentioned being underweight in Australia, the U.S., versus buybacks. Updated thoughts on that now that the balance sheet's in better shape? I'll turn it over. Thanks.
All of our intent right now is deleverage.
Thank you. We will now take our next question from Chris Murray of AltaCorp Capital. Please go ahead.
Thanks. Good morning. So there maybe -- if you can take this for you, just looking at your provisions line, I guess there's a few moving parts in there and we don't get the disclosure on the interims that we do on the full year. But I'm just wondering if you can give us some breakdown of what's left in terms of cash outflows for contracts that are loss positions? And along with that, I don't know who wants to take this one. Can you also give us some idea of what the agreement with Codelco actually implies on a cash basis for you?
I won't answer in great details. But just to give you some color, when you look at Page 17 and you have the list of prospects, on that list within resources, you essentially have the first project, that is a project that lost, and that's the one that will have a net cash out because of that loss. Now, that project got less than CAD 200 million to go. So, that's something you should expect. Then, at the bottom of the page in the infrastructure, the last two were at loss, slight loss, on LRT, but basically, those have already had most of the cash out to be expected from being at loss, because they're basically in operation at the moment. Overall, for LSTKs, we are expecting the run-off to be still a positive event. That's what I'd say. Now, on Codelco, I'm not going to say more than what we said in the press release, it was not material from an EBIT, or a cash perspective.
Okay. All right. I'll leave it there. That was only one question. Thank you.
Thank you. We'll now take our next question from Frederic Bastien of Raymond James. Please go ahead.
Good morning. My questions relate to the infrastructure services business, which saw a big jump in profitability. You did bring up some of the reasons -- could you delve further into the explanation why we saw a big jump especially on the OEM side?
I will jointly answer it with Sylvain. But I mean, one of the biggest jumps compared to last year was the introduction of Linxon. So, Linxon it's reported through that, that's joint venture with ABB to provide services for the installation of substations. So, that's one component. I think the other component is some projects coming online, such as the Ottawa light rail that brings O&M into the business.
Yes, just to add, I think the Linxon certainly adds to revenue. I think it's still in ramp up phase, so we are getting a little bit of a pickup on EBIT, but on EBIT side, that's not the biggest driver. As I said in my prepared remarks, it was mainly O&M and as the team worked through some of those contracts, we restate those contract as we go along as we enter the queue and as we find ways to optimize the margin generation on these contracts. So, as we do every year, we look at our contract and we reset the margin potential and that does create some positive re-forecast on those.
Well, I mean it would add, this is for me a really exciting part of the business. As we see some clients globally moving away from lump sum turnkey contracting, moving to alternative methods of procurement, this is the part of the business that's going to drive that ourselves.
Okay. Next question, you did mention or at least your caution for us not to expect miracles on that cash flow in the third quarter, but working capital did eat up over CAD2 million bucks of cash. Was that largely as anticipated?
I would say, yes. And not sure if we said, don't expect miracles at the time, but we did say to expect a usage, simply because of the losses recorded in the lump sum projects. But, yes, the quarter for us is in line with our expectations.
Okay, and then small adjustment to the purchase price you paid for business, would you mind giving us a bit more color on that?
I think this was the closure of the Linxon remaining purchase price adjustments that we set.
Correct, yes.
Yes. So, it's the completion of the Linxon purchase accounting period.
And that would have been reported under Infrastructure services?
Yes. Linxon is a part of the Infrastructure services. Yes.
Okay, that's all I have. Thanks and congrats, Ian.
Thank you. We will now take our next question from Maxim Sytchev of National Bank Financial. Please go ahead.
Just a quick question, maybe to Sylvain. First of all, the covenant increased to four times by December of this year. Is that just a function of the rolling Q4 and just the LTM EBITDA, or how should we read into this?
Well, all there is to read is, we had that covenant for the first two quarters with our banks and early in Q3, we just proactively worked with them and agreed to just extend it through the year, as we work through our deleveraging plan. So, there's not much else to read into it. The 3.4 we closed this quarter, in terms of the covenant, is within that. It's also within our contractual covenant of [indiscernible]; so that's good. And the driver, as you well know, the driver is more of the poorer EBITDA, especially, the last three quarters and as we just burned our off, the covenant should get back in place. And we always knew that Q2 would be a bit of a pinch.
So, should we expect the leverage metric to come down in Q4, especially as you alluded to generating positive OCF?
Yes, I think we are basically, as I said, we have four quarters there. Three of them are pretty difficult within that number in Q3 that we added. This quarter was still a bit lower than the same quarter last year, because resources had positive EBITDA last year. As we look at Q4, we should be replacing a lower performing quarter with a better performing quarter.
On the right math from there.
Right. And is it fair to say, I mean obviously, as you had another provision in resources, that right now you have your hands around all those projects that, we should be assuming, basically breakeven on a going forward basis for LSTK as an item?
Well, I don't think we want to be definitive about where we see the actual results. But, what we can say is that we have got our hands around the jobs. Historically, 2.7 billion of those jobs are performed really well and the 500 million have performed above breakeven. So, we have never said there isn't zero risk in this business, but we've got a really good handle on it. I think that's how we're feeling now.
Right. No, that's fair enough. And actually, Ian, in terms of your commentary around the compression business, I suppose you alluding to the [ legacy volaris ] sort of assets. Can you maybe talk about what is the market for those types of companies, if you were trying to offload it? Trying to think if there were actually potential buyers, even if you wanted to sell this particular piece of the business?
Well, obviously, we're in the process. So, I don't really want to comment on the viability of that, but as soon as we've got a fix on it, we will be announcing and yes, obviously you're right about the asset. I mean, as I said before, it doesn't really fit with us anymore, but that's not to say that it doesn't fit with other companies and with other owners, because it is a viable asset, it's just that we got it with the acquisition of Kentz. Kentz acquired it because they are flow-through from their LSTK business and obviously, that's no longer the case for us.
Right. And is there a potential timeline that you feel comfortable telegraphing or not at this moment, specifically?
No. I don't think we could share that now, but obviously, it's absolutely on our agenda to get this done.
Okay. Okay, excellent. That's it from me. And congrats on the appointment.
Thank you. We will now take our next question from Michael Tupholme of TD Securities. Please go ahead.
Thanks. Good morning. I just wanted to go back to the leverage ratio and the covenant. So, can you confirm in the third quarter was the covenant 3.75?
No, it's 4.
It was 4 in the --
A great, yes, it was 4 as well.
Okay. So, it's been 4 all year and this extension is just keeping it at 4 through the remainder of the year?
That's right, that's exactly right. It was extended early part of our Q3 for the rest of the year.
Okay. I guess I was under the impression that it was going to be 3.75 times in the third quarter. But, so, maybe I'm just -- the fact that you've got that extension in place early in the third quarter. Did that take it from what was supposed to be 3.75 at one point in the third quarter, up to 4 for the third quarter?
Yes. The original agreement that we have in place is 3.75 and at the beginning of the year, we agreed to go to 4 for two quarters and we revisited that with our bankers in Q3 to keep it at 4 through the rest of the year, as we work through our deleveraging plan. Now, you could argue, it wasn't necessary, because we called it 2.4 and the normal covenant would have gone back to 3.75. We did that proactively just because we're just trying to manage proactively our relationship with the banks.
Okay. Right now, that makes sense. You were asked about infrastructure services and the strong performance there from a margin perspective. I just wanted to clarify, you referenced the favorable impact of some re-forecast related to O&M contracts. Is that a one-time benefit that would have come through and help the margin in the quarter? Or is that some sort of a sustainable benefit? And I guess the bigger question really is, what is the right way to think about margins in that Infrastructure Services segment going forward? Because, there were a lot higher this quarter than anything we've seen.
I think there is a component there, of the one-off re-forecast. But, I think the way to think about the business is obviously looking back, and its historical performance, which I would say is kind of at the higher end of single-digit. So, that's the way I think about this business, it's absolutely part of our future and we would expect to see that growth from this sector as we move further into [ PMCM-type ] jobs, integrated role jobs, alliance type contracting, all of that, as well as the O&M business that we've been operating for a long time.
Yes, just to add to that, in the O&M business, they review their contracts on an ongoing basis and they try to optimize the delivery of the work. So, they will have re-forecast like this on an ongoing basis. In last year, we had a similar effect. They don't come in the third quarter necessarily, they come in as these contracts are reviewed. So, that's the way to think of it. Now, I think what Ian said, in high single-digit run rate type margins is probably the way to think of it. So, a bit stronger in this quarter. But, that's just going to evolve quarter-to-quarter as contracts are optimized.
I guess I understand the outlook commentary you are providing around the margins for this business going forward being high single-digits, and maybe that's the most important point. But, when I look back historically, I guess, we only have about six quarters of history, before we got the third quarter number and the highest margin that was ever delivered was 7.5% and more frequently, we are sort of in the high 3% or mid-4% range. So, what is it that is now allowing you to do high single-digit margins in this business?
Well, I think the O&M business, the long-term piece of it and the additional contracts that we're seeing in that business are contributing to a better mix within that. And that's basically all I can say on that.
Okay. And so, I guess one of those was the Ottawa LRT coming on. Were there others as well?
There's been some wins through the year in social infrastructure. I can't bring out anything else specific that would change that and obviously, this part of the business got recreated in the strategy. So, we're also in the process of obviously right-sizing the overhead for this business. I don't think we can add anything else to that.
Okay. Fair enough. And I guess just on that point, with respect to the overhead for right-sizing, I guess you've essentially reiterated your cost savings guidance. Can you talk about what the run rate savings level you were at was I guess at the end of the third quarter, and how we see that progressing as we move forward?
I'm not sure we are looking at it that way. What we have to achieve is that, when we get to the end of this year, the run rate going forward into 2020 has delivered CAD 250 million of savings and we are on target for that. And I think we also said that we would say within this year, CAD 100 million and we're on target for that, which obviously means that the majority of that [ part ] to go has been done. I mean, we're pretty confident we'll achieve both. I think, that's kind of my way to look at it.
Okay. Just lastly, and this goes back to something that, I believe it was Derek asked earlier, but I'm just trying to reconcile the change in the LSTK backlog to the actual revenue that you delivered. So, it's a little hard in resources, because there is more than just LSTK work flowing through that one, but if we look at Infrastructure EPC projects, the LSTK backlog is down about CAD 155 million sequentially quarter-over-quarter. Yet the revenue delivered in that segment in the quarter was CAD 289 million. So, you're doing a lot more revenue than the actual work off of backlog. I'm not sure if this is sort of what you tried to address earlier, answer earlier, but can you just explain the variance there in?
Yes. I think most of that comes to scope changes, so then there'll be one thing as we work the burn off is if there are elements of these projects that the client exchange and that could increase the revenue for those projects. So we're not bidding on new work, we're not taking on new work, but there are contractual obligations to perform. So I had a bit of --
And we have being too specific that there was a couple of things that were pretty large in terms of scope change that are in the quarter. So, we're probably not typical going forward. [Indiscernible] put backlog in that the kind of which you can kind of see that up to the same extent the every quarter.
Okay. Helpful. Thank you.
Thank you. Ladies and gentlemen, that's all the time we have for questions today. Mr. Denis Jasmin at this time, I would like to turn the conference back over to you for any additional or closing remarks. Thank you.
Thank you. I know there's a few individual still in the queue. And, sorry, I apologize for that, but it's open personal integrity and we have to end the call. If you have any other questions, please don't hesitate to call. It would be my pleasure to answer your questions. Thank you very much everyone and have a beautiful day.
Thank you very much. Thank you.
Ladies and gentlemen, this concludes today's call. Thank you for your participation. You may now disconnect.