Dexterra Group Inc

TSX:DXT

Earnings Call Transcript 2022-Q2

[Operator]

Thank you for standing by. This is the conference operator. Welcome to Dexterra Group's Second Quarter Results Conference Call. [Operator Instructions] And the conference is being recorded. [Operator Instructions]

I would now like to turn the conference over to Drew Knight, Chief Financial Officer. Please go ahead.

[R. Knight, executive]

Thank you, Arielle, and good morning. My name is Drew Knight, and I am the Chief Financial Officer of Dexterra Group Inc. With me today on the call are John MacCuish, CEO; and our Board Chair, Bill McFarland, who will provide some brief introductory comments.

The format of this conference call will be the same as our past calls. After a brief presentation, we will take questions, with the call ending by 9:15 Eastern Time. We will be commenting on our Q2 results, Q2 2022 results, with the assumption that you have read the Q2 earnings release. The slide presentation, which supports today's comments, is also posted on our website, and we encourage participants to access the slides and follow along with our presentation.

Before we begin, I would like to make some comments about forward-looking information. In yesterday's news release and on Slide 2 of the presentation that we have posted on our website, you will find cautionary notes in that regard. While I won't read the content of the cautionary notes in their entirety, we do claim their protection for any forward-looking information that we might disclose on this conference call today.

I will now turn it over to Bill McFarland for his introductory comments.

[R. McFarland, executive]

Thank you, Drew, and welcome to everyone. Q2 results had a number of positive developments, including the revenue for IFM and WAFES continuing to grow as planned, and we will be close to reaching our $1 billion revenue goal on an annualized basis in the back half of 2022.

Our EBITDA in IFM and WAFES also improved over prior periods despite being negatively impacted by inflationary cost pressures. And EBITDA margins will improve significantly in the back half of 2022 in both IFM and WAFES businesses as cost escalation clauses are phased in.

We also have a Modular action plan that is progressing, which included efforts to renegotiate many supplier and customer arrangements for projects in the backlog given the significant impact of inflation on this business. These and other efforts should bring the Modular business back to modest profitability in Q3 with a path to more normalized margins in 2023.

So big picture, the challenging results in the Modular business resulted in the group results being below expectations. However, we have pivoted and expect much stronger profitability in the back half of 2022 in all 3 business units and continue to be committed to building long-term shareholder value through a strong dividend and capital appreciation over time.

I will now pass it over to John MacCuish.

[John Mac Cuish, executive]

Thank you, Bill. Our Q2 revenue was $234 million, representing a 35% increase compared to the same quarter in 2021, slightly ahead of our Q1 in 2022.

The increase of revenue in Q2 2022 was primarily attributed to the additional revenue generated through the acquisitions of Dana Hospitality and the Tricom Group, and a substantial increase in WAFES revenue due to increased activity levels in the energy sector and successful rebids on contracts. We're also pleased with IFM's organic growth, and increased traffic in airports started to appear in Q2 as a baseline for greater growth in the back half of the year.

Adjusted EBITDA for Q2 2022 was $13.6 million and lower than expectations given the Modular Solutions decline. We are executing an action plan, which will return the business to profitability in Q3 2022. We announced executive changes for this business during the quarter and are actively recruiting for a new President of the Modular business.

Mark Becker, our COO, is the acting President, and has completed a comprehensive review of the Modular business, which will produce both short-term and long-term results. We are poised for continued company-wide revenue growth in 2022 and 2023 with new business wins and as the economy moves into a post-pandemic environment.

The group is proactively addressing inflationary and supply chain pressures and labor availability across all business units. Cost escalation clauses and contracts will kick in and help us significantly improve margins in all our businesses in the back half of the year.

I'll now dive into some more details by business unit. Starting with IFM, we are pleased to announce the appointment of Sanjay Gomes as our President of the IFM business unit. Sanjay comes to Dexterra with a strong track record of revenue growth in support services businesses and will help us achieve our goal of building an IFM business with more scale.

The IFM business revenue in Q2 2022 is up 68% from Q2 2021. The increase primarily reflects the acquisitions, which contributed $24.9 million in revenue in Q2 2022. Excluding the acquisitions, revenue increased by $1.5 million compared to Q2 in 2021.

IFM continues to be focused on growth from recent new business wins and increased traffic in airports in the back half of 2022. The segment is building on the increased scale of operations with the acquisitions, bolstered by education sector's peak back-to-school season starting in September and new business contracts, which mobilize in the upcoming quarters. EBITDA margins will also improve as cost escalation clauses hit their anniversary dates.

We also remain focused on executing on our expansion strategy through both organic growth and mergers and acquisitions. The acquisition strategy is active and focused on expanding IFM service offerings and geographical coverage.

Moving over to WAFES. We are also -- we're also pleased to announce that Jeff Litchfield was promoted to be the President of the WAFES business unit as Mark Becker took on expanded duties. Jeff has been groomed for this role over the past couple of years, and the transition has been seamless.

Our WAFES business had revenue growth of $31.6 million compared to Q2 2021 and $4 million compared to Q1 2022. WAFES revenue performance was strong in Q2 2022 due to the $23.8 million increase in catering, infrastructure installs and rental activities in Western Canada, which resulted in increased occupancy and utilization across all services; and a $7.8 million increase in revenue in Energy Services from higher mat sales and increased trucking and install work, with a partial offset from lower fire support activity. This growth represents a recovery from the abnormally low activity levels in 2021 due to the COVID-19 pandemic and the 2022 resurgence in the energy sector.

The Crossroads Lodge in Kitimat, British Columbia reopened in Q2 2022. This facility, with 736 beds, had limited occupancy in Q2, and is expected to increase in Q3 and be at full capacity in Q4 of this year.

Forestry is a seasonal business, with its activities taking place in Q2 and Q3 each year. Forestry year-to-date revenues for 2022 was $8.5 million as compared to $9.3 million in 2021. This is due to a slower seasonal start caused by spring weather, which delayed the planting of trees. We expect strong results from our Forestry business in Q3 this year.

EBITDA margins were lower in Q2 and year-to-date and will improve significantly in the back half of the year, with contributions from Crossroads, matting sales already contracted for in Q3 and Q4 and the execution of contract escalation clauses to address cost inflations, which cannot be passed on to the clients in the short term. WAFES has also renewed 100% of its key contracts, which were subject to rebid.

Modular Solutions segment revenues for Q2 2022 were $49.6 million compared to $48.2 million in Q2 2021 and $43.3 million in Q1 2022. Adjusted EBITDA for Q2 2022 was a loss of $3 million compared to a profit of $4.7 million in Q2 2021 and $0.4 million in Q1 2022. Losses in this business unit were the result of significant cost increases on fixed-price client contracts. Subcontractor cost increases approximating 30%, material cost inflation, supply chain impacts and labor shortages causing premium cost of overtime and outsourcing all contribute to our costs overall.

We have initiated action plans to improve profitability to more normal levels over the back half of the year and expect to be profitable in Q3 2022, with EBITDA approximating 3% to 4% of revenue in the back half of the year. Margins will be below normal levels in the back half of the year as we continue to work through the backlog of contracts. We have also negotiated new terms on many projects, which limit our future exposure to inflation.

Key points of the plan include: adding new talent, improving project management and contract pricing; building in inflation clauses into contracts and revising terms with existing suppliers to create more cost certainty; increasing the project pipeline to improve throughput volumes and optimize overhead absorption at our plants; and implementing revenue diversification strategies to reduce concentration risk with large clients. The latter 2 points will take more time to achieve lasting results.

Revenue in the back half of 2022 is to exceed the year-to-date results. The backlog of projects for Modular Solutions was $117 million in rapid affordable housing at the end of Q2, which excludes backlog of $48 million for industrial and U.S. manufacturing supply projects. And additionally, Modular Solutions has incremental recurring business worth approximately $40 million per annum, which consists of education modules and specialty kiosks.

The segment has won bids for approximately $20 million worth of modular supply of multi-family duplex units in the U.S. They are expected to be completed in the second half of this year and early 2023 as Modular diversifies its portfolio of end-use products and clients. It is fair to say the Modular business has been challenged, but our actions and our strong backlog are allowing us to pivot quickly.

I'll now turn it over to Drew for comments on our financial position.

[R. Knight, executive]

Thank you, John. Looking at Slide 10. Our adjusted EBITDA was $13.6 million compared to $17 million in Q1 2022 and $18.3 million in Q2 2021, excluding the $4.2 million of CEWS funding that quarter. IFM and WAFES continued to perform well for both revenue and EBITDA in Q2 2022 and exceeded the results from both Q1 2022 and Q2 2021. Their positive impact was offset by a Modular decline year-over-year by $7.7 million.

We expect to return the Modular business to profitability starting in Q3 2022, and expect strong EBITDA and margin growth in IFM and WAFES in Q3 and Q4 due to revenue mix and the escalation -- and the execution of cost escalation clauses in client contracts, which typically have a timing lag compared to when cost inflation has been incurred in Q1 and Q2 of 2022.

Flipping to Slide 11. The IFM business had adjusted EBITDA as a percentage of revenue of 6.1% in Q2 2022, which is consistent with Q1 2022. Increased product costs and labor shortages has resulted in downward pressure on EBITDA margins in 2022. The lower margin will improve to around 7% as the education and recreational sectors return in the fall and the cost escalation clauses reach anniversary dates, which allow us to pass inflation cost increases to clients.

The WAFES business had adjusted EBITDA, excluding CEWS, as a percentage of revenue -- sorry, let me start again. The WAFES business had adjusted EBITDA, excluding CEWS, as a percentage of revenue of 14% for Q2 2022 and year-to-date results. The decrease in 2022 is primarily due to the mix of contract revenues and inflationary impacts resulting from increased costs for food, fuel and utilities, which are passed on to customers, but there is a lag in our ability to pass on these costs immediately. EBITDA margins will increase significantly in the back half of 2022 due to execution of contract cost escalation clauses, the Crossroads occupancy increases and strong Energy Services business activity.

The Modular business had an adjusted EBITDA loss of $3 million for Q2 2022 compared to $4.7 million in Q2 2021. The EBITDA loss was a year-over-year decline of $7.7 million and was unexpectedly large as Q2 costs escalated further beyond the already-inflated Q1 costs for fixed-price contracts. This inflation impact will dissipate as new customer and supplier arrangements have been negotiated and old contracts in the backlog are completed in Q3 and Q4 of 2022.

Flipping to Slide 12. The corporation's financial position and liquidity remains strong, with $61.2 million of unused capacity on its credit lines at June 30, 2022. Working capital investments will reduce in Q3 and Q4 due to the collection of negotiated holdbacks of $15 million on some larger long-term contracts and improvements in days sales outstanding in each business unit. Additional free cash flow will be generated by operations in the back half of the year due to normal course seasonality of inventory and client cash receipts in both Modular and the Forestry work in WAFES.

The conversion of EBITDA to free cash flow for 2022 is expected to approximate 50%, and our leverage is expected to be about 1.2x trailing 12-month EBITDA by year-end. Dexterra Group also declared a dividend for Q3 2022 of $0.0875 per share for shareholders of record at September 30, 2022, to be paid on October 14, 2022.

I will now return it back to John for closing comments.

[John Mac Cuish, executive]

Thank you, Drew. So what does the back half of 2022 look like? Sales are likely to approximate the $1 billion run rate on an annualized basis, which was the medium-term goal at the time of our merger. EBITDA will exhibit strong growth, with the Modular returning to profitability, proactive management of inflation in all business units and continued strong EBITDA growth for both IFM and WAFES. This allows us to continue to pay a healthy dividend yield, also given the strong conversion of EBITDA to free cash flow for the full year.

The focus of the IFM business is on our organic growth and executing on our M&A strategy. The WAFES business is expected to continue to grow in 2022 given the increased natural resource activity nationwide. Recent changes in leadership, focus and a strong action plan should assist our Modular business unit in returning to profitability in Q3, with a more normalized EBITDA level of 6% profitability in 2023 as it works through the backlog of fixed-price contracts. The demand for affordable housing in urban centers continues to grow, and government programs are seeking to address this need, including modular housing solutions.

In conclusion, we expect the back half of 2022 to be much stronger than the first half of the year in all facets of the business. Our ongoing focus is to be a support service champion by being customer-focused, capital-light, by decentralizing our operations model and moving decision-making closer to our clients and their customers. Maintaining a focus on discipline with capital investment and a robust M&A strategy will help us reach this goal.

This concludes our prepared remarks for today. At this time, I'll turn the call back to our operator for the Q&A portion of the call. We ask that you begin by limiting yourself to 2 questions. If we have time at the end, we'll circle back for additional questions. And thank you for joining us today. Please go ahead, operator.

[Operator]

[Operator Instructions] Our first question comes from Michael Doumet of Scotiabank.

[Michael Doumet, analyst]

Putting aside the Modular Solutions for the moment, it seems like the cost inflation had a larger-than-expected impact to IFM and the loss despite the escalation clause. So I'm just wondering, was the negative surprise there due to an acceleration in inflation quarter-over-quarter? Like are you seeing a deceleration at this point? I'm just curious, do most contracts have annual escalation clauses? Or are they more frequent than that?

[John Mac Cuish, executive]

So I'll put some color around that. I -- the impact on the margins in the quarter were about 1%. So we are looking to see that grow in the back half of the year as the anniversary dates come with their existing contracts. We have an opportunity in the majority of our service contracts, whether they be in WAFES or IFM, to have annual [ COLAs ] that are in the agreement. So I think we're -- as these anniversary dates come, I think we'll be in a position to rightsize those costs.

The other thing is, we're working hard with -- our supply chain and procurement has done a good job to mute some of the ongoing inflationary impacts. One of the things that caused the inflation is also the struggle with labor and what that might do for perhaps overtime or having to go to more subcontractors than we would like, because we do like to be predominantly self-delivery.

So overall, the impact is about 1% on the IFM -- in the IFM business, about 2% in WAFES and about 10% in Modular. And we believe, going forward, with our actions, that will be muted, and we've got our -- our war on inflation will continue.

[Michael Doumet, analyst]

And I guess, on the Modular, how much of the backlog today consists of fixed-price contracts? And I guess, the question here, what are the risks that the segment doesn't quite reach profitability in Q3?

[R. Knight, executive]

Well, I guess, Zach (sic) [ Michael ], most of the contracts in the backlog have either been recently priced that already reflect the current cost base. And most of them have new clauses for timing and validity so that they get repriced pretty regularly. So every 30 days, the price gets reset on many of the contracts now. So we've made that change.

And I guess, I would say, we've already gone through July and the business is a little better than breakeven. So we're -- it's not tremendously profitable, but we've already seen significant traction on our plans, and so we're not expecting a hole. We're already at breakeven and looking to improve that.

[Operator]

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

[Chris Murray, analyst]

Maybe going back to think about IFM for a second. When you first did the -- announced the acquisitions of Dana and Tricom, I think you were talking originally about revenue run rate somewhere in the $100 million range and $35 million range, respectively. Obviously, as you guys have noted, some of that has been a little bit lower than previously expected. But I think you did talk about the fact schools return in the fall, that you might see that starting to improve. Is it fair to think that we probably get to those levels, though, as we reach into 2023?

[R. Knight, executive]

Sorry. Go ahead.

[John Mac Cuish, executive]

Yes. Look, absolutely. We absolutely will get there. Yes, just to talk about Dana, for example. We -- Q2 is roughly $25 million. We see Q3 as $25 million, maybe a bit. But then in Q4, we're going to be up $8 million to $10 million as education kicks in, the universities are back, the ski hills are active in our leisure sector. So we're very confident about those -- about that business and where it will be.

[R. Knight, executive]

Yes. And I think, Chris, the Tricom business we knew had some new business that was launching later in the year. So in -- combined, in the quarter, you think it looked like it was around $25 million. But with that growth that John mentioned of an extra $10 million, it's going to get there on a full year basis.

So Dana, in 2021, full contracts, they were $100 million for the year, and we're fully expecting them to get there. So those numbers are still good on a full year basis, just there is -- there are some dips and dives in the quarters.

[Chris Murray, analyst]

Yes. No, that's fair. That helps. And then thinking about the WAFES business, I guess, first of all, very strong Energy Services business with rentals. I think you guys called that out. Certainly, the run rate that you're at right now, Forestry seems to be coming together.

One of the swing factors, I think, is just maybe making sure we're all understanding the impact of the Kitimat lodge. I'll sort of put it on maybe the previous management team when that lodge was first being designed and built. They had indicated that they saw it as a kind of a $50-million-a-year type revenue opportunity at full occupancy, with margins that are typical of that category of lodge in a high demand environment.

Is that how you're still seeing it? Or has something sort of changed? I mean, it's been a couple of years since we've really had those discussions maybe in detail on it. But any sort of update or detail that you could give us would be helpful.

[R. Knight, executive]

Yes. Chris, thanks for the history lesson. I wasn't around with previous management when they made those assertions. But yes, that number is actually a pretty good number. So we're dangerously close to that $50 million when it's fully occupied, and we expect to be there in Q4.

The past quarter, because it's not fully occupied, it was really a breakeven. But if you recall, it was shut down in 2021 and through Q1, and it actually was a drain because there was still some maintenance on the site and no revenue coming in.

So with the limited occupancy in Q2, it got to breakeven. And then like you said, in Q4, when we get to full occupancy, it's in the high 40s for revenue and a high-margin project due to the capital investment that was there in the past.

[Operator]

Our next question comes from Zachary Evershed of National Bank.

[Zachary Evershed, analyst]

I was hoping you could help us quantify the risks to pass-throughs required to hit the near-term margin guidance you provided in each segment. It sounds like Modular is already breakeven, but you get to that 3% to 4% number. And if you could clarify if that's for Q3, or is that for H2?

[R. Knight, executive]

Yes. So it's -- those comments were for the back half. So Modular, specifically, we're thinking it will trend to that 3% to 4% as we move through the final months of the year here. So we're confident we'll get there because there's still -- some of those contracts get worked off the backlog, Zach. And as the newer projects come on, they reflect current pricing and current margins. So we do expect to get there.

And then in IFM and WAFES, those contract escalators, they're live and happening as we move through the year. And the -- as John mentioned earlier, the impact of that was about 1 point of margin on the IFM business and 2 points of margin on the WAFES business. So we're expecting to get that back.

Yes. And it was -- in total, that's worth almost $2.5 million. There was nearly $2 million in the WAFES business and a little over $0.5 million in the IFM business.

[Zachary Evershed, analyst]

Understood. And then will we see cost synergies bring Dana's margins closer to in line with legacy IFM? Or will it still run at a lower level?

[John Mac Cuish, executive]

No. I think we're shooting -- you'll see about a 7% margin. I think as we're working through Dana, we've done the onboarding, we get things back to school, we get our escalation clauses in, whether our clients kick in. A lot of them kick in this month, to be honest with you, but they usually are on the anniversary of the contract.

We're having great cooperation with all our clients in and around fighting inflation. And there's a good view on the IFM that will definitely get that margins back up to the 7%. And we're winning work. The pipeline is strong, and we've got some big rebids that we've won. So we're very comfortable with growing those margins in the back half.

[Operator]

[Operator Instructions] Our next question comes from Frederic Bastien of Raymond James.

[Frederic Bastien, analyst]

You provided some good color on the margin profile for Modular Solutions heading into the back half of the year. But what would be an appropriate margin that we should expect from the segment longer term once all this inflationary pressure is behind you?

[R. Knight, executive]

Yes. I think, Zach, traditionally, that business has been around -- or sorry, I said Zach. Sorry, Frederic.

Frederic, that business has trended around 6%, and we're looking to get back to that 6% range in 2023. It's basically a mix of business as part of the issue because we have the affordable housing stuff. We've got the U.S. business kicking in. And then we've also got our traditional education portables and industrial products.

We're gradually diversifying that business, as you know, and the mix will impact the margin as we move through the year. But we expect the back half here, as we said, 3% to 4%. And then when we get into 2023, we'll start trending towards 6%.

[Frederic Bastien, analyst]

And what sort of -- I think you did discuss it in the prior call, but if you could just remind us what sort of opportunities are you looking at in the U.S.? And I think there was also a mention of potentially going after hotel-related opportunities. So I was wondering if you could touch on those, please?

[R. Knight, executive]

Well, I think at the moment, our U.S. business is all -- it's not social housing. It is affordable housing, and always multi-unit residential buildings. A mix of duplexes and mid-rise structures in a couple of different states: Montana, Washington and California.

There's no hotels on the docket at the moment, but they're on our pipeline as targets because a lot of those suburban hotels are real, direct fit for this modular type of work. And we've done those hotels in the past, pre-pandemic. The hotel market in Canada is really just getting started, the U.S. a little bit further along.

[John Mac Cuish, executive]

Yes. I'd just add to that, Drew, that when it comes to diversification and U.S. supply only and even in our domestic market, we've just hired a new sales leader for Modular. And with -- the person has 10 years Modular experience, he really knows the industry. So we'll be quite focused on our profitable diversification, if I can call it that.

[Frederic Bastien, analyst]

I appreciate the color.

[R. Knight, executive]

Thanks, Frederic.

[Operator]

This concludes the question-and-answer session and today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.