Dexterra Group Inc

TSX:DXT

Earnings Call Transcript 2023-Q2

[Operator]

Welcome to Dexterra Group's Second Quarter 2023 Results Conference Call. As a reminder, all participants are in listen-only mode, 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, [Ayshea], 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 Mark Becker, CEO; and our Board Chair, Bill McFarland, who will provide some brief introductory comments.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 with the assumption that you've read the Q2 earnings press release and MD&A and financial statements. The slide presentation, which supports today's comments is posted on our website, and we encourage participants to access the slides and follow along with our presentation. For the Q&A portion of the call, we will limit each person to a few questions at a time. 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 to our website, you will find cautionary notes in that regard. 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]

Good morning, and thank you for joining the call this morning. I'm pleased to report that the organization achieved record results in Q2 2023. This included stronger results from all of our business units. Management's focus in 2023 of profitability and execution is making a difference and has set Dexterra up for future success. On an annualized basis, we're very close to our announced goal at the time of the merger 3 years ago of over $1 billion in revenue and $100 million in EBITDA. Our financial position is strong, and we have experienced leaders in place. The team has demonstrated flexibility and the ability to pivot effectively in the post-COVID world. We also believe our stock is significantly undervalued and intend to continue to buy back shares opportunistically. I will now pass it over to Mark Becker for his comments on the business and outlook for the rest of 2023.

[Mark Becker, executive]

Great. Thank you, Bill. Good morning, everyone. As Bill said, we're very pleased with our results in Q2, continuing the positive momentum we've established this year. Our focus continues to be on execution and profitability, driving growth and margin expansion. I'll cover the by-business-unit details in a moment, but first I want to reinforce our key focus areas listed on Slide 5 that make up our framework of our 2023 business plan. These focus areas are unchanged from our last update and remain our key leverage points to improve and grow the business. Our consistency in this plan is helping us to continue to make a positive impact in the business broadly, both top line and bottom line. Inflation and labor market conditions generally remain a factor for us across the businesses. While we've seen price abatements in a number of key supply commodities and some improvement in labor availability, generally speaking, market conditions continue to challenge us in critical areas such as food and labor costs. We remain very focused on managing those pressures, working proactively and collaboratively with our clients on contract pricing adjustments, strategic supply chain arrangements and other operational initiatives to drive better margins. Overall, we're very happy with our ongoing progress and efforts in this area, and it's demonstrated in our results. So moving to IFM on Slide 6. Our focus in IFM is on new sales growth and continuing to improve EBITDA margins through operational improvements, inflation management and contract rationalization. IFM revenues are up 17% compared to Q2 last year, primarily due to new business wins in the post-secondary education, hotel and rail segments. Relative to Q1, revenues are lower relative to the seasonal dip in education and leisure. Additionally, we are exiting, or have exited, approximately $10 million to $15 million in contracts with unsustainable commercial terms where we are unable to achieve adequate profitability in a post-COVID environment. Netting out the impact of these rationalized contracts for IFM, our EBITDA margin is 6.6% for the quarter. This ongoing repositioning and rationalizing of the IFM business portfolio will help us move faster in the near-term towards our target of 7% or greater EBITDA margin. New sales have been particularly strong this year in IFM, with significant new profitable contracts related to post-secondary education and other segments circa of about $50 million coming onstream primarily in Q4. Mobilization of these new contracts will support a strong back end of the year from September on. Lastly, we remain active in exploring acquisition targets in the IFM space for potential execution later in 2023 or 2024. Moving on to WAFES on Slide 7. Revenue from the WAFES business was up significantly compared to Q2 last year and higher than Q1, primarily due to unprecedented wildfire support and overall robust market activity across the natural resources market segment. We've been doing all we can to support firefighting efforts across Canada from Quebec to British Columbia, and activity continues into Q3, albeit now is primarily focused in BC. We're seeing high occupancy levels in workforce accommodations across our portfolio as well as high utilization and activity levels in energy services in the Montney-Duvernay natural gas development regions of Northwest Alberta, Northeast B.C. We also closed a significant contract change order related to the recovery of inflationary costs on one of our major projects in Q2. The influence of the fires and contract change order are the primary drivers of the unusually high profitability in Q2, which resulted in a 18% EBITDA yield compared to what would be a more normal 15%. Looking forward, strong camp occupancies, including coastal gas line projects and our Kitimat camp at LNG Canada are expected to continue into the back half of the year. Similar to IFM, new sales momentum has been strong this year in WAFES with several new major camp projects and contracts coming onstream in 2024 that will support the WAFES business, going forward, as the current major projects like Coastal GasLink and LNG Canada move into their completion phases. Lastly, on modular, Slide 8. Revenues were as expected in Q2, driven primarily by our ongoing social affordable construction projects, educational portables and industrial segment activities. Profitability continues to be positive as a result of good progress on our 4-point business improvement plan. We continue to progress through the group of fixed-price BC social affordable housing projects, which accounted for $11 million in revenue in the quarter. The remaining $24 million backlog associated with these projects is still expected to be substantially complete by year-end. Normalizing Q2 for the BC housing contract, the remaining work delivered is approximately 5% EBITDA as the business continues to focus on building towards the target of sustainable EBITDA margins of 6% or greater in 2024. Our project backlog has been drawn down so far in 2023, primarily due to the timing of awards for new social affordable housing projects in the approval process is under the latest tranche of federal government funding. U.S. supply-only activity also remains muted due to the higher interest rate environment impacting real estate development there. The timing of securing new contracts is impacting the current utilization at our manufacturing plants, which are managing through adjustments to trade staffing levels and other production management measures. However, the longer-term demand for social and affordable housing remains strong, and with the number of bids and proposals in play, we expect the backlog to reach an inflection point soon and begin to rebuild. Sales and rebuilding the backlog remains a primary priority for us. We're also pursuing other areas of opportunity in industrial and indigenous housing projects, as well as a strong and active educational portables market. Overall, we expect modular to continue at similar quarterly revenue levels and remain profitable through the second half of 2023. With that, I will turn it over to Drew for some comments on our financial position.

[R. Knight, executive]

Thank you, Mark. I'll speak about our financial position and capital markets on Slide 10. Our financial position and liquidity remains strong. The Board of Directors approved a new credit facility yesterday, which is expected to close this month with a maturity date of September 7, 2026. This will include an expanded available limit of $260 million plus an uncommitted accordion of $150 million and provide expanded flexibility to pursue accretive acquisitions. We expect our leverage to be a little over 1x EBITDA by the end of this year in the absence of acquisitions. Dexterra commenced an NCIB on May 15, 2023, under which we can repurchase up to 1.3 million shares for cancellation, or about 2% of our common shares outstanding. For Q2, we have repurchased 189,100 common shares at a weighted average price of $5.60 per share for total consideration of $1.1 million. We continue to believe that the company is significantly undervalued, and we'll continue to be opportunistic in repurchasing shares in the coming quarters. For the full year, we expect adjusted free cash flow conversion from EBITDA will continue to track to approximately 40% to 50%. As in prior years, free cash flow is affected by the timing of capital expenditures and by investments in working capital primarily associated with business growth. We expect strong free cash flow conversion in the back half of the year similar to 2022. We declared a dividend for Q3 2023 of $0.0875 per share for shareholders of record at September 30, 2023, to be paid October 13, 2023, which is unchanged and is a 6% return on our current share price. I will now turn it back over to Mark for closing comments.

[Mark Becker, executive]

Thanks, Drew. The points on Slide 11 in our deck serve to summarize what we've covered today and our key focus areas, going forward, for the balance of the year. My focus and the focus of the Dexterra team in upcoming quarters is to continue to drive strong execution, improve margins and profitability through the effective management of our business and any inflation effects. We will continue our growth story through strong sales and organic expansion as well as potential strategic acquisitions to build our IFM platform and to enhance the services we offer to our clients. Our financial position and liquidity are strong, and we continue to focus on free cash flow and reducing debt, excluding merger acquisition activities. As we continue to execute, improve and sustain our profitability and grow, we believe that the market will recognize our true value over time. We've made good progress in the first half of 2023. I'm confident and our employees are energized about our plans and the future ahead for the company, a future that will deliver strong stakeholder value to shareholders, employees, customers, suppliers and our communities as we continue our growth and success story. This concludes our prepared remarks, and I will turn the call back to [Ayshea] for the Q&A portion of the call.

[Operator]

[Operator Instructions] The first question comes from Chris Murray with ATB Capital Markets.

[Kyle Brock, analyst]

This is Kyle on behalf of Chris. In the MD&A, you called out a $5 million nonrecurring add-back in WAFES. Hoping you can provide a bit some color on what's in that number and if we should be expecting similar add-backs in the second half.

[R. Knight, executive]

Thanks, Kyle. Yes, the $5 million add-back in WAFES is related to a couple of things. It's partly related to a change order on a large project, a camp project that we have, and it's also related to the fire support activities during the quarter. Much of that will continue on into Q3 this year. And that comment was more related to next year when some of that stuff may not be there.

[Operator]

The next question comes from Aaron MacNeil with TD Cowen.

[Aaron MacNeil, analyst]

As it relates to the $50 million in incremental IFM revenues, can you just give us a sense of what your margin expectations are for that work? I assume it's incremental to your current margins, but maybe you could just give us a flavor for that.

[Mark Becker, executive]

Good question. That work, we had a really good season this year related to post-secondary education services. That season is, typically, changeovers in those contracts happens in the spring, and we did very, very well on that front. It's a fair chunk of that $50 million that's going to come onstream in the fall.As well, we're getting good traction in our hotel and rail sectors as well, services sectors as well, which has also got similar timing. All of that, IFM broadly, we are targeting kind of that 7% or higher EBITDA margin for that business, and anything that we bring on is kind of measured against that benchmark and higher. Obviously, there's a mix of business. Some integrated IFM business is higher, call it 10% EBITDA margins, some of it's lower. But generally, we want to have everything kind of 7% and more as we work towards that target overall for that business.

[Aaron MacNeil, analyst]

Switching gears to the modular business, can you walk us through Canada's different affordable housing initiatives, the status of government funding tranches, and what we need to see happen to see an uptick in bookings related to that end market?

[Mark Becker, executive]

Yes. Pretty much everything is under the Rapid Housing Initiative now, which has had several tranches of funding. The latest tranche of funding is active this year. So proposals went in. $2.5 billion is the latest tranche of funding for affordable housing. Proposals went in from municipalities, agencies, areas that are proposing, even First Nation communities where we're seeing proposals going in for affordable housing. All those proposals went in in the spring, and awards are just kind of underway right now.So through the summer, those proponents who are putting in affordable housing are receiving kind of funding decisions from RHI and through CMHC, is how it's done, this summer. So we're seeing that real time happening right now as that funding comes across. I would say, Aaron, generally speaking, and we hear this kind of at all levels, we hear this at the federal level, we hear this at the provincial level, even the municipal level; that none of those groups are happy with the amount of affordable housing that's getting done, and I'm sure you can see that in the media. So there's a lot of energy to get that fund, get those projects live, get those projects awarded, get those beds built. And of course, there's always steps to that, the funding thing that we're in now, the funding processes that we're in now. And then once things get awarded, there's the design phase as well as the permitting phase and public consultation in some situations with some municipalities. But we are expecting in the back half of the year to see quite a few awards in that social affordable housing space.

[Operator]

The next question comes from Zachary Evershed with National Bank Financial.

[Zachary Evershed, analyst]

So just following up on Aaron's question on the timing of some RHI funding; previously, I think you guys have discussed a bit of a dip in Q3 as there was an air pocket in the backlog. But some of the commentary in the prepared remarks indicated that we should actually see a bit more of a steady pace in modular. Could you confirm that that is the case, that we'll see roughly equivalent quarter-over-quarter revenues and margin in the segment?

[Mark Becker, executive]

Yes. Revenues, we expect to be very similar to what we've seen so far this year. And a lot of that is just through the current process that we have, like the current projects that we have going through, having another strong year in educational portables and industrial units in Central Canada, and also the social affordable housing projects that we have ongoing from a revenue perspective.Manufacturing, we've trimmed back our trade labor levels, which we normally do when we see lumpiness in these projects in terms of manufacturing versus field construction. But as I mentioned to Aaron, awards around social affordable housing are kind of real-time. They're not going to come all within 1 week or 1 2-week span. We'll see it over a course of the next few months. And then, as those projects come to bear through the balance of the year, we'll start going towards rebuilding our backlog. And it's not just affordable housing, as well. We've got sales efforts on kind of a wide range of areas, including student housing as well as senior housing that we're waiting on. We're actually seeing a pretty good diversification of projects. It's just a matter of bringing those to bear and getting the awards across the line.

[Zachary Evershed, analyst]

And then for my second one, how much more portfolio rationalization is left to be done at IFM?

[Mark Becker, executive]

Not a lot. I think that $10 million to $15 million, Zach, we're talking about is kind of for the year. And this year is kind of how we estimate, there's stuff that's in flight. We'll always take a look at kind of the low end, or the low end of our profitability of our contracts. But we're working our way through it.I think one of the big positives for us in IFM is the strong sales, which is kind of giving us the room, to be honest, to kind of rationalize some of the other contracts and still continue to grow the business. So we're going to work through to get there. I mean, our target for next year is that 7% target. Now we got to manage inflation and price increases related to that, but that is our target for 2024 to be at that 7% level.

[Operator]

[Operator Instructions] The next question comes from Trevor Reynolds with Acumen Capital.

[Trevor Reynolds, analyst]

Just on the contracts that were rationalized, is there competition that was undercutting you, or what were the negotiations like on those contracts?

[Mark Becker, executive]

Yes. Good question, Trevor. The pandemic is kind of in our rearview mirror, thank goodness for all of us. But things have changed in some of our scopes in the field, and profitability that maybe was in a certain position has changed, and the scopes of work are being changed by the clients. So in those situations, obviously, we try to work with clients to adjust those scopes so they're kind of a profitable kind of net add to us. That's possible in some situations, some situations, it's not. A majority of situations, it is possible, and we are kind of reconfiguring contracts to more meet our targets.And as well, we're really not losing things to competitors. It's more just kind of as we're reconfiguring contracts and as they currently exist. And again, in most cases, we're able to get those in a place. And even it's very much in tandem with inflation effects, as well. We have constant ongoing conversations with clients around inflation effects. Contracts have inflation terms but doesn't always cover everything, and everything at the magnitude that we've seen. So it all kind of ties together. But any of these contracts that are, I guess, structurally marginal, if I could say it that way, again, we're looking to re-scope those or we are looking to exit those with those clients. And we look to exit those professionally.

[Trevor Reynolds, analyst]

Just on the free cash flow conversion, obviously lagging year-to-date. Just maybe what has to change to get that to the levels that you guys are targeting?

[R. Knight, executive]

Yes. Good question, Trevor. I think the business, as we've said in our materials, the business naturally provides 40% to 50% conversion of EBITDA. We just had a couple of one-timers in the first half here that, one, we did replenish some matting CapEx. We did some CapEx in matting related to a couple of specific contract opportunities.And then also, with the growth in the business last year, we looked at fixing our vendor relations and payment terms. And so we did a 2x injection of capital to fix our working capital. There was a first tranche in June, and there'll be another tranche in July that already happened. So those are kind of one-timers. And other than those things, the business naturally provides greater than 40% and closer to 50% free cash flow conversion.

[Operator]

The next question comes from Sean Jack with Raymond James.

[Sean Jack, analyst]

Just wanted to know, do you see any opportunities to win more recurring work in the wildfire space stemming from this large surge in wildfire demand?

[Mark Becker, executive]

Wildfire in any given year can be everything from 0 to very, very significant as we saw this year, Sean. So, I mean, obviously depends on weather conditions regionally, and this year we saw dry conditions and high wildfires really across the country this year.One thing I would say to you, Sean, is we are continuing to look at that business and how we can support it better. Some of the equipment that we do have in our inventory that we use for support we also cater and operate fixed fire-based camps in Alberta. We're constantly looking at that and adjacencies related to that so that, again, we can make a contribution to that business segment as best as we can when we do have strong fire years. So the big driver is really environmental conditions. But Jeff Litchfield, our Business Unit President, myself and others, we're kind of just looking at how we can build adjacencies and how we can even better serve that market when there is activity related to wildfires.

[Sean Jack, analyst]

And then the last one, kind of more of a conceptual one. Kind of talked about in the remarks a little bit about M&A. I was wondering, just honestly for everyone else's understanding, could you describe kind of potential ideal candidates for the business right now of what M&A would look like, or what type of capital you guys would like to deploy?

[Mark Becker, executive]

Yes. Good question, Sean. And really for us, and I think we've been consistent with this message, we see the growth opportunity, market opportunity around the IFM space. So for us, it's really a focus on finding the right opportunities that will support that growth strategy.Very active work for us at this time. And I would say kind of our, I guess, list of criteria that we would say is what we would use on our screen for acquisition targets is really related to expanding our scope of scale in IFM, and I would say scope and scale and maybe even geography, to a degree. We are looking at U.S.-based opportunities. A significant IFM business platform for growth, one that is going to not only be an accretive acquisition, but something we can build off of, as well. Some of these acquisition targets in IFM, there's technology solutions that are interesting to us that could expand what we currently have around IFM technology. People and talent is an important piece, as well as a complementary culture that would be a good fit for us. So that's kind of the criteria. The other very important thing I would mention is we do view acquisitions around the investment related to that acquisition on a reasonably conservative basis. We want to maintain our kind of debt ratios at 2.5x or less, say, and kind of declining quickly. So as we look at sizes of opportunities related to our debt capacity and kind of our leverage targets, that's kind of how we measure it.

[Operator]

The next question comes from Kirk Wilson with Beacon Securities.

[Kirk Wilson, analyst]

Most of my questions, I guess, have been answered. I wondered if you can walk us through the outlook for the Crossroads Lodge and maybe the impact from the labor issues out there with LNG Canada, and then look at the occupancy here in the back half of the year as it relates to margins from that business.

[Mark Becker, executive]

Yes. Good questions, Kirk. Kitimat Crossroads Lodge is pretty full right now. The LNG Canada project is kind of getting into that completion phase this year and next year, and we've got a lot of occupancy in Crossroads right now. And you're alluding to kind of some of the some of the media coverage around some of the union action or union agreements, if I could say it that way, related to the Cedar Valley Lodge, which is the actual lodge on-site at LNG Canada, as well as our Crossroads Lodge. The Cedar Valley Lodge, and I have to give my timing straight here, but I think 3 weeks ago or whatever closed their agreement. We're very close to closing our agreement with the [United Care] Union on Kitimat Crossroads. So we don't anticipate any disruption related to those agreements kind of no different than we saw with Cedar Valley Lodge.

[Operator]

The next question comes from Zachary Evershed with National Bank Financial.

[Zachary Evershed, analyst]

Just one last one. If we look at the balance of share repurchases versus M&A opportunities, how are the economics shaking out? Is it still looking a lot more attractive on the NCIB versus seller expectations on multiples?

[R. Knight, executive]

Yes. I think, Zack, we'll continue to be opportunistic. Today's pricing level, it's a good buying opportunity, but certainly we're looking to deploy capital for acquisitions. So we'll keep our eye on the ball there.

[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.