Dexterra Group Inc

TSX:DXT

Earnings Call Transcript 2022-Q4

[Operator]

Welcome to Dexterra Group's Fourth Quarter 2022 Results Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. [Operator Instruction]

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

[Drew Knight, CFO]

Thank you, Carl, and good afternoon. 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; Mark Becker, our incoming 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 5:15 Eastern Time.

We will be commenting on our Q4 2022 results with the assumption that you have read the Q4 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.

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 in there 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.

[William McFarland, Independent Chair]

Thank you, Drew, and welcome. The overall Q4 and 2022 year-end results were below expectations as we dealt with one-time nonrecurring items and cost pressures in the Modular business relating to a series of 2021 fixed price contracts, primarily in the BC social affordable housing space. We also experienced a slower start and post-COVID world to the Dana business, which we recently acquired in January 2022. Management will discuss these items in more detail on the call.

On a positive note, our WAFES business had a great Q4 and year. The IFM business is also well-positioned for strong profitability starting in Q1 2023 and the Modular business 4 point plan is being executed.

Dexterra enters 2023 solidly financed. With a strong management team and is very focused on improving profitability. Our long-term goals continue to be develop profitable sustainable business that delivers above average returns to shareholders, coupled with being an organization that all stakeholders are proud of.

It is my pleasure today to welcome Mark Becker, our new CEO, effective May 1, 2023 to this call. And I also want to give a big thanks to John MacCuish for all his efforts, insights and support over the past several years. John has been instrumental in building our Dexterra platform, which will lead to future success.

And before I pass it over to John, let me reinforce the management team and board of Dexterra enters 2023 with optimism. About the future and its excited about the prospects of the company. John, over to you?

[John MacCuish, CEO]

Thank you, Bill. Our revenue was $971 million in 2022 and $243 million in Q increases of 32% and 26%, respectively compared to 2021. All three business units experienced healthy revenue growth. Adjusted EBITDA was challenged at $64.7 million for 2022 and $14 million in Q4.

Lower EBITDA was primarily due to fixed price contracts in the Modular social affordable housing business. The cost inflation impacted our results. We are proactively managing inflation across the business, including reviewing and in acting, caused escalation clauses and client contracts. We are implementing strategic sourcing initiatives across all commodities and subcontractors. Addressing food inflation and managing labor hours to drive greater productivity.

I will now go into additional details by business unit. Starting with IFM, just business unit. Increased annual revenue by 80%,. To $279 million for 2022. For Q4, revenue doubled to $78 million compared to 2021. This increase was largely driven by the 2022 acquisitions, which contributed revenue of $108 million for 2022 and $33 million for -- in Q4.

Excluding the acquisitions organic growth was 10% for 2022 and 16 % for Q4. We continue to see good organic growth and new wins in 2023. Adjusted EBITDA of $13.5 million for 2022 and $2.7 million in Q4 with about $2 million or 17% on a full year basis. After adjusting for '20, '21 queues of $1.7 million.

Our 2022 profit was impacted by negative margins and Dana due to the reopening of its services, including startup costs. We are confident that Dana business will have good margins starting in Q1 2023. And with a base of business of over $80 million annually this will have a big impact on our 2023 profitability.

Excluding the impact of loss contracts and Dana, adjusted EBITDA margins in Q4 2022 were approximately 6%. The majority of our IFM contracts include inflation provisions. However, there is a lag before these costs are passed on to clients, which would -- which reduced margins somewhere in the neighborhood of 100 basis points in 2022.

On December 2, 2022, we signed an agreement to acquire all outstanding shares of VCI Controls. I'm pleased to say that that acquisition closed on January the 31, 2023. VCI has capability to our service offerings, including building automation controls and energy efficiency solutions. These skills bolster our ability to help clients address emerging healthy building requirements and net zero carbon building performance.

Moving over to WAFES, this business unit increased annual revenue by 24%, demonstrating the strength of our brand and strong market position. For Q4, revenue grew 10% year-over-year in our slowest quarter. These increases are attributed to growth in camp catering, install activities and higher occupancy levels. Our WAFES business is very strong and continues to renew contracts, win new work and grow market share.

An important component of WAFES is energy services, which increased revenue significantly in 2022. Energy Services results are a product of very strong demand for access matting and space rentals in the natural resource sector. The WAFES strong revenue translated to record EBITDA that more than compensated for the $6.6 million in Q's funding received in 2021.

Our adjusted EBITDA as a percentage of revenue of 15% was lower than in 2021. This reflected both the mix of business and the impact of inflation. Q4 included retroactive price increases of $2.8 million. The Modular Solutions business grew 2022 revenues by 10%. Profitability was impacted by cost inflation as discussed earlier.

Total cost impacts amounted to about $20 million on contracts with revenue about $150 million, of which about $65 million was recorded in 2022. The additional revenue will be recorded in 2023 as the projects are completed. These 2023 projects will have a nominal EBITDA as the estimated losses have been recorded in 2022, including a special $8 million cost in Q4.

We are focused on executing our 4-point business improvement plan. This plan is: a, improve our project management practices and process. Fee pricing validity mechanisms in new -- all new contracts. Three, implement strategic supply chain management issues for lumber and other commodities. And finally to continue to diversify the project pipeline.

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

[Drew Knight, CFO]

Thank you, John. I'll speak about nonrecurring items on Slide 10. Corporate costs included $12.1 million of non-recurring costs. The largest item relates to pre-merger commercial disputes of $6.9 million, which are now substantially complete.

And in Q4, we also provided for future losses on an onerous IFM contract, system implementation and integration costs and severance as we right sized our talent pool. Normalized SG&A costs were $38.2 million or 4% of revenue for 2022, which is down from 5% for 2021 due to the increased scale of the business.

Looking at Slide 11, the corporation's financial position and liquidity remain strong with debt at $94 million, $95 million of unused capacity on our credit lines at the end of 2022. Debt levels are expected to be further reduced in upcoming quarters in the absence of acquisitions.

We are in a strong financial position and expect to renew our debt facility in the next 6 months. The interest costs on our debt has been impacted by the increases in the Bank of Canada rate in 2022. The interest rate in Q4 was approximately 7.6%.

Free cash flow was $40.9 million in 2022 and is expected to approximate 50% of EBITDA in future periods. We think this is a key market leading KPI. Dexterra declared a dividend for the first quarter of 2023 of $0.0875 per share payable to shareholders of record at the close of business on March 31, 2023, which will be paid on April 17, 2023.

I will now turn it over to Mark for closing comments.

[Mark Becker, Incoming CEO]

Great. Thanks, Drew and glad to be part of the call and excited to be about my new opportunity at Dexterra. I'll be speaking to some of the points on Slide 13. In my role as COO, I gained a strong understanding of our business, our clients and our markets. We bolstered the organization in 2022 with three strong business unit presence. My focus -- the focus of my team over the next couple of quarters first and foremost, is execution and profitability.

I'm confident we have strong plans in place to achieve this result. In IFM, we are addressing specific accounts with lower margins to address inflationary challenges. In the Dana business we right sized the organization and adjusted product pricing, while maintaining the quality expected from our Dana brand.

Also in Dana, we had some pre-COVID contracts that had to be renegotiated or terminated, as in the post-pandemic world the dynamics around workforces and offices related to hybrid work environment, retail hospitals changed substantially. These have all been addressed.

Additionally, there were restart large contracts requiring new staff as many people had found jobs during the pandemic elsewhere during the pandemic. And there was also inflation costs to be dealt with. And 2023 we're doubling down on our sales efforts and Dana around key geographies, market verticals and cross selling opportunities, with good early wins and results in 2023.

Collectively, this will all add all lead to greater profitability and IFM in 2023. A key metric for Modular Solutions is the backlog of projects. We're closely monitoring the timing of new affordable housing and other projects expected to come to market in mid 2023. Relative to our available planning capacity.

U.S housing sector has also experienced some slowdown, given higher interest rates. We're confident that the social affordable housing market will broadly remain strong with access to government funding and we're seeing ample signs of that. A key focus for us will be to build the backlog as we continue to look to diversify our product lines.

In WAFES, with our strong brand and delivery capabilities, we're continuing to take advantage of the market conditions around the energy and mining segments to maximize not only our current revenue returns, but also our sales pipeline. No different than the other business units inflation management is key. And the loss team is taking a proactive and rigorous approach to continuous support our strong margins.

And lastly, we're continuing with our M&A program in 202, and hope to close some accretive acquisitions in the back half of the year. Big picture our company is undervalued in the market and we believe as we execute significantly improve our profitability and grow especially in the IFM space that the market will recognize our value over time.

I'm confident and energized about our plans and excited to be as the new CEO of Dexterra and the future ahead. This concludes our prepared remarks and I'll turn the back -- call back to Carl for the Q&A portion.

[Operator]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Chris Murray of ATB Capital Markets. Please go ahead.

[Chris Murray, ATB Capital Markets]

Yes, thanks, folks. Good afternoon. So first, John, offered my congratulations in your retirement, really appreciate all the help you've given us over the years. I guess first question is on the $8 million write-down in Modular. Can you help us understand at what point should the projects [indiscernible] into that write down actually be completed? And how do we think about margin profile on a go-forward basis past that?

[John MacCuish, CEO]

Yes, Thanks, Chris. Good question. We took the provision at the end of 2022 to reflect some of the losses that we've seen on those projects. And what that really manifests is, nominalized margins that we'll see on these projects as we complete them through the year. And the -- we know, we've seen, the market survey has seen a 20% increase kind of year-over-year in inflation costs and residential building. But we've tried to reflect that in our projects. And we think we've covered it, but it really manifests in terms of kind of nominalized margins through 2023. And we will be completing these projects for the balance of the year. So our kind of our new contract provisions, our new approach to execution on projects takes place on new projects, that will be transitioning through 2023. But we do expect to complete all these projects that we're talking about before the end of the year.

[Chris Murray, ATB Capital Markets]

Okay. That's awful. And then you've historically talked about kind of a, call it a high single-digit type EBITDA margin. Is that still sort of the expectation as we exit '23 and into '24?

[John MacCuish, CEO]

Yes, I mean, some of it is related to the inflation that we will see going forward and the inflation effects that we see. And we do see a bit of a delay on contracts and projects, specifically around Modular. We've been at that 6% level in the past. There'll be seeking to get back to that, and we will be seeking to execute kind of our new tranche of projects at that level. So that's the level we would be seeking to get to and hopefully, beyond.

[Chris Murray, ATB Capital Markets]

Okay. And that’s helpful. And then just kind of move on -- a couple quick clarifications, guys. The new acquisition, and maybe I'm just trying to understand who did the acquisition of the business for IFM. But then you kind of had to take some immediate charges around restructuring. Could you just maybe explain that one a little bit better. I was just going through the MD&A and talking about [indiscernible].

Market again, Chris, and the provision that we thought was really related to the systems integration with CCI, as we integrated into our business. Really related to tracking available on hours materials and subcontractors. So it's related to the acquisition of that element of the business, we bought it from -- into our systems. So that's a one-time cost that we Incorporated, and it will help us kind of execute VCI part of our Dexterra on demand business going forward.

[John MacCuish, CEO]

Okay. And then and I think if you're, it's John, if you're referring to Dana, I just want to point out that, only 50% of their projects were active. And so that was just the realization of bringing those back online and fully implementing them as we move forward after COVID. No, it's awful. Thank you. And then, Drew, just one clarification. You'd mentioned the charge was due to pre-acquisition contracts. I'm assuming you're making -- you’re implying pre-acquisition with horizon north so like these are from a couple of years ago. This wasn't due to gain or anything that's happened recently.

[Chris Murray, ATB Capital Markets]

That's correct. Okay, thanks.

[John MacCuish, CEO]

No problem. The next question.

[Operator]

Certainly, sir. The next question comes from Michael Doumet of Scotiabank. Please go ahead.

[Michael Doumet, Scotiabank]

Hey, good afternoon, guys. Chris -- congratulate to John. Congratulate Mark on the upcoming role. Maybe, Mark, first question for you. I think your last slide to address some of it, but I wanted to ask what you thought were some of the largest opportunities or best opportunities for Dexterra. And primarily from a capital market standpoint, how would you like for investors to regard Dexterra in the next couple of years?

[Mark Becker, Incoming CEO]

That's a good question, Michael. And I would say, from my perspective we are a growth story, and we are looking to continue to grow in IFM. And as we -- as I mentioned, our focus this year is really around profitability and execution. And as we do that, we are continuing our merger acquisition program, where we are looking at targets, looking at opportunities that will be accretive to the business. And with good luck here, around how we execute in 2023, we're hopefully -- hopeful to bring some additional accretive deals to the table that will help us grow. And specifically, again, around the IFM side of things.

[Michael Doumet, Scotiabank]

Okay, perfect. That's helpful. And then the second question I have is on [indiscernible] Modular Solutions. I think we all appreciate how the end market and the growth prospects are really compelling. But you've dealt with many challenges, and there's also been disappointing. So I'm wondering, this is, like an industry issue, and whether you think maybe the industry needs to get a little bit smarter in terms of how it quotes and how it protects margins. In your opinion whether there's still a lot of work to do in terms of understanding how to get this business, any industry to something that's a little bit more profitable and high return.

[Mark Becker, Incoming CEO]

Yes, when you say industry, Michael, I treat that as kind of a construction industry, because I think, doesn't matter in this environment, whether you've been in Modular and or, any other kind of construction, it's been challenging. John talked about kind of what we call our 4-point plan related to kind of improving our execution. And this things we're putting in place now, and others are in the industry as well. So we're not unique in that regard. But related specifically around some of the commercial mechanisms in the contracts, related to pricing validity. Like, as an example, some of our affordable housing projects or clients are getting 30-day validity on their pricing for their projects, meaning the pricing that we charge them for the turnkey project is really only valid for 30 days related to subcontract costs, material costs underneath that. Our clients don't love that, but it's the reality of today that we see in this inflationary environment. And actually, to be honest, they're reacting quite well and moving their project approvals along. So I think that focus on the commercial side with the contracts is one of the key things that will get us into profitable mode, and really the other things related to execution around project management. And additionally, some of the supply chain things that we're working on both around securing material prices, bulk purchases, which helps us related to that, Michael.

[Michael Doumet, Scotiabank]

That's good to hear. And maybe just one sneaky -- just try to sneak one in here for a third. Just how certain are you that the $8 million provisional [indiscernible]?

[Drew Knight, CFO]

We're trying to get that number, right. We don't want to overshoot and we don't want to undershoot. But as we see the end horizon, if I could say it that way, Michael, around these projects, we're kind of seeing the end of the tunnel or the finish line on these projects, and really trying to set that right. Because even just from an accounting perspective, and just the financial perspective, we do want to kind of get that good balance related to what we think we need to complete those projects.

[Operator]

[Operator Instructions] The next question comes from Zachary Evershed of National Bank Financial. Please go ahead.

[Zachary Evershed, National Bank Financial]

Good afternoon, everyone. Thanks for taking my questions.

[John MacCuish, CEO]

Hey, Zach.

[Zachary Evershed, National Bank Financial]

Could you get deeper into what's not working with Dana. Now that schools back in session and the compression and the expected annual run rate revenues, just some more color around that please.

[Mark Becker, Incoming CEO]

Yes, Zack, it's Mark. And we're actually seeing better results at Dana at this point, since the beginning of the year. And I think as you alluded to, it's our peak season related to Dana, related to the educational environment as [technical difficulty] leisure, ski hill side of things. But some of the things I mentioned related to some of the contract remediation, if I could say it that way, on Dana, as well as getting some of these new projects ramped back up again. We are delivering better results from Dana and we're seeing that kind of real time as we go along this year.

[Zachary Evershed, National Bank Financial]

Thanks for that. And then the Modular backlog declining quarter-over-quarter by more than the revenue booked in Q4, could you dive into details there? And do you think that the $40 million in annualized revenues recurring? Do you think that's at risk?

[Drew Knight, CFO]

Yes, I mean, we have seen the backlog drop to some degree, and some of that Zach is, is just working those projects through the plant and through construction execution in the field. We continue to see a lot of inertia around, particularly around affordable housing projects and funding. We do hear from some of the major municipalities and constituents that they're not -- their budgets are not shrinking, they're not staying the same. They're actually growing in terms of the projects that they're trying to bring to bear and affordable housing, that trend to bring to bear it really boils down to a question of a question of timing related to when those things are coming to bear. And in fact, what our clients are actually making sure they're very well aware of where we are in terms of our plant capacity and as our project management related capacity. So it's kind of an ongoing conversation, but we certainly see a lot of projects coming forward. And we expect that backlog to increase. One thing we are seeing those, Zach, I mentioned is around school portables. That’s a very strong business for us. And we are seeing quite an increase in school portables that are coming to market and that we're manufacturing and selling.

[Operator]

The next question comes from Frederic Bastien of Raymond James. Please go ahead.

[Frederic Bastien, Raymond James]

Good afternoon. There was a little to no commentary made on TRICOM. Can you provide an update on how that business is going? And how is it meeting your expectations for growth?

[Mark Becker, Incoming CEO]

Yes, thanks, Frederic. Mark, again. We're actually very pleased with TRICOM and what we call our HRL business unit, which is hospitality, rail and leisure. And a lot of the activity both in Canada, central Canada, Western Canada, and now into the U.S., Washington State, Arizona, Texas, I would say one of the strengths we're seeing with that business is the sales profile that they're bringing to bear. And really bringing on new contracts as we -- as they -- as we saw them doing when they were an independent company before we acquired their assets. They're continuing to do that. And I would say by looking at our sales pipeline, and our sales profile that we're bringing to bear and bringing to bring into the P&L is actually kind of one of our strongest elements that we do have across our portfolio. The leaders that we've got running that are continuing to kind of impress us with their what they're able to bring to the table. So we're actually quite happy with the [indiscernible].

[Frederic Bastien, Raymond James]

Okay. Thanks for that. Just want to move to your -- the smaller acquisition you completed just before the year-end VCI Controls. We haven't had the opportunity to talk with you since, can you provide a little bit of background on our business and what it will bring to Dexterra?

[Mark Becker, Incoming CEO]

Yes, VCI is really, really a kind of a building envelope controls, kind of solution and organization that's kind of got a well established kind of capability and business around HVAC, energy and management systems. And it's really complimentary to we've got it kind of connected directly up to our Dexterra on demand business because a lot of it is related to mobile field work and direct field work to contractors, but Harvey declines, but we're really leveraging that element across all of our business lines in IFM, and our business elements in IFM. And I think, you've heard from us before, that really the integrated side, I guess, of integrated facility management, the more complex side, the more building energy systems, building envelope work, this is actually bringing a set of capability, some people with expertise, that is really helping us to leverage that across our portfolio and really, really ties into the kind of the healthy buildings situation that we see a lot of interest from clients. And we are able to bring that to bear with the VCI solution and people that we do have and ties in as well to kind of the little carbon environment. All of our clients, particularly around buildings and facilities are, as everyone is, measuring carbon, measuring carbon reduction and part of how you do that is actually with energy systems and HVAC systems. So, we're really looking to take what's I guess I'll characterize as a smaller acquisition and really leverage that broadly across Dexterra IFM, as it relates to the capability that we bring.

[Operator]

The next question comes from Trevor Reynolds of Acumen Capital. Please go ahead.

[Trevor Reynolds, Acumen Capital]

Hey, guys. I'm just wondering, you guys discuss the lag and cost pass through in IFM. I'm just wondering, when most of those took effect, like, should we be expecting a clean Q1 on that front?

A - Mark Becker

That's good question, Trevor. And we are still seeing inflation continuing on here. Albeit things have abated a little. We are still seeing it. And so you know, of all the things that we're working on here, and we work on tactically related to profitability improvement, that's almost the number one thing that we're working on, and it's across our contracts, or contracts vary in terms of the provisions, most haven't. Provisions related to either -- connections to [indiscernible] or connections to repricing on contracts. But for us, it doesn't matter. And it's across all of our business units. We're taking a very proactive and a very active approach with our clients, related to bringing to them pricing increases, pricing changes, adjustments to contracts, related to inflation. And so, really, that's got to continue. And, if you take out, certainly the IFM side, we've got kind of a 6% margin less Dana. We're looking to build from that. But that's really going to be dependent on how quickly we can resolve and how fast we can stay ahead of that ball waiver related to inflation, and no different in losses? Well, albeit at a higher margin. There's a lot of effort going on related to that to address inflation, kind of across the portfolio contract by contract and client, but -- client by client. And I would say, our clients are listening, they -- they're aware, and they're seeing it from all their providers that inflation is a big deal. And I would say generally, we're finding good collaboration with them. It's a matter of just keeping the effort moving and getting through it. And at the end of the day, we can't really predict inflation. But our point and our effort is really to stay ahead of that with our clients. And as we stay ahead of that, it's our mechanism related to maintaining our margins.

[Trevor Reynolds, Acumen Capital]

That's helpful. Thanks. Like on and then I guess, just the follow-up, like, are you looking at all on new contracts that you're putting out like, is there ways to decrease that lag time in terms of the inflationary pass through?

[Mark Becker, Incoming CEO]

Yes, that's a good point. And definitely in all our contracts, and this wouldn't be unique to us or anyone, everyone else is really sharpening what they're putting into their commercial agreements in their contracts related to inflation. And to be honest, clients are expecting that and they're dealing with that because we went for so many years with very flat inflation environment where you always wanted inflation indexing, because some of these contracts are very long cycle and you have to have an inflation index, but just the level of acuity, the level of profile related to inflation, it's a much more significant part of all our contracts that we are putting in place.

[Operator]

Thank you. 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.