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News Release |
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Annual Meeting Remarks by Chairman and President
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Annual Meeting of Shareholders |
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Remarks by John M. Beck, Chairman and CEO and Scott C. Balfour, President and CFO (Check against delivery) John Beck Good morning. I am pleased to have this opportunity, along with our President and CFO, Scott Balfour, to speak to you about Aecon's performance in 2006 and what we see as we look toward Aecon's future. Much of what we will share with you in the next few minutes can be summed up in two words – “Aecon Works”. In terms of our strategy to deliver improved financial performance for our shareholders – Aecon works. In terms of our chosen markets – whether it's infrastructure in Ontario, oilsands development in Alberta or our airport concession in Ecuador – Aecon works. In terms of our commitment to quality, safety and reliability in completing the work we do for our clients – Aecon works. But it is our people, more than any other facet of Aecon, who convey this idea best of all. When I see their willingness to develop new ideas and to expand and share their knowledge – when I see the attention to detail in the work that they do every day– when I look in their eyes and see the pride they take in what they are doing – I know that Aecon works. Scott Balfour Last year at this meeting we took a very bold step. Based on our assessment of the markets, and our ability to respond to market opportunities, John and I stood before you and said that our plan was to deliver earnings of 75 cents per share in 2008. I recall that after that meeting there were a number of people who, while applauding our optimism, thought the target was a bit aggressive. Some scepticism was understandable given the challenges that we had experienced in prior years . . . but what had become apparent to senior management and our Board was that two factors – one internal and one external – were coming together to mark the beginning of a period of improved financial performance for Aecon. The first factor is our strategic focus. Throughout 2005 we had methodically reviewed every facet of our business to find out what was working, and what wasn't. Later that year and into 2006 we initiated a number of changes that impacted our structure, personnel, incentives, business planning and reporting procedures. And we embedded these changes in a new strategic plan that we've been using to guide all of our decisions since that time. John Beck There are four elements that define this new strategic focus: 1. Invest in our people 2. Focus on our core strengths 3. Build stickiness with our clients 4. Focus on profitability - drive margins and “think lean” In addition to our strategic focus, the other factor that makes Aecon work is the growth dynamic in each of our core markets. Aecon is well positioned in key segments in two of the highest growth regions of Canada – Ontario and Alberta. In 2006, these two provinces accounted for almost 80 percent of our revenue. Within these regions, we are well positioned in the segments of the construction market that are in strong and sustainable growth cycles:
and
To really understand what makes Aecon work, it's important to understand both our internal strategy and our external markets – so we plan to focus most of our remarks this morning on these two areas. Scott Balfour But first, we'd like to frame our remarks in the context of our 2006 financial performance. Fiscal 2006 marked what we believe is the beginning of a sustainable period of improved financial performance for Aecon. Last year, Aecon reported earnings per share of 31 cents on revenue of $1.1 billion . . . versus a loss of 4 cents per share on virtually the same top line in the prior year. And, while new bookings increased by 17 percent to $1.3 billion, the real story of 2006 is the margins generated. Gross margins improved year over year by 44 percent to $96 million . . . a major factor in operating profit nearly tripling to $20 million in 2006. And backlog, an indicator of future performance, grew by 36 percent to $786 million. Importantly, this improved performance continued into the traditionally weak first quarter, when Aecon reported a threefold increase in gross margins, to end the quarter with a net loss of just $3 million – versus a net loss of $10.9 million for the same period last year. This chart shows the history of Aecon's backlog revenue, quarter by quarter, over the last five years. You will note that, beginning in 2005, concurrent with the enactment of changes from our strategic review process, Aecon started to win more work and our backlog started to grow. John Beck But as we noted earlier, this is not a story about revenue growth – it's a story about margin growth. This line illustrates the margins contained within our backlog. It shows clearly that, while Aecon has been booking more work since 2005, the margins embedded in our backlog have grown even faster than our backlog revenue over that period. Backlog margins are now at their highest point since the beginning of the decade, having more than doubled in the last five quarters. Part of this improvement is the result of a change in revenue mix toward Civil and Industrial work, and away from traditionally lower-margin Buildings work. But it's also that market dynamics have shifted more of the pricing power to our side of the negotiating table – resulting in backlog margins that are even stronger than the margins we're earning on our current work. Scott Balfour With that financial performance as a backdrop, let's look more closely at how our strategic focus has helped to shape these results. There is one reason why investing in our people is at the top of our strategic plan – our people are a source of competitive advantage for Aecon. While having the right equipment is essential to making money in any segment of the construction business, without the right people to run that equipment or bid and manage the project – a grader or a back hoe is just a big piece of yellow iron that sits in the yard and costs you money. People enable the innovation and efficiency that ultimately leads to improved margins. At Aecon, we have a salaried work force of over 800 people – plus access to an army of hourly workers that number more than 3,000. Our professional staff includes engineers, project managers and accountants. And we have collective agreements in place with a dozen different unions covering workers in virtually every sector of the industry. This year, we will spend more than a million dollars on training and developing the skills of our people as part of our commitment to building and sustaining a learning culture at Aecon. And while we are strong advocates of investing in our people, we also encourage our people to invest in us. More than 20 percent of our salaried staff are shareholders in Aecon. John Beck To appreciate the importance of this strategic investment, it's important to stress that in many of our markets, skilled construction people – especially experienced engineers and construction managers – are in high demand and can command a premium price for their services. This is particularly true in some parts of Alberta. And, while we have our share of staffing challenges, the investment we're making in our people, the learning culture we're creating, and the ever increasing priority we're placing on ‘people issues' are building a distinct competitive advantage for Aecon. In fact, even through this year's hot market for construction services, our turnover rate among our salaried employees has actually dropped compared to last year. At Aecon, we don't speak about investing in people without emphasizing safety. We are very proud of Aecon's safety program – acknowledged across Canada as industry leading. As this graph illustrates, year after year, Aecon's safety program produces an injury rate significantly below others in the industry. But we're not about to rest on our laurels. We continue to strive toward our ‘zero injury' goal. And we continue to focus on our commitment: safety first – every day, everywhere. Scott Balfour The second element in our strategy is that we focus on our core strengths – and resist the temptation to chase every opportunity that presents itself. Inside Aecon we use a more colourful sports analogy to describe this. When we evaluate an opportunity, we ask ourselves if this particular pitch is squarely in our strike zone … or is it closer to the margins of our core capabilities where there is less certainty of making solid contact and earning a profit. And when we look at the size and risk profile of an opportunity, we remind ourselves that putting together a string of singles and doubles can move us further ahead, than trying to make the year's profit on one “home run” swing at a single big deal. An example of this strategy in action is the Calgary Ring Road – a project sponsored by the Government of Alberta. We elected not to pursue one of the huge EPC or P3 contracts the government was letting to manage this work. Instead, we opted to focus on winning sub-contracts that were a little smaller and squarely in our strike zone … the “golden crumbs” as we call them. John Beck As announced last week, we have now secured two significant bridge building sub-contracts on this project totalling over 30 million dollars – contracts with solid margins and a suitable risk profile. As one of the larger, more diversified suppliers of construction services, it might be natural to see us as a “Jack of all trades”. But we believe that being big without being strategic is a prescription for failure. That's why, in this time of tremendous growth in the Canadian market, we have focussed almost exclusively on Canada in our new project pursuits. Our international work today is limited to our two concession assets overseas and support for the strong Buildings team we have in the Seattle area. In short, we are careful about weighing the value of the prize against the cost of the chase and the risk profile of each project we pursue. This does not mean we won't look for opportunities to take on large projects – like our joint venture at the Bruce Nuclear plant in Ontario – but they need to be in areas where we have a high degree of certainty of a profitable outcome. To come back to the baseball analogy, it means we have the patience to wait for the right pitches. Scott Balfour Some of you may be familiar with the popular television program featuring the coffee drinking contractor, with the crew-cut and brown overalls, who says you're supposed to get three quotes for every home renovation job. But he also says you need to look at more than just price. Because, as he points out, all of the renovation nightmares that make it onto his program, were probably done by the guy with the lowest bid. As part of our strategic review process, we took a very hard look at what we do for our customers – not just what we are contracted to do, but what we actually do to make a difference in the outcomes that are important to them. What we are looking for in every one of our businesses is an opportunity to decommoditize what we do, so that price is not the only factor – or even the deciding factor – in winning a contract. We achieve customer stickiness by orienting ourselves to each client's specific priorities. This can include non-price factors like quality, safety, reporting systems, client access and control of work schedules, even staffing continuity. We've been doing this very successfully for several years in our utilities business where we work as the supplier-of-choice for a number of major utility companies, like Union Gas. John Beck Under these partnership arrangements, we work closely and transparently with our client – sometimes opening our books to them in exchange for designation as their exclusive contractor for a specified region. As a result, Aecon gets a predicable workflow of projects that would be uneconomical to bid on a one-off basis, and the client gets the certainty of a contractor who delivers reliable quality work at a fair price. And we have taken this idea of customer stickiness one step further by developing a customized “field operating software” – or FOS system – for our installers assigned to the Union Gas contract [SHOW FOS-PDA]. Our staff now uses FOS software on their PDAs to update their work and progress in real time – issuing a customized digital invoice on completion of each installation. This makes it more efficient for both Union Gas and Aecon to manage invoicing and financial reporting on small projects. And because these arrangements are embedded into both our systems and work processes, they provide increased value-added to our client … and they make it more difficult for a competitor to challenge our position by undercutting us by a point or two on price. In our Industrial segment, we know that some of our fabrication customers, who are contracting with us to fabricate specialty pipe for example, are really looking to us for reliability, quality and timeliness – regardless of the challenges we face in terms of tight labour markets or supplier constraints. In many cases, such as large refinery projects in the oilsands, our contracts are a small part of a huge project where there are serious economic consequences if things are not done right the first time – on time. In these cases, Aecon's proven track record of delivering reliability for our clients is gold. It doesn't make sense for these clients to try out a new contractor offering a small price advantage if there is any risk that they may not deliver timely quality on a critical path item. This does not mean that price isn't an important element in their choice of supplier – but it's not the only element. Scott Balfour The final strategic element focuses on finding ways to consistently improve our margins. This pursuit has led us along three vectors – improved efficiency, vertical integration and cross selling. The first place we looked for better margins was in our own backyard by finding ways to reduce risk and be more efficient at the work we do. One place, among many others, where we're reducing risk is ensuring that we take strategic advantage of the improved negotiating position we have in some markets. Today, in certain markets, conditions allow us to keep some margin-eroding risks – such as labour risk – on the client's side of the table. In these instances, we may end up with the same price at the top of the contract, but with much greater certainty that the margins at which we bid the job will match the margins we earn at the end of the project. Aecon's vertical integration has also contributed to our growing margins by improving our operating efficiency and by allowing us to capture margin on work that would otherwise have been earned by a sub-contractor. John Beck Perhaps the best example is the scope of work that we are capable of performing for the Ministry of Transportation of Ontario. On a given roadbuilding job in Ontario, we are able to earn margin on:
are often located under our roads, and
. . . all in addition to the paving and bridge building that is usually associated with our work. This vertical integration also allows us to earn margin on work that we don't win by supplying services and products like aggregates to those who do. Scott Balfour Cross selling from one division to another is a natural fit for a company with our diversity of services – and a natural way to maximize margins. One example is the situation faced by our Utilities customer, Union Gas, who needed to build a compressor station. Our Utilities group doesn't do this type of work, but our Industrial group does it every day. Because of our strong relationship, Union Gas knew Aecon's standard of quality, the high regard for safety and the fair pricing they could expect from Aecon. So … to make a long story short, our Industrial division got the compressor station job. Then, when Union Gas was looking to outsource the facilities management of their dozens of field offices, they turned to our Programs group, inside our Buildings division, who provide just these services to other clients with similar needs. The end result is that one strong relationship has spawned opportunities for two other divisions to add value to the same client. Taken together, as we push each one of these vectors out and find more opportunities for increased efficiency, vertical integration and cross selling, we expect to do an even better job of maximizing our margins. John Beck As we said earlier, good strategy is just one part of the equation that has contributed to Aecon's improved financial performance. The strong “super cycles” in those market segments where Aecon has traditionally been well-positioned … power generation, oilsands development, and civil construction – especially transportation infrastructure… they are the other part of the equation. And, emerging on Aecon's horizon – healthcare infrastructure. We see a number of factors contributing to sustain these market dynamics over the visible planning horizon… including what has become known as the ‘infrastructure deficit”. Like the fiscal deficit, the infrastructure deficit is a term that has moved from the lexicon of bureaucrats and policy makers to the consumers who experience this deficit every time they get in their car to travel to work; every time they open their hydro bill; and every time they sit in a hospital waiting room. When we look at Canada's transportation infrastructure, we see assets that are in the autumn of their years. Unfortunately these assets are not like fine wines (or CEOs) that improve with age. Scott Balfour According to Statistics Canada, the government owns engineered infrastructure assets (roads, bridges and sewer systems) that are worth an estimated $155 billion dollars. The average service life for roads and highways in this country is 28 years. By 2003, the average age of Canada's roads had reached 17 years – almost 60 percent of their useful life. And with an average age of 23 years, our bridges have reached half of their useful life. As this network of roads and bridges continues to age, it needs to be repaired and replaced. This factor alone is enough to create a demand boom in the coming years as we deal with historic underfunding of our transportation infrastructure. But there are other factors at work that are accelerating the ageing process. Increased urbanization and growing automobile usage will put even more cars and trucks over the same stretch of asphalt, making its useful life degrade even more rapidly. We've all experienced this whenever we're stuck on a highway like the Gardiner Expressway and the radio announcer gives us the comforting news that – “it's just volume of traffic causing the delay.” For Aecon, the upside is that we are getting our share of the contracts that are being let to bring Canada's infrastructure deficit back into balance. Last year we completed $240 million worth of contracts to build or rebuild Canada's ageing roads and bridges. Our backlog reported at the end of Q1 has another $240 million worth of work waiting to be built. Along the way, we have become the largest contractor to the Ministry of Transportation of Ontario, a position we intend to preserve. John Beck In Ontario, urbanization has combined with industrialization to create another deficit. This chart shows the gap that is developing between Ontario's consumption of electricity and our total installed generation capacity. The vulnerability of Canada's largest city to the loss of electricity was brought home in the summer of 2005 when the Toronto blackout left millions without power. This was not something that the people of “energy rich” Ontario ever expected to experience. And it set the stage for a surge in the public demand for increased generating capacity. Pushing back on the other side of the agenda is a growing level of public demand for the idea of sustainable development… to reduce, to conserve, and to “go green”. Both of these somewhat conflicting demands are real, and must be addressed. The conflict has been resolved in the short term by the Province's decision to carve out a portion of the missing power gap by building alternative generation, including gas fired co-generation plants. Nuclear power remains one-half of the long term solution. Aecon is one of Ontario's most experienced and respected constructors of power generating facilities. We have had a hand in building, expanding and maintaining virtually every form of power generating facility used in the Province – from the early hydro facilities to natural gas and cogeneration plants, to the Bruce Nuclear facility. Last year we completed $75 million worth of contracts to maintain or increase Ontario's power generating capacity, and our backlog reported at the end of Q1 has another $100 million worth of work scheduled for future periods. Scott Balfour Another area of growth that is coming onto our planning horizon is in the expansion and renewal of Canada's healthcare infrastructure. Canada's population is greying. Partly the result of the post-war baby boom, but also the result of improved life expectancy, the percentage of our total population represented by those over 65 has been steadily increasing for most of the last century. By 2011 – four years from now – almost 15 percent of our population will be over 65 and entering a period when they will start to become higher consumers of health care services. In Ontario, much of our health care infrastructure was built when doctors still made house calls. On average, the hospitals in this province are more than 40 years old. And the nature of the care they deliver has changed significantly, with an increasing number of services being delivered through hospitals on an outpatient basis. This means that much of this forty-year-old infrastructure needs to be replaced, reconfigured or upgraded to extend its useful life. And, while we don't dominate health care infrastructure construction in Ontario the way we do in road building, as existing construction capacity gets utilized, our Buildings Group is very well positioned to pick up work in this sector. John Beck There is a common theme running through each of the areas where we are seeing increased demand for construction services – they are all dependent on funding support from the taxpayer. Twenty years ago this would have been very bad news because in the eighties, Canada had a different kind of deficit – one that meant one third of every dollar of revenue raised by the federal government was spent on servicing the country's accumulated debt. In this constrained fiscal environment, the reality that eventually dawned on every political party was that new capital expenditures had to take a back seat to deficit reduction. Today, with debt service accounting for half as much of each federal revenue dollar as it did back then, there is a much higher degree of flexibility in how tax dollars are allocated. And a much higher degree of political commitment to addressing our infrastructure deficit. In fact, this political commitment was demonstrated on Friday with the province's multi-billion dollar announcement of new funding for transportation infrastructure in the GTA – including the expansion of current infrastructure and the construction of several new light rail transit lines. But fiscal capacity is not the only thing that has changed in the last twenty years to make public sector infrastructure contracting more appealing. Governments of every political stripe have realized that they do not need to directly finance, operate or even own these assets – giving rise to significant increases in the number of infrastructure projects being developed through public private partnerships or other forms of alternative financing arrangements. Scott Balfour The final market segment we want to discuss is oilsands development. Second only to the reserves in Saudi Arabia, the Alberta oilsands deposits are being developed through the combined efforts of the public and private sectors. From 1994 to 2003, approximately $30 billion was spent on the development of this resource, with a further $80 billion planned over the next 16 years. In 2005 alone, industry investment in the oilsands totalled approximately $10 billion. Aecon is playing a growing role in this development, primarily through our Industrial Group, which includes our fabrication and module assembly facilities located in Edmonton. Last year we completed $113 million worth of contracts to support the development of the oilsands. Our backlog reported at the end of Q1 includes $63 million worth of work scheduled for future periods, and that backlog is growing as evidenced by our more recent multi-million-dollar modular assembly contract from Shell Canada.
Each of these market segments – road and bridge building, power generation, healthcare infrastructure and oilsands development – is experiencing economic and demographic forces that are driving higher levels of capital investment. And, while we don't expect these “super cycles” to run uninterrupted for ever, we believe the underlying forces contributing to their strong growth are sustainable, and will be with us for some time. Taken together, we believe they offer very attractive market conditions for Aecon in our visible planning horizon. John Beck If the Aecon investment story was limited to the convergence of our core strengths intersecting with strong and sustainable markets, this would be enough of a compelling story for most growth oriented investors. But as all of you know, there is another chapter to the Aecon story that centres on the value embedded in our two concession assets – the Cross Israel Highway and the Quito International Airport. The Quito Airport is our latest concession asset. We own a 45 percent interest in a 35-year concession for the revenues that will be earned by the new airport as well as those earned from the existing airport while the new facility is under construction. The construction phase of the new airport, in which we hold a 50 percent interest, is valued at 410 million dollars and is progressing on schedule toward its planned completion in 2010. Unlike the Cross Israel Highway, the Quito Airport is not a Greenfield project in that there is an established traffic pattern from the existing airport on which to estimate the value of future cash flows from the concession on the new and larger airport. In 2006, 3.8 million passengers moved through the Quito airport, an increase of more than 15 percent from 2005. And in the first quarter of this year, the existing airport handled just under one million passengers, representing an increase of more than 10 percent from the same period last year. This investment, which we expect to provide an after tax IRR of more than 20 percent – over and above the construction profits that will be earned over the next four years – is an important part of Aecon's value story. Aecon also holds a 25 percent interest in the Derech Eretz consortium that owns the 30-year concession rights for the Cross Israel Highway. We began building the first section of the highway in 1999, finished it four years later, and are expecting to close shortly on a previously announced contract for a northern extension of the highway, known as “Section 18”. The book value of this asset is recorded on our balance sheet at 43 million dollars, but the full market value of this asset will be determined by what a third party will pay for the future cash flows from the toll concession. In March of this year, the average number of weekday trips on the highway had increased by almost 18 percent over the same period last year to over 86,000 cars per day. These results are in line with our expectations and support the third party analyst estimates of a market value for our interest in the concession of between 70 and 80 million dollars. We expect to see an initial monetization of our Cross Israel Highway investment shortly, when the Section 18 extension project achieves financial close. As part of the arrangements at financial close, Aecon will receive at least 10 million US dollars in cash from the consortium. Scott Balfour As John noted, the real test of the value of any asset is what someone will offer to pay for it in the open market. As the highway builds up a longer operating history, its traffic patterns become more certain, the risk to a purchaser is reduced, and the value range solidifies. All of this was part of our planning framework when we made the investment in this asset in 1999. What was not known at the time, however, was the almost insatiable appetite for this kind of investment that is now coming from large infrastructure funds. While it is too early to say if these investors will have interest in acquiring the concession assets in our portfolio, what is known is that their participation in the market is having a crowding effect on other investors like pension funds and life insurance companies that have been the traditional buyers of long-life assets. Ultimately, like any other market, more buyers is good news for the sellers. So, as compelling as our growth story is, investors should not lose sight of the potential appreciation in value that Aecon is building in these two international concessions. John Beck Strategically focused … seizing growth … driving value. This is what makes Aecon work. We achieved important milestones in 2006 and on behalf of all of the people at Aecon, I want to thank you, our investors, for your continued support. But I also want to echo something that I said at last year's annual meeting. While we have accomplished a lot in the last year, those of us who live and breathe Aecon every day believe that our best days are yet to come. The strategic focus that we use to guide our planning and decision-making is working well. The key market segments that we service are in strong growth cycles. The concession assets in which we are invested are growing in value. And the equity markets are beginning to share in our confidence that we are on track to achieve our target of 75 cents per share in earnings in 2008. Thank you for your attention. Scott and I would be pleased to answer any questions you may have. --30--
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