Quanta Services Inc (PWR) — Q2 2019 Earnings Call Transcript

Thank you, and welcome, everyone, to the Quanta Services Second Quarter 2019 Earnings Conference Call. This morning, we issued a press release announcing our second quarter results, which can be found in the Investors & Media section of our website at quantaservices.com, along with a summary of our 2019 outlook and commentary that we will discuss this morning. Please remember that information reported on this call speaks only as of today, August 1, 2019, and therefore, you're advised that any time-sensitive information may no longer be accurate as of any replay of this call. This call will include forward-looking statements intended to qualify under the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. These include all statements reflecting Quanta's expectations, intentions, assumptions or beliefs about future events or performance that do not solely relate to historical or current facts. Forward-looking statements involve certain risks, uncertainties and assumptions that are difficult to predict or beyond Quanta's control, and actual results may differ materially from those expressed or implied. For additional information concerning some of these risks, uncertainties and assumptions, please refer to the cautionary language included in today's press release, along with the company's 2018 annual report on Form 10-K and its other documents filed with the Securities and Exchange Commission, which are available on Quanta's or the SEC's website. You should not place undue reliance on forward-looking statements, and Quanta does not undertake any obligation to update such statements and disclaims any written or oral statements made by any third party regarding the subject matter of this call. Please also note that we will present certain historical and forecasted non-GAAP financial measures in today's call, including adjusted diluted EPS, backlog, EBITDA and free cash flow. Reconciliations of these measures to their most directly comparable GAAP financial measures are included in our earnings release. Lastly, if you would like to be notified when Quanta publishes news releases and other information, please sign up for e-mail alerts through the Investors & Media section of quantaservices.com. We also encourage investors and others interested in our company to follow Quanta IR and Quanta Services on social media channels listed on our website. With that, I would now like to turn the call over to Mr. Duke Austin, Quanta's President and CEO.

Thanks, Kip. Good morning, everyone, and welcome to the Quanta Services Second Quarter 2019 Earnings Conference Call. On the call, I will provide operational and strategic commentary before turning it over to Derrick Jensen, Quanta's Chief Financial Officer, who will provide a detailed review of our second quarter results. Following Derrick's comments, we welcome your questions. This morning, we reported record consolidated second quarter revenues, as well as our highest ever quarterly Electric Power segment revenue. Our record quarter backlog of $12.8 billion bodes well for our expectations this year and opportunity for multiyear growth, and continues to be driven primarily by incremental growth of programmatic spending. It is noteworthy that we achieved the $11 billion in backlog for the first time at the end of 2017. And in only 1.5 years, we have grown our backlog to more than 14% to the record level we reported this morning. We believe there is opportunity to add significant new backlog over the coming quarters from several larger electric transmission and pipeline projects. Also, we see multiyear, multibillion-dollar fire hardening programs coming for 2020 and 2021 that are not reflected in our backlog due to the current difficulty of quantifying the specifics of scope and timing. Before I provide my operational and strategic commentary, I wanted to touch on the charge we took in the second quarter. On our last earnings conference call and in subsequent investor conference webcasts, we discussed that projects dispute with an agency at the Peruvian government regarding certain fiber-optic networks that the Quanta subsidiary in Peru had been constructing for them under our previously awarded concession arrangement. As discussed in our press release this morning, we believe the contracts for the project were wrongfully terminated, that performance and payment bonds totaling $112 million were wrongfully called, and that the Peruvian governmental agency is not entitled to the alleged amount of liquidated damages. As of the date of the contract termination and prior to calling the bonds, Quanta's subsidiary had incurred approximately $157 million of construction cost for the projects and had received approximately $100 million in payments. That means after returning the project to the customer, as required by the contracts and which is expected to occur before year-end, the agency of the Peruvian government will possess the as-completed fiber build and more money from the bond proceeds than it has paid Quanta under the project contracts. We believe that represents an abuse of power and unfair treatment by the agency of the Peruvian government, and that their actions have provided them with unjust enrichment. Our Peruvian subsidiary has filed for arbitration and intends to vigorously pursue its claims related to these matters, as well as claims relating to payment for completed work and lost income for future operation and maintenance of the assets. Quanta's primary end markets in operations are performing well and have strong, multiyear growth opportunities. While we originally entered select Latin American markets based on attractive opportunities for Quanta to support our North American customers, those opportunities must also be favorable to margins with an attractive risk/reward profile. To that end, we are evaluating our strategy and relevant opportunities for our existing Latin American operations. Furthermore, this incident distracts from another strong quarter in which we had continued robust base business activity in our core markets and other significant year-over-year margin improvements in all our primary service offerings. Turning to our broader operating results. Our Electric Power operations have performed well during the first half of this year from both the revenue and margin perspectives. We expect our electric operations revenues to increase during the second half of this year, while also maintaining double-digit margins, driven primarily by broad base business strength through supporting the growing CapEx and OpEx programs of our utility customers. Several devastating hurricanes and other severe weather events over the last 7 years in the United States have resulted in large, multiyear, and multibillion-dollar storm hardening initiatives. However, there is more than a decade of significant additional investment required. For example, the State of Florida recently signed legislation that requires utilities to create 10-year hardening plans that will call for more undergrounding and steel and concrete structures. As a result, one of our customers has said that he believes that the undergrounding of distribution laterals represents a $25 billion to $35 billion incremental capital investment opportunity over the next 20 to 30 years. In the near term, this utility expects to invest between $11.5 billion and $13.5 billion in transmission and distribution projects through 2022, which includes $3 billion to $4 billion for storm hardening. Using storm hardening initiatives as a proxy, we believe the fire hardening initiatives in the Western United States are just the beginning. It will remain active for 2 decades or more and could require tens of billions of dollars of investment. Earlier this year, the California Public Utility Commission required the 3 major California utilities to file their 2019 wildfire safety plans, which detailed approximately $4 billion of incremental strategic investments in the near term, aimed at reducing fire risk and preventing future wildfires in the state. We are currently working with multiple utilities to that end and believe these large multiyear fire hardening programs are still in the early stages. We are also seeing larger electric transmission projects being planned due to load growth in certain areas of the United States, driven by data centers, LNG export, industrial facilities, and hydrocarbon production areas, such as the Permian Basin. We believe the award of some of these larger projects is imminent. Additionally, we expect to begin construction on the East-West Tie Line Project and have recently secured medium-sized electric transmission projects, both in Canada later this year. Our U.S. communication operations continue to show improvements over 2018. We have slightly adjusted our full year 2019 revenue expectation to around $400 million from $500 million, primarily due to the elimination of revenues associated with the canceled Peruvian fiber project and permitting and engineering delays on some domestic telecom projects. However, despite the charge, we still expect to achieve mid-single-digit operating income margins on a full year basis this year, with upper single-digit margins as we exit the year. Our customers are pushing fiber closer to their customers, fiber backhaul densification continues, additional fiber is being deployed for 5G wireless networks, and broadband network expansion initiatives in rural markets are ongoing. We also continue to believe Quanta is uniquely positioned to provide solutions to both wireless carriers and utility companies as 5G infrastructure is increasingly deployed on the electric distribution system, which will require significant electric lining resources. Quanta plays a critical role in facilitating the economy, technologies, and the lower carbon footprint of the future. Our economy continues to move towards lower emissions for power generation through greater renewables adoption. This shift requires new transmission tie lines and substations to be built, and the existing grid must be upgraded and modified to accommodate greater levels of intermittent power. Implementation and widespread adoption of new technologies in services, such as 5G, autonomous vehicles and electric vehicles, all require power, and new infrastructure, with the power grid of today not designed to meet those needs. We are in active discussions with key players in these arenas, helping them to understand the infrastructure that is required to support these technologies and how Quanta can help them execute their go-to-market strategies. We continue to believe that the role Quanta will increasingly play in the economy and technologies of the future is not well understood by many of our stakeholders. Our pipeline and industrial segment has increased revenue more than 16% and more than doubled operating income in the first half of this year compared to the first half of last year. As we move into the seasonally stronger second half of the year, we expect continued base business growth and profitability momentum. Demand for those services is growing as utility customers execute on multi-decade system modernization and safety initiatives. We also see opportunity to further expand and scale our gas distribution operations in the Northeastern United States and other select markets that provide attractive growth and accretive margin opportunities. Additionally, our transmission and midstream pipeline operations are in active construction on several larger pipeline projects that are performing well. We continue to evaluate opportunities to strategically expand our pipeline and industrial operations as we gain scale and diversity. We believe the result will be a segment with higher margins, less cyclicality, and a repeatable and sustainable earnings stream. A frequent topic of conversation with the investment community of late is how we think our business might perform in a recessionary environment. Given the duration of the current economic expansion cycle, I want to stress that we are not seeing softness in our business, nor are any of our customers indicating to us that they are slowing down or concerned about a recession. That said, while we cannot predict the characteristics or magnitude of any future recession in a hypothetical, normal economic recession of moderate GDP decline and duration, we believe that we could still grow our base business revenues while largely maintaining our current margin profile. Over the years, we have executed on our strategy to mitigate risk inherent in our business, including economic risk through diversification. We have a diverse customer base with low customer concentration, a broad and diverse geographic presence, and a diverse and expanding line of services. We believe our diversification strategy, favorable industry dynamics, and strategic investments we have made largely mitigate the impact of a recession. Overall, we believe the majority of our revenues are derived from customers and in markets that are driven by longer-term, visible dynamics that should be resilient to economic softness. More than 60% of our revenues are driven by regulated utility spending. Utilities have multiyear investment programs that are necessary and have been approved by regulators to move forward. It is worth noting that our Electric Power segment revenues have grown at a 7% CAGR since 2013, with base business revenues growing at a faster rate. This revenue growth occurred in an environment with flat electricity demand, significantly reduced larger project activity, and the collapse of oil prices in late 2014 and 2015, which adversely affected our Canadian operations. Our pipeline and industrial segment increased revenues consistently through the collapse of oil prices in late 2014 and 2015 despite challenges in Canada, which is an energy industry-driven economy. Since that period, we have significantly increased our base business operations. For example, our gas utility-driven distribution operations are meaningfully larger now than at that time. Our end markets are driven by long-term secular dynamics that we have talked about during our earnings calls and investor events for many years. The infrastructure we build and maintain is required for a safe and reliable delivery of critical services necessary to support the economic and social prosperity of the people, businesses, and industries in the geographies that we operate. We believe these dynamics in our positioning in the market put us in a position to potentially mitigate the impact of many economic concerns. Our first half results have been solid, and we are increasing our full-year revenue outlook for the second time this year to reflect our expectation of a strengthening second half. Our end markets and visibility are strong, and we continue to believe we're in a multiyear upcycle, with opportunities for continued record backlog in 2019. We are focused on our strategy of generating a more resilient and predictable earnings stream and will continue to evaluate how aspects of our operations fit with our model and our core business. Our customers' CapEx and OpEx plans continue to grow to historic levels. We are having conversations with customers about programs that are larger in size and longer in duration than we have ever experienced, and there is no sign of a slowdown in the near term. I strongly believe that the industry dynamics and opportunities we see for at least the next 5 to 10 years are exactly what Quanta is built for. We continue to expect our base business to grow double digits this year and account for approximately 90% of our 2019 revenues and believe we can grow base business revenues at a mid-single-digit to double-digit CAGR over the next 3 to 5 years. We continue to see more than $3 billion each of larger electric transmission and pipeline projects, which is a conservative investment estimate, and expect some could be awarded over the coming quarters. There are also prospects for new multiyear alliance programs over the near and medium term, and we expect robust growth from our communications infrastructure services operations with improved profitability. We are focused on operating the business for the long term and expect to continue to distinguish ourselves through safe execution and best-in-class leadership. We will pursue opportunities to enhance Quanta's base business and leadership position in the industry and provide innovative solutions to our customers. We believe Quanta's diversity, unique operating model, and entrepreneurial mindset form the foundation that will allow us to continue to generate long-term value for all our stakeholders. With that, I will now turn the call over to Derrick Jensen, our CFO, for his review of our second quarter results.

Thanks, Duke, and good morning, everyone. Today, we announced record second quarter 2019 revenues of $2.84 billion, a 7% increase over the second quarter of 2019. For the second quarter of 2019, net income attributable to common stock was $27.3 million or $0.19 per diluted share. Adjusted diluted earnings per share, a non-GAAP measure, was $0.31. As disclosed in today's earnings release, we recognized a charge of $79.2 million during the quarter, which impacted both GAAP EPS and adjusted EPS by $0.54 per diluted share. The charge includes a reduction of previously recognized earnings on the project, a reserve against a portion of unpaid project costs incurred through the contract termination date, and an accrual for a portion of alleged liquidated damages and estimated costs to complete the project turnover and close out the project. As of June 30, 2019, Quanta has a net receivable position on the project of approximately $120 million, which we have now classified as a nonrecurring asset. Included in this receivable is $87 million paid to the Peruvian agency during the second quarter through the exercise of advanced payment bonds posted to the project, which Quanta believes were wrongfully called. The bonds were to be exercised only if it had been determined the previous advance payments were not used for their intended purpose. The Peruvian agency exercised the bond in their full amount without affording our Peruvian subsidiary an opportunity to provide evidence of its expenditures on the project. The expenditures incurred were substantially in excess of the advance payments, and we believe the entire advance payment had been used for their intended purpose. Therefore, we strongly believe we are entitled to reimbursement. Quanta has never had a bond called by a customer, and it is the aggressiveness of their tactics, including the termination of the contracts and the inherent risks associated with international arbitration that influenced certain of our assessments of our GAAP financial positions. We are disappointed with the way events have unfolded around the project and have filed for arbitration. However, we don't anticipate any additional meaningful costs for the remainder of 2019 or beyond. It is also important to note that the reduction in future operations associated with this Peruvian work has a negligible impact on our future expectations. Turning to a discussion of our broader results. Our Electric Power revenues increased 10% when compared to the second quarter of 2018 to $1.73 billion, and represent record quarterly revenues for the segment. This increase continues to be driven by the elevated levels of base business activity as our utility customers expand their investment in grid modernization and infrastructure hardening, particularly in the Western U.S. The strength of the base business from the second quarter 2019 offset approximately $138 million in reduced revenues from larger projects when compared to the second quarter of 2018. Also contributing to the increase were approximately $35 million in revenues from acquired businesses. Our telecommunication revenues within the segment were negatively impacted by approximately $50 million for previously recognized revenue associated with the Peruvian telecommunications project that was reserved against as part of the $79.2 million charge in the quarter. Excluding the impact of the $50 million revenue reversal, our telecommunications revenues grew for the fifth consecutive quarter, with U.S. operations driving that trend. Operating margin in the Electric Power segment was 5.4% in the second quarter of 2019 versus 9.3% in the second quarter of 2018. Included in segment margins is the charge associated with the Peruvian project, which negatively impacted segment margins by 430 basis points. Excluding our telecommunications operations, which are included within the Electric Power segment, Electric Power margins were approximately 10%, a slight improvement over Electric Power margins during 2Q '18. The margin improvement was attributable to solid execution across base business activities in the segment, which helped to offset the anticipated softness during the second quarter from our Canadian operations due to normal seasonality and the transition of crews and equipment off the Fort McMurray transmission project. We had nominal, larger project revenues in Canada during the second quarter resulting in lower fixed cost absorption; however, 2Q '18 included the substantial contribution from the Fort McMurray project. Margins in our telecommunications operations bore the impact of the $79.2 million charge, resulting in a loss for the quarter. However, excluding that charge, margins were near mid-single digits, led by performance in our U.S. telecom operations. Of note, as it relates to the Fort McMurray transmission project, you may have seen that in June 2019, our partner, Canadian Utilities Limited, an ATCO company, announced that definitive agreements have been reached to sell the Alberta PowerLine limited partnership. The sale is expected to close in the fourth quarter of 2019 or the first quarter of 2020, subject to receipt of regulatory approvals and satisfaction of other customary closing conditions and should result in gross proceeds to Quanta of roughly USD 47 million at current exchange rates. Our pipeline and industrial segment revenues increased 1.7% when compared to the second quarter of 2018 to $1.1 billion. This increase is attributable to slightly increased revenues from larger projects. Operating margin for the pipeline and industrial segment was 6.3% in 2Q '19, an increase over the 4% margin in 2Q '18, which included a 40 basis point impact related to combined charges associated with the impairment of a construction barge and severance and restructuring costs. The margin agreement over 2Q '18 is primarily driven by improved execution across our base business operations as well as higher earnings on larger pipeline projects. The strength of these results overcame a $13.6 million additional loss associated with continued rework and startup delays on a processing facility that was approximately 96% complete as of June 30, 2019. A substantial component of this increased loss in the second quarter was incremental liquidated damages amounts due to continued delays in completion, which have now been accrued to the maximum contractual amount. We are in the final stages of this project and believe we have accrued all known losses. Corporate and non-allocated costs increased $17.5 million in the second quarter of 2019 as compared to the second quarter of 2018. This increase was primarily due to changes in the fair value of contingent consideration liabilities, with the $4.4 million increase associated with these estimates recognized in 2Q '19 compared to a $6.3 million decrease in 2Q '18. Also contributing were increased legal and professional fees and increased intangible amortization expense. Overall, 2Q '19 adjusted EBITDA, a non-GAAP measure, was $166 million, which includes the negative impact of the $79.2 million charge related to the Peruvian project. This compares to $199 million in the second quarter of 2018. For the second quarter of 2019, we had negative free cash flow of $173 million. Cash flow used in operating activities was $109 million and net capital expenditures were $64 million. The largest individual driver of the negative cash flow was the exercise of the $112 million in bonds against Quanta in connection with the Peruvian project. Also contributing was continued mobilization and tuning costs on certain base business projects as well as ongoing extended collection cycles with certain utility customers. As we discussed on last quarter's call, our periodic cash flow has been impacted by billing process changes for certain customers and other slow pay dynamics that have impacted our ability to time the invoice and collect for services performed. This is not isolated to a single customer, and while these extended collection dynamics translate to increased contract asset positions on our balance sheet, we are not aware of any material risk to the ultimate billing and collection of these balances. These negative items were partially offset by the collection of approximately $109 million of pre-petition receivables related to PG&E's bankruptcy proceeding. DSO for the quarter was 91 days compared to 74 days for the same period in 2018. Although impacted to some extent by the items previously described, 3 days of this ratio is attributable to the reclassification of significant retainage balances from long-term to current receivables during the first quarter of 2019 for the Fort McMurray project. We continue to expect collection of this larger balance by year-end. Also, 4 to 5 days of the ratio is due to the impact of retainage in various pipeline projects largely completed in previous periods. We did not purchase any of our common stock during the second quarter of 2019, and had approximately $287 million of available authorization remaining on our $500 million stock repurchase program at June 30, 2019. Additionally, during the second quarter of 2019, we announced our third-quarter cash dividend of $0.04 per share, totaling $6.2 million. At June 30, 2019, we had $751 million in total liquidity, which resulted in a debt-to-EBITDA ratio, as calculated under our senior secured credit agreement, of approximately 1.99x. As of June 30, 2019, our aggregate total remaining performance obligations were estimated to be approximately $4.7 billion, approximately 77% of which is expected to be recognized in the next 12 months. Our aggregate total backlog as of June 30, 2019, was $12.8 billion, an increase of 11% over the second quarter of 2018 and 3% over year-end 2018. Twelve-month backlog was $7.5 billion, in line with the second quarter of 2018, and up 7% from December 31, 2018. Our total backlog continues to expand as we capitalize on the growing infrastructure investment activity across our end markets, and specifically, the longer-term demand for our base business activities. Turning to guidance. Given the continued strength in our base business and improved visibility into the remainder of the year, we are increasing our consolidated revenue range to be between $11.5 billion and $11.9 billion. With regard to the Electric Power segment, we now expect revenues to range between $7.2 billion and $7.4 billion, with the third quarter revenues slightly higher than fourth quarter revenues due to normal seasonality. On an annual basis, we see aggregate electric segment operating margins ranging from 8.4% to 8.9%, with the $79.2 million effect of the Peruvian project impacting annual operating margins by roughly 110 basis points. As it relates to operating margins associated with our electric operations, the timing of the commencement of certain larger projects in Canada that impacted second quarter margins is anticipated to continue somewhat into the third quarter. However, we expect Canadian operations will improve profitability in the fourth quarter, particularly as large transmission opportunities move to construction. We expect overall electric operations will maintain double-digit margins for the rest of this year at levels in line with the second quarter. Regarding our telecommunications operations, we continue to see the opportunity for operating margins to achieve upper single digits by the fourth quarter of 2019, with our U.S. telecom operations leading the way with a potential to hit 10% by year-end. We now expect pipeline and industrial segment revenues to range between $4.3 billion and $4.5 billion. We see full-year margins between 5.5% and 6%. We have lowered the top end of our margin range due to pressure from the approximately $22 million of year-to-date losses recognized on the processing facility, which impacted margins for the year by approximately 50 basis points at the midpoint of our revenue range. Our operating margin range otherwise reflects continued confidence in our ability to execute on base business work. We expect third quarter margins to be the strongest of the year for the segment with the seasonal decline in the fourth quarter. While we expect increased revenue estimates to deliver profits within our guided segment margin ranges and incremental earnings per share, the negative impact of the $0.54 per share charge in the second quarter results in our full-year earnings per share expectations to now range between $2.46 to $2.79, and our adjusted earnings per share expectations to range between $2.99 and $3.33. Similarly, our expectations for adjusted EBITDA, including the charge, now range between $852 million and $932 million. From a cash flow perspective, compared to our original guidance at the beginning of the year, the $700 million increase in our overall revenue expectation and associated working capital to support this growth, as well as the unexpected cash outflow associated with the Peruvian project, together have impacted our cash flow expectations for the year by almost $200 million. Additionally, wet weather delays impacted cleanup activities on certain pipeline projects in the second quarter that have called into question our ability to collect several significant retainage balances by the end of the year, which if not collected by year-end, would become 2020 collection events. As a result of these items and some level of the previously described billing delays, we now expect free cash flow between $100 million and $300 million. Given these cash flow dynamics, we are increasing our forecasted interest expense to range between $58 million and $60 million. Looking beyond 2019, we continue to expect stronger free cash flow generation as our base business activities create a more recurring and predictable earnings profile, with the primary cash flow pressure being attributable to working capital to support revenue growth. While our second quarter results were negatively impacted by the Peruvian telecommunications project, we believe our broader performance and increased annual revenue guidance continues to reinforce the quality of our craft skilled labor workforce and the ongoing demand for our services. We continue to be confident in the strength of our operations, our prospects for profitable growth, and the repeatable and sustainable nature of our core markets. This concludes our formal presentation, and we will now open the line for Q&A.

Duke, can you give us some more color on how to think about fire and storm hardening? The concern that some investors have is that fire hardening work may peak this year in California, but I know you mentioned the example with the long-term spend potential of your storm hardening customer in Florida, which makes sense. When we look at fire hardening, it looks like PG&E's higher spend would be in relatively new term. So what kind of visibility do you have to fire hardening initiatives leading to multiyear growth?

Yes. In the Western U.S., particularly in fire-prone areas like California, there have been tragic losses. Such incidents often prompt regulators and public utilities to support initiatives aimed at improving and reinforcing the electrical grid. We are currently witnessing the early phases of this movement. There is a strong willingness among people to invest in more advanced and resilient systems. This need for modernization, along with efforts to strengthen against storms, is driving demand across North America and beyond. Historically, we've seen similar efforts on the East Coast related to hurricane preparedness, and there is still significant potential for improvement in that area. These initiatives are still in their infancy, and given that many of the systems are aging, progress will take time, with investments likely spanning several years as we navigate this early phase in the Western U.S.

Duke, somewhat of a related question, but you've continually talked about $3 billion of large projects visibility in both Electric Power and pipeline and infrastructure. But you sounded a little bit more confident about large electric power projects can be booked, and you used the word imminent. Did something change over the last few months to where maybe there's a bit more urgency for our customers? Or is it just time has passed by so you're getting closer to larger project work?

I think, from our standpoint, we're trying to point out the fact that the larger project pipeline is still there and robust. It hasn't moved. I guess, if I said 10, we'd have to calculate that every quarter. So we just say it's more than $3 billion to give you a sense that it's out there. When we look at these larger projects, we see more of them today than we did last quarter. They're supporting, like we said on the call, your data centers, your LNG exports, they all take big load, all your industrial centers are growing. All that takes big load. Your Permian Basin, we talked about, that's load. So you're seeing those larger projects come into play now more so than you've seen in the past. What we've done over the past 2 or 3 years or even longer, we've done it with no load growth or even negative load growth. So now as you start to see these larger complexes come into play, you start to see load growth and the need for transmission and larger transmission. So yes, I do think, today, we certainly see more larger electric transmission projects than we have in the past, and I believe we'll see some awarded in the next few quarters.

So just looking at some of these challenges you've had on certain projects like you mentioned in Peru and the processing project. Do you view these as just kind of things that occurred during the normal course of business? Or are you making the efforts to strengthen the project oversight and trying to avoid those types of issues?

Yes, Noelle, the project was a processing facility located in Texas, and that was the first one. Overall, I would note that both of those projects were bid over four years ago and initiated even earlier. When considering this in relation to our business and the strategies outlined in our strategic plans, we've emphasized the importance of developing more repeatable, sustainable, and predictable earnings streams. The two projects are remnants of our past efforts. Since then, we've pursued a strategy of moving towards ten and one, remaining focused on becoming more sustainable and repeatable as a company. This has been reflected in our ongoing backlog. We will complete these projects, but looking ahead, the backlog aligns with our strategic goals, which will shape our future outcomes.

Okay. That's helpful. And then second, could you just comment on what you're seeing with Stronghold in the quarter and how you're thinking about turnaround and maintenance work as you look into the back half of this year and into next?

Yes, Stronghold's done a great job positioning itself in the industrial market. We're really proud of that business. It continues to meet or beat expectations and set records for themselves. So we're excited about the industrial business and what it's done for us. It positions us well in the Gulf Coast, and we're very, very happy with the management team there.

Just going back to your prepared commentary, confidence around mid-single-digit growth in your base business and hopefully some projects layering on top of that. If I do the math and really assume that your margins bounce back next year, which I hope they do and expand, am I thinking wrong when I'm thinking about adjusted earnings power of nicely above $4 by 2021?

Yes. Tahira, look, I'll let Derrick do the math. But I would say for myself is we are creating a nice base business that continues to see growth across the board supporting our utility customers. But our CapEx and OpEx spends continue to get bigger. Our telecom business is extremely robust. As we look at our gas distribution business, our industrial business, it's robust. So everything that we see in our end markets allows us to think that we'll grow the company, will expand some margin profile within the segments. We talked about a double-digit margin on the electric side. We believe we can operate there over time. We talked about the gas to continue to bring it up into the mid-singles, even higher single digits on some of the areas in that as we move forward. So we do believe that's possible. We'll continue to strive to do that. Ninety percent of this year is base business, and we believe we'll tack on some larger projects as we move into the next year. So the opportunities are there. We continue to drive the base. I'd equate the EPS, but I'll let Derrick roll it out.

Yes, I mean, I don't have anything to add. It's all based upon what happens in the core aspects of our business, which Duke laid out. And those, that mass would translate into the numbers you referenced.

I hear you, Derrick. And just based on what you've laid out for the future, I don't know if the free cash flow revision to your guidance for this year constraints you. But should I be thinking this is an opportunity to buy back stock proactively?

From our perspective, we don't comment as to how we'll be in the market relative to the buybacks of individual stocks. I'll tell you the number one thing we focused on is kind of what the near-term opportunities are for deployment of capital. And a lot of times, that has to do with what we lean into first in the working capital as well as acquisitions and investments, all mindful of the liquidity position of the company. So we have had some movements in kind of working capital demands. And so we'll be very focused on ultimately making sure that deleveraged profiles stay within our boundaries. Having said all of that, you can see we've been an active buyer of our stock for a number of years, and you can see the levels at which we have moved into it.

I would like to begin by discussing Peru. Derrick, you've already outlined some of the numbers, but could you provide us with a clear idea of the worst-case scenario to ensure we understand the potential earnings charge and cash flow impact?

Well, on a go-forward basis, we don't have anything in our expectations relative to this contract. The aspect of everything is, on a go-forward basis, is effectively recurring operations and nothing associated with the contract as the contract was terminated. We have no backlog and no revenue expectations. On a year-to-date basis, I mean, we have taken a charge that we think puts us in a position towards the most likely scenario of our recovery. We do believe that there is a significant upside to the position because as we go into arbitration, we think our positions are strong. We do believe that we'll be putting forward various cases that will lead to a degree of recovery. I will say that, as I commented to my remarks, we do have a receivable position of about $120 million left on that contract. The largest component of that is associated with the bonds that we think, which we believe were pulled wrongfully.

And I want to comment as well on that. Peru, when you look at that on the face of it, we will defend that vigorously. We will go after it with the most extreme effort that we can. We're putting everything we have behind that as far as collecting our money, collecting what's rightfully owed to us. We believe that's wrongfully terminated. And just on the face of it, we've basically built a fiber-optic network for the people of Peru and paid them to do it. So it doesn't make sense just on the face of it; it doesn't make sense from a contractual language, and we'll defend it vigorously.

One follow-up there is just is there anything worse that they could be asking you for than the $157 million that you have denoted in the press release? And then my real follow-up question is really on the telecom side of the business. What still has to happen for you to achieve that upper single-digit margin in telecom, exiting the year?

Yes. Peru first. Peru can ask us for anything under the sun. The problem is that they're on the wrong side of it, we're on the right side of it. And the contracts we've accrued, what we believe, or we've expensed, we believe is the right number, and we believe will be on the other side of that as we go into litigation. As far as what we need on telecom to get to double digits, it's scale. We're scaling in many areas, we have the opportunities to add more backlog, more customers, and I feel extremely confident as we get into the second half of this year that we'll continue to increase margin incrementally, while also adding customer bases. What's unseen is our place in 5G. The 5G component of telecom is unseen of why Quanta is positioned in the right spot. 5G, you need today every 562 feet per density, and that would have to go into the distribution arena. And so every single pull out there, 562 feet apart, needs an antenna, it needs an electric line. And so in order to do that, in order to get all the technology that you hear about autonomous vehicles, data centers, cloud, edge, whatever it may be, it's a convergence of heavy fiber and your 5G antennas. We sit right in the middle of that. And I can't say it enough of our opportunity there and how well we believe we're positioned for that opportunity in the future.

So I was hoping you could bridge the operating cash flow in the back end of the year. And maybe talk about how you are thinking about when the mobilization will peak out and the working capital burn will subside and the incremental cash that you get from PG&E? Is there any additional outflow from the Peru situation that you need to contemplate? Or any other project that's in a loss-making position that could burn cash?

Yes. First, I want to discuss the cash outflow. We currently have 41,807 employees, which is a significant increase as we progress. It's beneficial for us to grow our workforce, and while cash is flowing out, it is important that it comes back in at a faster rate. As long as we continue to grow at our current pace in the base business, there will be some cash outflow. It will become more consistent as the growth rate stabilizes. We experienced some anomalies this quarter, but the base business has drawn cash, and we expect it to return. Currently, our days sales outstanding in the base business are elevated because our customers are catching up with the growth. This has made it more challenging for us to send out invoices; while they are paying on time, the process has lagged. As they catch up, I believe our days sales outstanding will return to a more normal level. Now, I'll let Derrick provide additional insights.

I agree with Duke's comments. Currently, we are about 91 days into the year. The Wolf Lake collection alone likely accounts for a reduction of about 3 days. Typically, we experience cash outflows in the first part of the year and cash inflows in the latter half. I expect this trend to continue for 2019. We have the potential to achieve positive free cash flow in the third quarter and even more in the fourth quarter, aligning with our usual seasonal patterns. The lower revenue levels in the fourth quarter are factored into our model, which generally results in a cash turnaround. Additionally, I believe we will see reduced Days Sales Outstanding (DSOs). By the end of the year, we could see DSOs declining into the low 80s, which aligns with what we mentioned in the first quarter. As we move forward, this should lead to more normalized collection and billing cycles with our customers.

That's helpful. And then just switching over to Lat Am. In the release, you mentioned that you're evaluating whether to just stay in the business. And I was hoping you could give a little bit of color on that. Is there potential sale? Is it a wind-down, hardly about the timeframe or the framework to approach that decision? And then lastly, how big is that business right now?

Yes. So to answer your question, in Lat Am, certainly all those strategies are on the table. What I would say is the company has said and continues to believe our strategy is to be more repeatable, sustainable, and less risk. If Lat Am is creating risk, both from a macro standpoint, geopolitical standpoint, we are focused on derisking the business as a strategy. So when we look at that, we went to Latin America to support our North American customers on their builds in those countries. We felt like that we mitigated those risks even in this project. It was a 10-year, $250 million project that had a lot of maintenance over time. We felt really good about where we're at. When you have geopolitical-type risks in countries that change from a growing middle class to something different, we'll certainly look to derisk those business and derisk those parts of the world. So we've stated our strategy, and we're certainly sticking to that.

On a run-rate basis, I would say that Lat Am is probably in the $100 million range at this stage.

Duke, on the fire hardening initiatives, and in particular, I guess, the work with PG&E, are they being more selective in terms of who they're working with, just given their current position in Chapter 11? I'm just wondering if that's actually allowing you to capture some more share with them?

We've been a line contractor for PG&E for a long time, and they are likely our top electric customer. We've often supported each other, and we have a good understanding of the area and the people, making them a great customer. However, they are just one customer among many in the Western Hemisphere that have fire hardening projects. We are increasingly focused on programmatic work, which involves more than just construction. We are also expanding our global efforts in engineering and distribution engineering. The company is shifting towards more programmatic initiatives, and as utilities cannot ramp up quickly, we are able to assist them in creating the right environment and cost structure for ratepayers. Collaborating on major projects in the West and beyond makes sense for us. Labor resources are limited, and we have invested over $100 million in training, which positions us well for these environments. We have noted that we have never encountered such a unique macro market landscape that Quanta can capitalize on, which aligns perfectly with our capabilities.

Okay. I appreciate that. And my follow-up is on the pipeline side. I mean, it sounds like plenty of work to do with there. I guess, are you seeing any customers trying to accelerate project schedules and kind of getting into an election year and maybe there's some questions about what the regulatory environment looks like two years from now?

Yes, I would say that every one of them would move as quickly as possible. However, they will be careful about obtaining permits and ensuring everything is properly completed. It’s not ideal to start and stop projects for either party, so I would prefer they secure all their permits. I believe they share that perspective. That said, I think the processing will become smoother under the current FERC administration and in Washington over time as the courts stabilize and similar factors improve. Regarding the Permian Basin, there is a lot coming out of Texas, with significant support for LNG. Canada also has projects that are about to commence, so we anticipate a lot of activity in large pipeline projects for at least the next few years. We are still actively securing work for this year.

Derrick, could you clarify what was the revenue expectation you thought the telecom business could deliver in 2019? And how does that compare to 2018?

Yes, I would estimate that we're likely in the $400 million to $450 million run rate range. It becomes a bit challenging to pinpoint due to the revenue adjustments related to the Peruvian project. However, on a run-rate basis, it's likely within that range. Last year, I believe we finished around $350 million, but I need to verify that.

I'm sorry, and that's total company or is that just U.S.?

That's total company. Last year, we ended up about $270 million.

Okay.

I would say in general, we paced that growth, and the opportunity for us to grow more is certainly there. We wanted to make sure the permitting and such was in place before we started deploying mass crews to the systems. We're really worried about the margin profile there and making sure that we deliver on that. And that's certainly by design. The business itself and the business is out there; we could pull the business up much more, but it would dilute margins on the growth. And I don't think it's the right thing to do. I think we'll pace it, scale it more efficiently. So it's by design. We can certainly move that needle up quite a bit there on the revenue side.

And then more of a bigger picture question. With a company that can deliver $900 million to $1 billion in EBITDA, would you think more normalized free cash flow numbers should be at some point over time on an annual basis?

The beginning of the year, we commented that we thought we could see free cash flow conversion related to EBITDA in the 40% range. I continue to think that we have the ability to see that. The biggest change that you saw relative to that expectation this year was the growth in the revenue side, which we said would always create potential drives against that number as well as what we've dealt with here relative to the Peruvian side. But on a go-forward basis, we see the ability just to get increase that conversion ratio, and I think you can see numbers approximating that 40% original guidance.

And I would say also that just our deployment of the baseload crews is unprecedented. It just is. We're deploying a bunch of baseload crews at this point.

And to Duke's point, those are the things that influence that number for us. Growth is inherently the biggest wild card relative to how we think about cash flow.

Most of my questions have been answered, but I guess Derrick or Duke, when we think about the pipeline and industrial business, the margins have grown this year with some one-time headwinds to margins and without big pipeline work. So I guess as I think about over sort of the next couple of years, understanding there are some scale that need to be had in geographic diversification, how do I think about normal sort of margin progression in that business assuming the base business seems to grow in line with your expectations? I mean because this year, if we adjust everything out, it's probably up almost, I think it's up to 6.3% relative to 4.3% last year. So I'm just trying to think is that a normal margin agreement that we should see as the base business tries to grow without pipe?

Jamie, we have stated that we will continue to increase those margins into the upper single digits. This is our aspiration and goal moving forward. I anticipate that it will gradually improve in years 7, 8, and even year 9. This kind of business is repeatable and sustainable, and we can achieve those margins. If you examine our distribution business, which we won't detail but have seen significant growth as we scale our operations, particularly in the Northeast, you will notice overall improvement in this segment. We are also mitigating risks associated with our major projects. I believe both our industrial and distribution businesses will continue to strengthen; our pipe business generates substantial free cash flow. When that picks up, it will certainly add to our performance, although it's not essential for reaching those margins.

I wanted to ask first about the margins in Electric Power. We came into Q2 thinking that was going to be the low point for the year. You outperformed that, and I'm just curious why you outperformed in Q2?

In the second quarter, we observed significant strength in the company as we scaled operations while adding crews. Utilization rates were high across the board, and we put in more man-hours than expected, which improved our margins through better equipment utilization. We did face some challenges in Canada, as anticipated, and we expect this to continue to affect us in the third quarter. However, we believe that the fourth quarter will show substantial improvement. We have opportunities that we think will contribute to our growth in 2020 and beyond, which makes us optimistic about our performance in Canada and our core business. We are seeing full or even higher utilization as we deploy crews, which leads to increased scale and margins. We've consistently stated that we aim for a 10% margin in that business over time, and I stand by that. There may be fluctuations, reaching up to 11% at times or down to 9%, but ultimately, we can maintain that 10% margin profile. Variability can occur from quarter to quarter, influenced by factors like storms or increased workload, which impacts the utilization of our fleet.

Yes. So just a couple of more very quick cash flow questions. But can you remind us, what's the remaining AR that's tied to PG&E that's still out there? And then does your guidance for $100 million to $300 million, does that include the $47 million you're planning to pick up on the Fort McMurray sale? And what quarter does that fall in?

Yes. The noncurrent asset component of PG&E is still roughly about $41 million. That is not in our expectations for this year. We still look at that as something that has the risk of going back or going into 2020 type of event. And then the Fort McMurray sale is not in our expectations at this stage. We believe that has a significant degree of risk of being into the first quarter part of 2020. So at this stage, it's not my current expectation.

Okay. And then, I guess, one last one on Peru. I think their total damages that they're claiming, if you add it up, is $157 million. And the cash that you guys have paid out, including the bonds that exercised, I think was $114 million. So I guess the question is, is that delta the amount, I mean if everything went against you that ultimately there is $40-plus million of potential cash that could out? And I guess the second part of that would be, are there any additional performance or surety bonds that they have the power to exercise?

There are no additional bonds outstanding. And I'd probably come back to answer the question more along the lines of I have $120 million of receivables still on the books. And to that end, that's the position we'll be looking to collect at a minimum.

And I don't believe that's the case. I believe that we'll eventually prevail and collect our bonds and beyond. So I don't believe we're in a position and the right position. And it should go the other way in my mind.

I want to thank our 41,807 employees. They're dedicated to the success of Quanta. I'd like to thank you all for participating in our second quarter conference call. We appreciate your questions and ongoing interest in Quanta Services. This concludes our call.