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Edited Transcript of DOW.AX earnings conference call or presentation 11-Feb-20 11:00pm GMT

Half Year 2020 Downer EDI Ltd Earnings Presentation

North Ryde, New South Wales Feb 14, 2020 (Thomson StreetEvents) -- Edited Transcript of Downer EDI Ltd earnings conference call or presentation Tuesday, February 11, 2020 at 11:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Grant Anthony Fenn

Downer EDI Limited - MD, CEO & Director

* Michael James Ferguson

Downer EDI Limited - CFO

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Conference Call Participants

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* Alexander George Philip Karpos

Goldman Sachs Group Inc., Research Division - Equity Analyst

* James Byrne

Citigroup Inc, Research Division - Research Analyst

* John Purtell

Macquarie Research - Analyst

* Paul Butler

Crédit Suisse AG, Research Division - Director

* Rohan Sundram

MST Marquee - Gaming and Contractors Analyst

* Scott Ryall

Rimor Equity Research Pty Ltd - Principal

* Wei-Weng Chen

JP Morgan Chase & Co, Research Division - Research Analyst

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Presentation

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Operator [1]

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Thank you for standing by, and welcome to the Downer Half Year 2020 Results Conference Call and Webcast. (Operator Instructions) I would now like to hand the conference over to Mr. Grant Fenn, CEO. Please go ahead.

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [2]

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Well, good morning, ladies and gentlemen, and thank you for joining the Downer team for the presentation of the Downer EDI Limited results for the 6 months to 31 December 2019. My name's Grant Fenn, and I'm the CEO of the Downer Group. This morning, I will take you through an overview of the results; and Michael Ferguson, our Group CFO, will cover the financial position of the company in more detail. And we'll take questions at the end of the presentation.

Well, despite Downer's service businesses performing well, construction losses, as you all know, have driven a disappointing result for the group in the first half of financial year 2020 and resulted in the group reducing its full year earnings guidance by $65 million after tax. Downer's directors have declared an interim dividend of $0.14 per share for the half. In early November, at our AGM, I highlighted that our cash performance for the 2020 financial year was not expected to be as strong as it had been in recent years due to a number of known factors, including the cash impact of Murra Warra wind farm, the timing of some cash flows from large projects winding down and the timing of cash payments for the first bogie overhaul for the Waratah trains. Now additionally, the half has been further impacted by the reported construction losses.

We expect cash flow conversion will improve in the second half, and we expect it to return to normal levels in 2021. Unfortunately, the loss-making construction projects that are now either complete or almost complete predate a number of changes the group has made to its risk in contracting limits over the past 18 months. During this period, we've been strictly limiting the risk in our construction portfolio in terms of the type of work, price, terms and conditions, and this has led to a material reduction in construction work-in-hand.

The strong pipeline of opportunities in our favored markets continues to drive Downer's work-in-hand. In total, Downer's work-in-hand has risen from $43.5 billion at 31 December 2018 to $44.3 billion at 30 June 2019 and $46.4 billion at 31 December. And we had $7.5 billion in new contract wins between July and December, largely in Urban Services. 89% of our work is in our Urban Services businesses, Transport, Utilities and Facilities. And all those businesses are strongly placed to win more work in their respective markets.

We have provided, for the first time, the profile of work-in-hand over time, which runs to 2062, with around $1 billion contracted in outer years beyond 2030. And that profile demonstrates the very strength and stability of our model.

Construction work-in-hand totals just $5.7 billion or 12% of the group's $46 billion of work-in-hand. Now 63% or $3.6 billion of that relates to low-risk contract forms such as alliances, cost reimbursable, fee-based or long-term panel arrangements for minor capital upgrade works. These contract forms are collaborative, profitable and enhance the long-term customer service relationship, and we'll continue to pursue these types of arrangements.

The remaining 37% or $2.1 billion of the work-in-hand is split between scheduler rates, design and construct and EPC-style contracts. Around $580 million or 28% of this $2.1 billion relates to projects of less than $15 million, i.e., relatively small projects and limited risk in total. Another 21% relates to projects under $50 million.

To accelerate our shift towards less volatile service markets, we have decided to focus our major construction efforts on areas where we have competitive differentiation. That's in Transport, so including road, rail and systems; high-voltage transmission and substations; telecommunications; water; wind in the balance of plant, and what that really means is road systems on the wind farms, the HV, the substations, et cetera, that's not inclusive of EPC on wind; and also facilities with Hawkins in New Zealand.

Our Engineering and Construction business will no longer tender for hard-dollar construction contracts in the solar, coal, iron ore and industrial S&P and E&I sectors. Our decision to withdraw from construction of large-scale solar farms is disappointing but inevitable, given that the market has almost evaporated over the past 12 months as developers, bankers and contractors have all struggled to come to terms with the risk of large power loss factors, grid stability problems, connection problems and equipment performance issues. These problems will, no doubt, get sorted out in time, but right now, we don't see a construction market in the short to medium term that will accept our terms and risk position on these matters. So we're out. We'll finish those projects for which we're committed.

Downer's traditional major construction markets in coal and iron ore are also subdued. With little happening in coal and iron ore, projects' time frames are extended. Downer's traditional competitive strength in E&I has been diminished somewhat as most project awards are now multidisciplinary, driving more commoditized price and contract terms and conditions. So it's been very hard to make money consistently.

Downer's service businesses continue to perform well. Group revenue increased 3.3% to $6.8 billion for the half, with Transport up 5.7% on strong performances in the road maintenance and transport projects businesses. Utilities revenue grew 16.8%, with strong growth in its power networks and water services business. Whilst the renewable construction business revenue grew, this did not flow through to earnings as you know. The telco business unit in Utilities was also down due to the wind-down of the nbn rollout. Facilities revenue grew 5.4%, with strong growth in the Government business and another good performance in defense. Spotless also saw revenue growth in the Infrastructure and Construction divisions, formerly Nuvo and AE Smith. However, this did not translate to earnings due to a number of challenged contracts. Building projects in New Zealand performed well during the period.

Mining continued to perform well, with revenue growth of 8.8%. EC&M revenue reduced by 25.3% due to the impact of the reduction in Construction revenue following the completion of the Ichthys power project and lower-than-expected revenue caused by project delays. This was, in part, offset by growing revenue from the asset services business, which continues to perform very well. Consistent with revenue, the strong earnings performances in Transport Services divisions and Utilities and EC&M and the Government services divisions of Spotless has been improving and pleasing. This has been offset in the half by the impact of the write-down of projects disclosed in the market update on 23rd of January and subdued results in the Spotless hospitality and Infrastructure and Construction businesses.

Downer's forward outlook is particularly robust given a pipeline of over $200 billion in attractive service opportunities in the next decade. Our market position of 1 or 2 in each market gives us confidence of securing a significant share of those opportunities. Urban Services markets in Australia and New Zealand will continue to grow with a range of services contracts in resources, defense and public transport coming to market. Around $20 billion of weighted opportunities are coming to market in the next 12 months. Downer's core markets of Transport, Utilities and Facilities look particularly buoyant and support our strategic shift into service-based markets.

I'll now hand over to our CFO, Michael Ferguson, to go through the financial aspects in more detail. Michael?

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Michael James Ferguson, Downer EDI Limited - CFO [3]

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Thanks, Grant. Good morning, everyone. I'll pick up from Slide 9, outlining the financial performance of the group for the half year. As we set out in our last full year results presentation, the first half of FY '20 has seen the group's initial adoption of the new accounting standard, AASB 16, accounting for leases. The new standard, in essence, requires all leases, including operating leases, to be recognized on the balance sheet. Further, and from a profit and loss perspective, the new standard replaces operating leases expense previously included in EBITDA, with additional interest expense arising from the lease obligations recognized on the balance sheet and the amortization of a right-to-use asset. Downer has adopted the new standard on a modified retrospective basis, meaning that the comparatives have not been adjusted. Accordingly, we have included the impact of the new standard in the table to allow users to make a like-for-like comparison, with the change percentage referred to in the slide comparing the pro forma pre-AASB 16 column with the prior period.

Whilst there has been very minimal impact to the group's reported earnings at an NPATA level, just $1.5 million, the table shows larger variances at EBITDA, depreciation and amortization and net interest expense, predominantly due to the reclassification of operating leases. A full reconciliation of the AASB impact is included in Slide 27 of the supplementary information.

Group revenue, including Downer's share of revenue from joint ventures, increased 3.3% to 6.8% -- $6.8 billion for the half year. Grant has spoken to the revenue performance for each of the segments. EBITDA, adjusting for the impact of AASB 16, dropped by 11% to $351.4 million from $396 million. Reported EBITDA after the impact of AASB 16 was $429.3 million. Consistent with revenue, the half has seen strong earnings performances in Transport and Mining, the services division in Utilities and EC&M and the Government services divisions of Spotless. This has been offset in the half by the EC&M construction performance and subdued results in the Spotless hospitality and the AE Smith and Nuvo businesses.

Depreciation and amortization on a like-for-like basis was slightly up by 1.4% to $147.1 million. Group EBITA, pre-AASB 16 of $204.3 million, decreased by 18.6%. Noncash acquisition-related amortization was $34.4 million compared to the prior year of $31.4 million, with the increase due to the intangible assets arising from the acquisition of the Downer-Mouchel joint venture at the end of the prior corresponding period. Net interest expense includes additional interest of $12.6 million arising from the recognition of an additional $728 million in lease liabilities on the adoption of AASB 16. Adjusting for this, interest has also benefited from lower interest-based rates and less interest from the unwind of the nRAH provision, offset by higher-average debt levels.

Tax expense of $35.5 million reflects an effective tax rate of 28%. The effective tax rate remains below the Australian statutory rate of 30% due to nontaxable distributions from joint ventures and a lower corporate tax rate in New Zealand. This all equates to a reported net profit after tax and before amortization or NPATA of $115.5 million, which is down 21.1% and represents 38.5% of the revised FY '20 guidance of $300 million NPATA. This represents a lower-than-traditional first half split due to the losses recognized in the period. Taking into account the impact of AASB 16, comparable NPATA would have been $117 million.

Downer's returns on funds employed has increased slightly to 12.6%. The Downer Board has declared an interim dividend of $0.14 per share unfranked. Downer has reduced its franking to 0, which, in part, reflects the impact of historic tax losses and the timing of Australian tax payments driven by ongoing contract positions. The $0.14 per share dividend is consistent with the 2019 final dividend and assuming the FY '20 final dividend is held at $0.14 per share, will sit within the targeted payout ratio range of 50% to 60% based on the revised guidance.

Slide 10, summary of earnings, highlights a number of items that have impacted the Facilities result and the unallocated or corporate costs. The first item relates to a number of legacy items included in the Spotless result, which relates to contracts and issues prior to the Downer acquisition. This includes the recognition of $23 million in noncash earnings relating to the resolution of the contract renegotiation at the Royal Adelaide Hospital. Downer identified at its FY '19 result that the proposed resolution would likely see a reduction in the provision amounts recognized to cover the losses through to the contract reset in June of 2022. The commercial resolution, which provides for additional contract payments, 1st of June 2022, was finalized during the period, significantly reducing cash losses. And the accounting treatment adopted leaves appropriate provisioning to absorb these losses up to the reset date.

Offsetting this benefit are Spotless' recognized losses on the completion of a number of legacy construction contracts in the Nuvo and AE Smith businesses, totaling $8.2 million, as well as some payroll -- some legacy payroll remediation costs as Spotless undertakes a review of the application of its numerous award and enterprise agreements. Whilst no material issues have been identified, the aggregate of this remediation made during the period is $3.9 million. Spotless also continues to incur significant restructuring and betterment costs as it invests in improved capability and processes. As a result, total restructuring costs incurred total $2.7 million for the period.

Adjusting for the impact of the significant items, the Spotless stand-alone result, as expected, has reduced compared to the corresponding prior period. This is due, in the most part, to the timing of events in the various hospitality contracts and lower margins on some of the construction contracts. Following the delisting of Spotless, their results have been released today on their website and a reconciliation of the Facilities result to the Spotless result has been included in the supplementary material on Slide 25.

The other item referred to -- the other item included on the summary of earnings schedule relates to the current portfolio review activity being undertaken within the Downer Group. Costs incurred during the period relating predominantly to vendor due diligence costs and restructuring activities totaled $2.7 million in relation to laundries and $3.2 million incurred in relation to Mining. These items, in aggregate, have had a net impact on statutory profit of $2.3 million on a pretax basis.

Slide 11 provides an overview of unallocated costs. Unallocated costs totaled $66.8 million and included $42.9 million of corporate costs and $23.9 million of amortization of acquired intangible assets. These costs are consistent with prior corresponding period.

Moving on to operating cash flow on Slide 12. As we have previously flagged, first half FY '20 has seen a number of operating cash flow challenges for the group. This has resulted in operating cash flow after adjusting for net interest paid and tax of $19.5 million, with an operating cash flow to EBITDA conversion of 4.5%.

The most significant items that have impacted the operating cash flow for the half have been set out on the left of the slide and include the cash outflows for the Murra Warra project; the cash outflow impact of prior period A&C losses and current outstanding claims positions; losses recognized in prior periods in renewable projects; the impact of cash outflow of the Waratah TLS bogie overhaul program; the cash flow timing for the major rail projects; and the WIP lock-up as the nbn contract winds down.

The FY '20 reported cash result also includes the benefit of the change in classification of lease payments from operating cash flow to financing cash flow and interest. This totaled $67.1 million. The slide highlights the causes for the poor cash performance, with the majority of issues arising from specific project performances. Adjusting for the impact of these items, conversion would have been approximately 80%. Downer's services business, in the most part, continued to deliver strong cash flow, and the second half performance will improve as the projects highlighted complete. We expect that as these factors resolve, we should see a return to strong operating cash flow performance in FY '21.

Downer continues to use receivables factoring for a very small portion of its debt-of-book in instances where it makes financial sense to do so after considering client payment terms and relative funding costs. Factoring as of 31 December 2019 was $137 million, an increase of $23.7 million from June, consistent with the increased revenue from the mining contract to which the factoring relates. Downer does not use reverse factoring of its payables.

Turning to overall cash flow on Slide 13. Net capital expenditure was $164.7 million, a reduction of 14% on the prior period. Consistent with prior periods, Downer's Mining business and the Spotless laundry business accounted for 60% of total capital. Other acquisitions relate to the third person consideration for businesses acquired in prior periods. Downer also continues to invest in technology, with capital being invested in data center upgrades and productivity improvement platforms across the Australian and New Zealand services businesses. Financing cash inflow relates to the additional financing in the half, with the net proceeds of $185.7 million predominantly explained by the additional medium-term note issuance of $200 million, offset by the repayment of some residual USPP debt.

Total dividends paid of $87.1 million is consistent with prior periods, whilst the group reduced its lease liability by $67 million in the half. Cash held at 31 December was $515 million, which when combined with undrawn facilities of $1.1 billion provides us with significant liquidity of $1.65 billion.

Turning to Slide 14, the Downer Group balance sheet remains strong with a strong net asset position. However, the impact of the reduced operating cash flow performance for the half has seen gearing increase to 31.3% from 24.9% at 30 June '19. Improved cash flow performance into the second half and into FY '21 will see gearing reduce.

Our group debt maturity profile is set out on Slide 15. Weighted average debt maturity has increased from 3.6 years at 30 June '19 to 3.7 years as the group continues to use long-term debt to match the increasing profile of its long-term contracts. The group's total net debt is $1.4 billion, with $703 million in Downer and $686 million in Spotless. The Spotless net debt has reduced slightly, consistent with the focus on debt reduction for that platform, with the Downer debt increasing $378.3 million as a result of the losses and the timing of operating cash.

Thank you very much. And I'll now hand back to Grant.

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [4]

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Thanks, Michael. In August, we announced a review into our Mining and laundries businesses to be completed in the first half of the 2020 financial year. And that review concluded that Downer should exit both the Mining and laundries businesses and this would provide an opportunity to increase returns to shareholders and reduce debt. The exit process for Mining continues with a number of bids being received last week ranging in price and conditionality. We're assessing those bids and other exit alternatives, including a demerger, and we'll update investors on next steps when appropriate. The exit process for laundries also continues with a range of indicative bids being received recently. Again, we'll update investors on next steps when appropriate.

Downer is focused on winning and delivering secure long-term service revenue and leveraging our expertise to drive margin expansion over time. Typically, there's a ramp-up on projects during the engineering, procurement and construction phase. And revenue is high, but so is capital intensity and risk.

As we've discussed today, we participate selectively in this space, identifying those projects that are linked to long-term operations and maintenance opportunities. Downer's focus is on the management of assets through their life cycle, which can be many decades. The work in this space delivers long-term predictable revenue, with opportunities for top line growth and the ability to improve margins over time through operational efficiencies and innovation. We're aligned to growing markets, and we have high-quality customers. And as we've said repeatedly in recent times, we are particularly leveraged to economic and social infrastructure, in other words, where the money is being spent. We continue to increase our exposure to low-capital services-oriented businesses, and we'll continue to make strategic acquisitions when appropriate opportunities arise, particularly if they fit with our Urban Services business, that's Transport, Utilities and Facilities. This growth will be accompanied by efficient use of capital, and we will seek to improve operating margins and ROFE. We'll continue to focus on strategic capital allocation as well as cost and capital efficiency. We have a strong balance sheet and credit rating, and this gives us the flexibility to reduce debt and invest in future growth opportunities.

Business growth, combined with efficient use of capital, will see Downer grow earnings per share and dividends per share over time. We'll increase dividends in line with earnings per share, and our payout ratio will remain over 50%. This business will be predictable and reliable.

Finally, I'll confirm our outlook statement. Downer is targeting NPATA of $300 million for the 2020 financial year.

I thank you very much, and I now will hand back to the operator and I invite you to ask questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from John Purtell from Macquarie.

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John Purtell, Macquarie Research - Analyst [2]

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I just had a couple of questions. Grant, I know you made some comments on this a few weeks ago. But look, essentially, the question is what are the changes that you're making to ensure no repeat of some of the project issues that we've seen in the last 12 months.

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [3]

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Yes. Well, John, we've made a number of changes quite some time ago, as I said in the statement or in the presentation I've just given. We made a number of changes around 18 months ago around the types of contracts that we take on and the like, and the contracts that have given us the problems really predate that. But -- so we've made a lot of change in that area, which has meant that our work-in-hand in those risky areas has reduced quite considerably. But in addition, what we've done in the last weeks after coming back and seeing the issues that we've had in those further jobs, which we announced in January, we've taken a decision to really focus our attention on delivering for our long-term service customers, so to the extent that they need small stuff done, then we concentrate on that, and in the areas where we have really competitive positions which are very strong and generally can get much better terms and conditions. And that is, as we've said, in transmission, in HV, in buildings in New Zealand, telecommunications and in wind also.

In wind, the reality of what we do there is the balance of plant. So we're doing the road systems. We're doing the substations. We're doing the HV connection work, et cetera. So we've taken the pretty -- very significant step, in fact, of restricting our Engineering and Construction business to really the markets of those and not going forward with solar, coal and iron ore. And the reality is, is that when we look at the forward markets there, particularly in solar, as I stated, the market is not there, certainly in the short to medium term. In the longer term, perhaps it is. But it's certainly not there at the moment. So it's not a big move for us to move in this direction from a work-in-hand and a future pipeline point of view. And even in coal and iron ore, again, that market is not particularly large and it's taking a long time to come to market. So we've taken a very big position here. So we've spoken about it, John, and I guess it's there in front of you.

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John Purtell, Macquarie Research - Analyst [4]

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Just a second question. In terms of the portfolio review, Grant, can you provide any sort of indicative timing for expectations for a definitive outcome on both mining and laundries?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [5]

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Yes, John. Well, John, I guess I could, mate, but I've been wrong before so I'm not going to repeat that. We've -- I think when we were back at the AGM, I was hopeful that it would be -- or sorry, back in August, we were hopeful that it would be by the end of the calendar year and, clearly, that's not. We're very hopeful it will be by the financial year.

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Operator [6]

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Your next question comes from James Byrne from Citi.

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James Byrne, Citigroup Inc, Research Division - Research Analyst [7]

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I wanted to focus, firstly, on the cash conversion results on Slide 12. Now it sounded like in your remarks that second half '20 cash conversion would be weak as well. I was hoping you might be able to provide some details on why the timing issues would persist across the June half as well. And if you could remark specifically on some more detail of the unwind of the nbn, I think that would be particularly helpful.

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [8]

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Yes, I will just touch on the cash flow for the second half. We don't see that as being weak. In fact, that will revert back to normal. But for the full year, obviously, and we guided for this in January, that it will get back to somewhere between 40% to 50% conversion. And we're saying that in '21, it should revert completely. On the nbn, Michael, do you want to give some color on that?

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Michael James Ferguson, Downer EDI Limited - CFO [9]

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Yes, I would. It relates predominantly to WIP lock-up and just delays as the backlog of finishing projects are approved and paid. And so the cash flow profiling is dependent on the final approvement of the last 10% or 20% of the work. It unlocks the final payment, and there's a fairly material backlog of approving those parts of the claims or so. We're working hard on that, reducing that into the second half as well.

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [10]

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Yes, you shouldn't read into that, that there's issues with those clients. It's just that the cash was front-loaded in the nbn. And when you get to the end of that, then there's a WIP lock-up for a period of time until all of those are run through the system.

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James Byrne, Citigroup Inc, Research Division - Research Analyst [11]

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I understand. Yes. I note also the remarks on provisioning for underpayments. I'm wondering whether you could provide us detail on this review, where the underpayments may have occurred and some quantification on how pervasive you think the problem is.

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [12]

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Yes. Look, we have been going through a review for quite some time now. It's been primarily directed in Spotless. Spotless has got a lot of employees, so we were very proactive on this early after taking it on. It's taken us quite a bit of time to get where we've got to. We've provided an amount of money for that, which is just under $4 million. We continue to do work there, as all companies really in Australia with large workforces, and that continues. And we're doing that in conjunction with the Spotless teams and also with their work.

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James Byrne, Citigroup Inc, Research Division - Research Analyst [13]

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Got it. All right. Just one last question for me, just on the Mining sale. Look, correct me if I'm wrong here, but the demerger effectively a dual-track process, that appears to be new information. I'm wondering how advanced is that demerger process and why have you chosen a dual-track process. You need the bidding tension against the trade sale according to the indicative prices you've received?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [14]

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Look, we could go into the tactics of how you sell an asset like this, but always, the tension is between the people that want to buy it. Also, you're continuing with the business and always -- we've always had demerger in the background as something that we would potentially look to. And as we come through to finalizing what we're doing, we're putting it all in the mix as to which we think will be better for shareholders.

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James Byrne, Citigroup Inc, Research Division - Research Analyst [15]

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Okay. So I mean, I shouldn't necessarily read into that as bids being lower than you otherwise might have expected or wanted?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [16]

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No. We've got a range of bids, and some of them are very, very healthy on the price side, but there's also a range of terms and conditions and doability, all right? So all of this is in the pot as we think about what we do here.

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James Byrne, Citigroup Inc, Research Division - Research Analyst [17]

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Okay. And a remark on how advanced that process is for the demerger specifically.

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [18]

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It's -- a lot of the work that we've done, I guess, is background of the demerger, so it's progressing.

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Operator [19]

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Your next question comes from Paul Butler from Crédit Suisse.

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Paul Butler, Crédit Suisse AG, Research Division - Director [20]

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I just wanted to ask about the Facility business. And we've -- I think we've seen a margin decline there, where I think in the prior corresponding period, you had about a 5% margin. And that's fallen to 4% now if I take the adjusted EBITA number you've provided. What's driving that?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [21]

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Well, we've -- as we sort of highlight here, we've had some issues in the construction arms of Nuvo and AE Smith. So that's been a particular issue for us since we've taken over the business, and we're dealing with that, of course. Just in this half, we've also had an impact, which is, I won't say timing, but it's just in the hospitality, around the number of events that have been on in our Facilities. It's not really driven by us, but the major events on -- in various venues. So that's dropped the hospitality down somewhat.

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Paul Butler, Crédit Suisse AG, Research Division - Director [22]

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So if we exclude these sort of construction-related issues, what have you seen on -- for the other businesses in there?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [23]

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Yes. We haven't seen -- look, I've not seen margins reducing on individual contracts. And it's a competitive market, of course, but I've not seen that. We continue to put investment into the business around winning work and completing. So there is some cost around that as you would expect, but nothing that we haven't expected.

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Paul Butler, Crédit Suisse AG, Research Division - Director [24]

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So going forward, are you targeting further operational improvement in this business? I mean should we be factoring in margin improvement here?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [25]

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Well, certainly, over time, that's exactly what we would expect. So we're still in the turnaround phase here. There's no doubt about that. We're still improving this business. And under some of the rocks that we pick up, there's further improvement to be done. We can't walk away from that. That's exactly the case. But the services parts of these businesses are going well and improving every day. So we're positive about it, but we're also still in the mode of addressing the issues that were inherent in the business.

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Paul Butler, Crédit Suisse AG, Research Division - Director [26]

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Okay. And in the Utilities business, you also mentioned there were some challenged contracts. Could you give us some more detail on that?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [27]

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In Utilities, that would have been the -- sorry, I'm just, excuse me, I'm just talking to Michael here. Yes. Sorry, yes. Just -- so renewables, yes?

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Paul Butler, Crédit Suisse AG, Research Division - Director [28]

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Right.

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [29]

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As we've spoken about previously.

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Paul Butler, Crédit Suisse AG, Research Division - Director [30]

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Okay. And are these challenged contracts, are they maintenance contracts? Are they construction-type contracts?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [31]

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No. Construction, construction-style contracts.

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Paul Butler, Crédit Suisse AG, Research Division - Director [32]

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Okay. So what proportion of utilities is construction versus maintenance activity, service activity?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [33]

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Yes. So into the future, it will be very small as we're sort of addressing -- the major part of that is solar, right? So as we said, we're out of solar, yes.

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Paul Butler, Crédit Suisse AG, Research Division - Director [34]

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Right. And when you were discussing the EC&M business, I mean, you obviously highlighted the issue with challenges around grid connections, and I think you listed a whole range of segments that you're not going to be bidding for work in for now. What -- I mean what areas are you open to taking on work in that business?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [35]

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Yes. So I -- as I mentioned, I'll just go through those again. Well, in that business, it will be -- we're moving the HV transmission and substations into that business, so Utilities will be purely services. So from a management perspective, that's where that will go. So it will be HV transmission and substations. It will be telecommunications. It will be wind, et cetera.

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Paul Butler, Crédit Suisse AG, Research Division - Director [36]

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Okay. And the result in Transport looked pretty attractive. Which parts of Transport are driving that margin improvement?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [37]

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Yes. So our Roads business has done very well. It's across, in particular, Australia. And our Transport projects business has also improved and going well and also our rolling stock business.

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Operator [38]

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(Operator Instructions) Your next question comes from Wei-Weng Chen from JPMorgan.

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Wei-Weng Chen, JP Morgan Chase & Co, Research Division - Research Analyst [39]

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You touched on it earlier, I just wanted to explicitly ask because I couldn't find it in your materials today. Cash conversion guidance for this full year of 40% to 50% is still applicable, yes?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [40]

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Yes. Sorry, we didn't put it into this because we normally don't guide, but we did in January. So yes, we still think that that's where we'll end up.

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Wei-Weng Chen, JP Morgan Chase & Co, Research Division - Research Analyst [41]

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Okay. Fair. And then on the NPATA guidance of $300 million, so we know Mining is expected to increase NPATA by $15 million to $20 million to $90 million to $100 million for the full year. Can you speak about the increase or the decrease in NPATA year-on-year from laundries?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [42]

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No, we're not going into that detail at this point. No.

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Wei-Weng Chen, JP Morgan Chase & Co, Research Division - Research Analyst [43]

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Yes. Okay. All right.

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [44]

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Mining, we've come out -- normally, we don't sort of break it up at this point during the year. You get to see it at the end of the year and you get to see it at the half year as to what the result is, with the exception for Mining because we came out on the -- in January with also some movement in the Mining position. And of course, we've got the sale process going.

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Wei-Weng Chen, JP Morgan Chase & Co, Research Division - Research Analyst [45]

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Yes. Okay. And then just on the factoring that you guys performed, is that on a nonrecourse basis, or is that recourse to Downer?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [46]

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Nonrecourse.

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Wei-Weng Chen, JP Morgan Chase & Co, Research Division - Research Analyst [47]

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Okay. And then just a last question for me, are you guys seeing in any of your segments issues or potential issues from the coronavirus in terms of your supply chain?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [48]

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Yes. Yes, that's -- we -- there's a few areas. We have got a large workforce, so we have a typical mix of staff, which include staff of Chinese background who visit China, particularly around Lunar New Year. So we've had those issues, not dissimilar to others. Of course, we also have a very significant joint venture with CRRC, the world's largest train builder. And we often have technical people, both from Downer and from CRRC, interchanging backwards and forwards from China, so obviously, that's curtailed at the moment.

In China, there's, because of the shutdown of many parts of the country there in terms of travel, et cetera, some parts of the CRRC supply chain is challenged at the moment. We don't think it's going to have a significant impact on production of either the Sydney Growth -- further extension of the Sydney Growth Trains or HCMT, but we watch it very closely and are managing it day-to-day.

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Operator [49]

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Your question comes from Rohan Sundram from MST.

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Rohan Sundram, MST Marquee - Gaming and Contractors Analyst [50]

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Can I just inquire as to roughly what portion of revenue would have come from nbn in terms of segment revenue?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [51]

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Yes, you could, but I don't have it right in front me here, mate, so maybe that's a question that we can take off-line.

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Rohan Sundram, MST Marquee - Gaming and Contractors Analyst [52]

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Okay. Sure. Well, what about with the margin reduction year-on-year in Utilities, was that mix? Is that because of nbn coming off, nbn being a higher-margin type of contract?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [53]

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Look, that will have some impact, but it's mainly the contracts that we were talking about before.

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Michael James Ferguson, Downer EDI Limited - CFO [54]

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Yes. The pass-through of Murra Warra is the biggest impact and some of the solar losses that were booked previously have gone through at 0 margin. So nbn is still profitable but on lower volumes. So there's not been a lot of change to the margin there.

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Rohan Sundram, MST Marquee - Gaming and Contractors Analyst [55]

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Okay. Will there be any contribution from nbn in '21? Or does it complete in full in the second half?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [56]

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There's different aspects of nbn, of course, and so I think there will still be a bit of construction, but it's now moving into maintenance phase, which we'll be in also.

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Operator [57]

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Your next question comes from Scott Ryall from Rimor Equity Research.

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Scott Ryall, Rimor Equity Research Pty Ltd - Principal [58]

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You answered the first part of my Utilities question just then, but I was wondering if you could comment on the -- how long do these renewable issues come for? And I apologize -- or keep going. And I apologize if you've answered that before, but there's a bunch of calls going on today. So I came on late.

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [59]

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No, that's okay. I know it's a fair question and a good one. Look, I would like to think it's solved in a reasonable period, but the grid issues, it is a very -- that's a very complex answer depending on where we go with baseload power. There's a whole portion of the market that don't think we need to spend a whole lot of new money on transmission, in that we have sort of micro grids. There's other parts of the market that says, no, we've got to fix our power transmission network system up, strengthen it significantly because of the distributed nature now of power generation on particularly solar, right?

So those issues exist. They are real. The regulators are doing their absolute best to try and make sure that the stability of the grid is maintained. That is proving very difficult and is impacting on the solar market and the wind, to a lesser degree, very significantly. And you see it with farms that have been built, volatile power loss factors on -- outside of what they're expecting. You're seeing it with connections into the grids, particularly where there's a lot of solar farms, et cetera. It's very, very difficult. So what that's meant is, is there's very much a hiatus of anything coming to market here. And when we look at it, we look at the risk position that we're prepared to take, particularly around connections, which we're not going to take. We're happy to do the connection work on cost reimbursable, but certainly, that's not bankable. It certainly hasn't been to date, not bankable from the financiers, and the developers don't want to take the risk, so why would the poor old contractor. We've been there before. So we're not doing that.

And then I think we've still got a series of issues with equipment, particularly inverters. So I'm sure that, that will be solved, and it will be solved in -- as fast as they can because it's very important. But when I look out in the next couple of years, I think it's very challenging. So that's -- and I should say, that's why we're focusing our attention into an area that we are market leaders very much, and that is transmission and substations, et cetera. Because they will be -- to get this right and to get our grid available for uptake of further renewables, that's the work that needs to be done. We're very good in that market, and that's where we're focusing our attention.

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Scott Ryall, Rimor Equity Research Pty Ltd - Principal [60]

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Yes. Okay. I understand that. And I'll refrain from political comment on it as well. But the -- I guess in terms of your specific Utilities business, obviously, the various renewables contracts have been a -- quite a big drag on your margins in this period. What I'm trying to do is get a sense of how long you think you'll be having revenue at almost 0 margin, as opposed to not having so much business and that margin pressure going away, I guess. Is it isolated for this year?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [61]

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Yes, we're just about out of it, right? So whilst we've still got -- we've got a couple on track, I don't expect those to go poorly. And we've got good risk positions on those. So we've got Bango wind farm, and that will be finished in May '21. But I expect those to be profitable -- or that to be profitable. We've got Limondale that will finish in June of this year. Again, we expect that to be profitable. Chichester, which is a large HV substation and also a solar farm, the solar farm's about a bit over $100 million there, I think, that will finish in May '21. And again, the connection there -- the connection risk there is that particular system is not on the grid. It's on its own grid. So the connection risk there is not large, and that will be finished by May '21. So very short term, and we expect to make money off those.

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Scott Ryall, Rimor Equity Research Pty Ltd - Principal [62]

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Yes. And could you just comment then, just while you talk about Chichester. The opportunity, I would have thought, is, as you say, the ones that don't require connection and those being built for specific customers or groups of customers in remote areas. Does your ability to win that business go away if you sell your Mining services business?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [63]

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No.

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Scott Ryall, Rimor Equity Research Pty Ltd - Principal [64]

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Or does it get impacted?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [65]

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Well, at the moment, I said that we -- there's not too many of those, can I just say, for a start. So we're not talking about a big number of things that aren't connecting into the grid. The biggest issue in solar is our risk positions, not the market position at the moment. And the market -- there is no market position because there's no one closing solar deals, and that's very difficult. But our Mining, look, the crossover of our contract Mining division with -- particularly with the construction is not substantial.

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Operator [66]

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Your next question comes from Alex Karpos from Goldman Sachs.

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Alexander George Philip Karpos, Goldman Sachs Group Inc., Research Division - Equity Analyst [67]

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Just a quick one to start. You've mentioned the -- detailed the issues on Nuvo and AE Smith impacting Spotless in the period. Can you just give more color there? Any specific projects that were driving this or any other factors to be aware of?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [68]

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Look, these are large-scale -- all these are building projects where they've taken a position to construct the mechanical, electrical, in some cases, positions on buildings. Now I'm not suggesting that Nuvo and AE Smith aren't good at their jobs. They are. But certain things have happened in those particular buildings. There's been a lot of changes, and what that means is actually getting revenue out of your clients in those situations is tough. So we've got Royal [Adelaide] Hospital. There's 2 or 3 others.

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Alexander George Philip Karpos, Goldman Sachs Group Inc., Research Division - Equity Analyst [69]

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Got it. And dovetailing off that, how long should we expect the kind of impacts here to weigh on margins for Spotless? And longer run, should we still expect to get to that roughly 5% margin rate?

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [70]

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Yes, look, I expect those issues to be closed out certainly in this financial year. We are working very hard so that we don't repeat these in Spotless, and this part of Spotless doesn't repeat. We're doing very well in other parts of Spotless. So we've got to curb those issues. And there's a lot of effort. We've put a lot of very, very, very good Downer people into these businesses. And we also have other people coming in to make sure that this business is a very good performer rather than what's happened in the past.

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Operator [71]

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We are now closing the question-and-answer session. I will now hand back to Mr. Fenn for closing remarks.

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Grant Anthony Fenn, Downer EDI Limited - MD, CEO & Director [72]

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Yes, thank you, Rachel. Look, thanks very much for coming on. I know it's a really busy day of results. And if you have additional questions that you want answered, please come through to our Investor Relations team with Michael. For those of you that are the various one-on-ones, we'll see you shortly. Thank you.