North American Construction Group Ltd

Good morning, ladies and gentlemen. Welcome to the North American Construction Group's earnings call for the first quarter ending March 31, 2020. At this time, all participants are in a listen-only mode. Following management's prepared remarks, there will be an opportunity for analysts, shareholders, and bondholders to ask questions. The media may monitor this call-in listen-only. They are free to quote any member of management, but they are asked not to quote remarks from any other participant without participant's permission. The company wishes to confirm that today's comments contain forward-looking information that actual results could differ materially from a conclusion, forecast, or projection contained in that forward-looking information. Certain material factors or assumptions were applied in drawing conclusions or in making forecasts or projections that are reflected in this forward-looking information. Additional information about these material factors is contained in the company's most recent management discussion and analysis, which is available on CDAR and EDGAR, as well as the company's website at nacg.ca. I will now turn the conference over to Martin Farren, Chairman and CEO. Please go ahead, sir.

Thanks, and a very good morning to everyone. Following on from three years of solid growth in 2017 to 2019, we entered 2020 full of optimism and enthusiasm. We were looking forward to another successful year based on plenty of work in hand and a strong backlog for the medium term. We expended our growth capital in January on new assets to support a key customer of the curl mine on firm contractual terms. We pressed on with our front-end loaded sustainable capital plan for the year and decided to call a convertible venture which had been deeply in the money for many months. Then, around March 15th, the gravity of the COVID-19 virus outbreak, combined with an oil price war, began to weigh heavily on our business. It would be easy to consign our Q1 performance to the record books with a who cares, that was then and this is now attitude, However, I will look back on it as a quarter went far in all cylinders. My amazing team of employees put up numbers that I always will be immensely proud of. In fact, if not for the deteriorating business conditions towards the end of the quarter, we would likely have put up an adjusted EBITDA number in the mid-60s, an adjusted EPS of close to $1. I will now hand the call over to Joseph Lambert, our President and Chief Operating Officer, to take us through the safety and other operational highlights shown on slides two to four. Jason Veenstra, our CFO, will then cover financial highlights from slides five to eight before I talk about our outlook using slide nine. Over to you, Joe.

Thanks, Martin. Looking at slide two, Our unwavering commitment to safety continued through Q1 and into the onset of the virus, where we further demonstrate that even with increasing workforce hours and winter conditions, we can maintain our industry-leading safety results. Starting March and continuing into Q2, our business has naturally felt the impact of this pandemic and is demonstrating our commitment to the health of our employees physically, emotionally, and financially. Physical health is protective of our policies and procedures, ensuring workplace hygiene and accommodating physical distancing and work from home. Emotional health is being bolstered through strong support from both our internal human resources team and external assistance programs. And finally, financially, through doing everything in our control to minimize layoffs during this pandemic. If there is anything positive to draw from this experience, is the heightened awareness and commitment to continuously improving employee health. Moving on to slide three with our business update, we have quite the contrast of a Q1 demonstration of what we can achieve in a stable market and normal weather pattern to that of an unanticipated, unusual Q2 opportunity to show our business resilience and ability to adjust quickly to the most volatile markets. In boxing terms, We certainly prefer to show our ring prowess and punching power like we did during the majority Q1 to that of demonstrating our ability to take a punch here in Q2. But in an inherently cyclical commodity business, both skills are required for sustainable business success. Moving on from the bottom of slide three and into slide four, you'll see what we believe to be characteristics of a strong corporate culture and that our core strategy remains intact and we have adjusted the priority on the objectives to match current business climate. We expect our customer first mentality, safe low cost provider reputation and client alliance relationships put us as a front runner in working with our long term oil sands clients to reduce costs, improve efficiency and weather this low oil price environment. The need for lower cost and improved efficiency only further reinforces the value of both our internal and external maintenance services. Our new component rebuild facility got up and running in Q1, and we will be ramping up through Q2 to provide low cost, high quality components, initially supporting our internal needs, and growing into next year with capacity for additional external revenue. Machine health is only second to employee health in our overall business success, and the value of these maintenance services only increases during economic downturns. Our oil sands fleet utilizations will obviously drop from our high Q1 levels and we're aggressively marketing, bidding, and pursuing work in other resource and geographic areas using our own business development and also through our NUNA group of companies. The virus impacts have not deferred our expected Q2 startup schedule for assuming operational management of a Texas lignite mine. I look forward to telling you all about our successful transition on our next quarterly call. To close out my brief comments, I'd like to take this opportunity to personally thank all of our employees, clients, shareholders, and other stakeholders that continue to support and show confidence in our business. We will again prove the naysayers wrong and demonstrate we can take a one-two punch of COVID and oil price and recover stronger than ever. The consistency of challenging events in the 12 plus years I've been a North American is an understood reality in the mining and construction industries. but our persistence and resilience have given us the abs of steel to absorb the impact for these such occasions. With that, I'll turn the call over to Jason for details on our financial health.

Thanks, Joe, and good morning, everyone. So I'm starting on slide five here with our top line. Revenue for the quarter of $199 million was $12 million above last year's Q1, despite the impact we realized at our mine sites in the latter half of March. As Joe mentioned, we started the year strong, which was a continuation of the momentum we had from Q4 2019. All business lines were positive year over year, with incremental organic growth being the dominant factor for the first time in a while. The posted quarter-over-quarter organic growth of 10% was primarily achieved through higher equipment availability and utilization. The 10% increase is inclusive of the COVID-19 revenue step down in the latter half of March. Further contributors to the year-over-year revenue increase were the partial quarter contribution of growth capital equipment purchased early in the quarter, as well as the coal mine management contract which commenced in late Q2 2019. Offsetting these revenue growth factors was the change in method of reporting for NUNA, which now classifies its revenue and equity earnings, and the Q4 2019 completion of work at the Highland Valley copper mine. Our share of NUNA revenue during a fairly quiet quarter was $10 million and is disclosed in the notes to the financial statements. Gross profit margin of 17.4% reflected a strong operating quarter as standard weather conditions and scopes of work provided for favorable operating conditions. Furthermore, the now fully integrated fleet lowered overall equipment idle time during this year's winter season and equipment maintenance costs were consistent with expectation. Offsetting these positives, the posted margin includes the impact of COVID-19 which started affecting operations in mid-March and resulted in reduced volumes and certain demobilization costs, as well as restricted site access, changes in operating protocols, and increased frequency of workforce health monitoring. Excluding the impact of COVID-19, normalized gross profit was over 20%, which properly reflects the run rate we were on prior to mid-March. For reference, the Q1 2019 gross margin of 15.9% was negatively affected by an early spring breakup and the completion of two legacy contracts at the Fort Hills mine. Depreciation of 16.3% was generally consistent with last year's rate of 15.7% on high component activity in the first quarter, but was unusually affected by a write-down of facilities in Fort McMurray for $1.8 million, which has seen market values drastically affected by the COVID-19 pandemic. Excluding this write-down, depreciation was 15.3% of revenue and trending as expected. Below gross profit, general and administrative expense excluding stock-based compensation was $8.7 million, or 4.4% of revenue. As mentioned in the past, this percentage level is our generally expected run rate and reflects the operating leverage in our heavy equipment business, which requires minimal incremental G&A when adding top line revenue. Before we look at net income and EPS, I'll touch on the strong gross adjusted EBITDA of $59.9 million. The adjusted EBITDA margin of 30.1% in the quarter benefited, as mentioned, by the favorable operating conditions and stable G&A, as well as the diversified businesses of external maintenance and mine management services. Below adjusted EBITDA of $60 million, interest expense of $5.5 million for the quarter and cash-related interest expense of $5.1 million were the same as both Q4 and Q3 2019 and relate to the debt financings we've put in place to fund growth. We remain very happy with the credit facility and capital lease financing rates given we operated at an overall cost of debt well below 5% during the first quarter. Below interest, we have routine income taxes of $6 million which gets us to adjusted net earnings of $18 million compared to $12.7 million last year. This $5.3 million year over year improvement can be very quickly summarized by the $5.4 million increase in adjusted EBIT as taxes and interest were consistent year over year. Adjusted EPS of $0.70 is the compilation of all the commentary provided and is a 37% increase year over year on the 7% year over year revenue increase. For clarity, we have not adjusted EPS for the more general operational impacts of COVID-19, which took an approximate range of 15 to 20 cents off our Q1 earnings. Moving on to slide 6, I'll summarize our cash flow. Cash generated from operations in the quarter prior to working capital was $54 million compared to the $45 million last year. Our front-loaded, sustaining net capital expenditures totaled $38 million, which was in line with our internal budget and expectation prior to the reductions which we will touch on later. Free cash flow of $9 million was also consistent with internal expectation and was impacted by both first quarter typical impacts of working capital and capital maintenance spending. Moving to our balance sheet on slide seven, liquidity of 108 million has remained relatively stable over the past three years as we put appropriate debt instruments in place to support our business and we don't see that changing. On a trailing 12 month basis, our senior leverage ratio as calculated by our credit facility was two times, well below our covenant of three. The increase of $65 million in senior debt was on account of two specific factors. First, a prudent and intentional increase of cash on our balance sheet of $33 million, which of course has no impact on net debt. And second, the $26 million of lease financing for growth capital related to a large hydraulic shovel and related assets we commissioned in January. To close out, I'll briefly touch on the capital returns that form the foundation of the business model. As at March 31, return on invested capital was 9.9%. Invested capital was $626 million. Trailing 12 adjusted EBIT of $76 million is the basis for the numerator and generated the 9.9%, which continues an impressive and the four-year trend. ROIC will be a key performance indicator as we manage both our operations and our balance sheet through this current situation. With those financial comments, I'll pass the call back over to Martin.

Okay, thanks, Jason. And now turning to slide nine to talk about our outlook, which for the time being is only shown for quarter two. We are close to being able to provide a full year outlook but need to conclude some discussions with our key Allsans customers first. Now the COVID-19 pandemic is having two main impacts on our Allsans related business which accounted for 75% of our EBIT in 2019. Firstly, it is causing a serious health threat to be managed very carefully with usually thousands of workers on each of the mine sites where we operate. Therefore, the best way for our customers to deal with this is to reduce workforce levels to the absolute minimum. This allows for better social distancing and cuts back dramatically on crew changes that can bring the virus onto site. This situation has meant that we have been excluded from one mine site since mid-March, which has disrupted our overburden operations there. We currently expect, though, to resume those operations by mid to late May and continue as normal. The second major impact of the pandemic is that it has caused a worldwide demand collapse for oil at a time when Saudi Arabia and Russia decided to provide a supply surge. The time-honored mantra that the best cure for a low oil price is a low oil price cannot work unless demand begins to normalize and recently announced supply cuts kick in. For the first time, we've seen production shut in at an all-sales mine, as producers simply run out of physical storage for the product. While that mine operates with just one production train, the need for our services is limited. However, our contract structure contemplated these types of occurrences. and the customer has the ability to move the committed volumes between operations. Should this be the case, we expect our base production volumes to remain intact, although there will be a time lag due to the need to relocate equipment. As I mentioned earlier, this is one of the key Allsans customer discussions we need to conclude prior to being able to provide a full year outlook. At another mine site, our client has announced an early and extended maintenance turnaround from early May until late June, when again the need for our services will be reduced on a temporary basis. So all in all, it appears that most of the disruption to our business will be felt in Q2, and we expect our all-sounds operations to normalize as the year progresses. We currently expect NUNA to be less impacted with their active seasonal work just getting started. Also, we remain on track to commence the operation of a second coal mine by the middle of the year, as Joe mentioned. Despite all the disruption to our all-sales business as just described, we still expect to be profitable and free cash flow positive for Q2. Although EBITDA will be down by 35% from Q2 of 2019, sustained capital will be reduced by 50%. which really demonstrates the variability of our cost and capital structure. One point of outlook that I can provide now is that for the second half of 2020, sustaining capital will likely be limited to $20 million. Although Q2 2020 will be our weakest quarter since the wildfire dominated second quarter of 2016, we bounced back strongly from that situation. and again, as Joe stated, we fully expect to do the same this time around. One near-term catalyst for us will probably be our core competence of very cost-effectively rebuilding whole equipment items and key components. We've invested significantly in facilities and personnel for this rebuild strategy over the last few years. It was interesting to hear from the Caterpillar equipment dealer in the east of the country on their earnest call state that there has been a recent surge in demand for used equipment, especially rebuilds, which is likely to endure for some time. The same thing will occur here in the West, and we will excel in that environment. With that, I'd now like to hand the call back to Jacqueline, the operator, for the Q&A session. Thanks.

Thank you. To ask a question, please press star one on your touch-tone phone If you wish to withdraw your question, you can press the pound sign. Once you have completed your questions and would like to return to the queue, please press star 1. After a brief pause, we will begin the Q&A session. Your first question comes from Erin McNeil from T&A Securities. Your line is open.

Hey, morning guys. Hope you and your families are doing well. Syncrude has announced that it's going to shut in some production. I believe that some of this relates to turnaround activity, but I guess the question for me is, does this positively or negatively impact your ability to renew the MSA that expires in 2021?

I don't honestly think that it'll make any difference. We've gone back to work on that site shortly. We've got committed volumes for the rest of the year. We plan to continue discussions about extending our MSA and volume commitments going forward. I don't see this maintenance turnaround impacting that to be honest.

You mentioned in your prepared remarks that NUNA will be less impacted, but as we look towards Q3, and obviously without getting into any specifics, can you maybe expand on that and give us an update on maybe some of the projects Nuna's been bidding on and at least on an anecdotal basis maybe talk about what we might expect for its seasonally strongest quarter of the year?

Yeah, I'll comment in general and maybe Joe can comment on specific projects but we are expecting Nuna to have a similar year to last year and as you recall they're The biggest quarter is always Q3 due to seasonality, of course, in the north. So we expect a very similar year from them in 2020, as I just mentioned. Joe, any specific projects you'd like to comment on?

We've had success with NUNA and gold projects in Ontario already for summer construction, and we're actively bidding more. So the gold marketplace is actually very active. and a lot of summer work including like tails dam raises and there's some new mine site opportunities coming up that NUNA is pursuing and believe they'll have great opportunity and we're actually partnering with them on one of them.

Great, thanks guys. I'll leave it there. Thank you.

Again, if you would like to ask a question, please press star 1 on your telephone keypad. The next question comes from Dave Billock. from CABC Markets. Your line is open.

Morning, everyone. Morning. So I guess maybe just starting off, and you kind of talked about in your prepared remarks that a lot of these client conversations are still ongoing, but in those conversations, can you share if there have been any sort of talk of pricing discounts, especially on contracted work at this stage?

Yeah, of course, you know, our customers have been through the shredder between the virus and low oil prices. So, you know, they're looking for help from us. And, you know, our business model is all about providing low cost solutions, no matter, you know, the environment. So we're trying to help, you know, we're trying to reduce our costs, pass that on to them, do things differently. all the usual things that we normally do. I think they really appreciate our support and we'll continue to help them as best we can because it's a tough time for them, for sure.

Understood. I guess moving over to, for some of the mine operators that have curtailed production Have you seen them redeploying their excess ore hauling equipment to overburden activities?

Joe, can you comment on that?

I didn't hear the question very well, Dan. Would you repeat it?

Yeah, for sure. Absolutely. Just for some of the mine operators that have curtailed production, have any of them redeployed excess ore hauling equipment to overburden removal?

I'm assuming some of them might be moving overburdened. For the most part, we haven't seen any equipment leaving sites or moving anywhere, but they're running their existing mine sites in places where they've reduced the ore feed. I believe they would switch and move a bit more overburdened, but I think it's a timing issue, Dane, where these are predominantly maintenance turnarounds being brought forward. So in their overall annual mine plan, these volumes of overburden or movement now, they would have been doing next quarter. And so I don't think it changes their overall overburden plans for the year. I think it changes what it was going to be in Q2 versus Q3.

Understood. Okay, that's very helpful. Thank you.

Yeah, Jane, we have committed volumes on many of these sites also, right? So we expect to complete those volumes this year. Right.

Okay. That's good. Thank you. That's helpful. Beyond Q2, how are you thinking about the rate of shared buybacks and would dialing that allocation up or down largely be a function of underlying free cash flow?

So as of today, Dane, we're close to 50% through the NCIB. So depending on what happens to the rest of the and a quarter here we could finish it. So it just depends on price and obviously we're buying every day at present with a stock in the sixes. So glad to be doing that and we'll keep going until the NCIP limit is reached.

Understood. Okay, that's helpful. Thank you. And then last question for me which is probably for Jason. How should we be thinking about changes in working capital specific to Q2 as well as for the balance of the year?

We should be pretty flat working capital wise given when the pandemic kind of hit us middle of March we kind of did collect a lot of accounts receivable we have a pretty quick turnaround and so I think if this hit would have been later in March it might have been a more pronounced I see a slight pickup in working capital in Q2 and then pretty flat coming out and obviously if we have a big Q4 we could see a bit of a build in accounts receivable but I really don't see much from an accounts receivable and payables perspective given the timing. A benefit we will see which will contribute to the slight improvement in Q2 is we will see a reduction in inventory, parts inventory, just with the natural flow of the business with the top line coming down.

Understood. Okay, great. That's all from me. I appreciate the color, guys. Congrats on a good quarter and hope everyone's staying safe.

Thank you.

Again, if you would like to ask a question, please press star 1 on your telephone keypad Your next question comes from Devon Schilling from PI. Your line is open.

Hi, guys. First off, congrats on the strong quarter here despite the challenging situation we're in right now. Thanks, Devon. Yeah, I was hoping if you guys could provide a bit of color here. You're talking about this one particular mine site where you're going to be entering some discussions of possibly redeploying some equipment. If talks there, I guess, fail to realize you guys being able to redeploy all the equipment that you were originally expecting, what's kind of the opportunity here to potentially re-deploy some of this equipment to go work with NUNA here? I see you guys added some equipment in Q1 for this whole project, so just trying to get a bit more color there on the opportunity.

We're always looking at sharing equipment with Nuna and Devin. Their needs are smaller than ours in terms of size. The opportunity is somewhat limited, but we're always looking at it. They're bidding some projects that require incremental equipment, so of course it will make sense for us to try and supply that from our fleet. We'll be doing that in the normal course. I'm sure it will help us as the year progresses.

Okay, that's great. I guess on another note here, it's safe to assume that the growth capex plans that were originally in place for this year are that wrapped up. There's nothing left in the rest of the year outside of this sustaining capital that you've just recently mentioned.

Yeah, that's correct. We expanded the growth capital very early in the year as planned. We bought a shovel and some excavators which are still operating on very favorable terms to us. So it's a good investment. Okay, great. I'll jump back in the queue for now. Thanks. Thank you, Devin.

Your next question comes from Richard Durene from Longport Partners. Your line is open.

Good morning. What percent of sales came from backlog? I didn't get a chance to go into the queue and see what backlog is. What was the exiting backlog?

Jason? We're at a billion dollars still, just under, around to a billion. It was about half of revenue in the first quarter, just off the top of my head, was related to backlog. We do have it in our MD&A.

And do you expect because of the virus and the lagging effects that more of 20s revenues will come out of backlog versus normal, whatever normal is these days?

Yeah, that makes sense, doesn't it? You know, I think, you know, the spot work that we do to make up the other 50% of our normal efforts will decrease. So our backlog will, you know, account for a large proportion of our revenues.

And then same way, you know, with the second quarter being the slow quarter, and adjusting for that. Your equipment utilization now, you also have to adjust for how fast breakup is and all that, but again, just a feel for where you are relative to normal in equipment utilization.

Joe, you want to take a shot of that?

Yeah, obviously I mentioned in my comments there that Q1 we were higher than normal. Obviously Q1 is going to be low. For the remainder of the year, what I'd say is that it'll be less than what we previously experienced. One thing I'd say is that it's more weighted towards the larger equipment. So when Martin was talking about backlog, most of the backlog is related to our larger trucks and shovels. And so even with You'll have a lower utilization, but it will be... I don't know how to put the numbers to that, but the equipment that is running is the larger equipment. So it will be higher revenue generated per hour equipment.

Right. Okay. That makes sense. And when you mentioned... Your committed volumes will get finished this year. From what you were just saying, it sounds like you'll be using them up somewhat faster than was the plan for 20.

Do I have? The committed volumes are annual commitments, Richard. The contract's don't have an ability. They can overproduce the committed volume in 2020, but there's not an ability to do 2021 volumes in 2020. They're distinctly separated into annual committed volumes.

Oh, I see. Okay. Good. Thank you very much.

Thank you, Richard.

Thank you, Richard.

There are no further questions at this time. I'll turn the call back over to your presenters.

Thanks Jacqueline and thanks to everybody else for joining us today. We look forward to talking to you again in the near future. All the best. Stay safe.