North American Construction Group Ltd

Good morning, ladies and gentlemen. Welcome to the North American Construction Group earnings call for the second quarter ended June 30, 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 a listen-only mode. They are free to quote any member of management, but they are asked not to quote remarks from any other participant without that participant's permission. Company's wishes to confirm that today's comments contain forward-looking information and 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 the 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 SADAR and EDGAR as well as the company's website at nacg.ca. I will now turn the conference over to Martin Farron, Chairman and CEO, please go ahead.

Thanks and a very good morning to everyone. As one of the very few companies that provided any sort of outlook for the second quarter, We were determined to both minimize the impact of the COVID-19 pandemic on the health and safety of our employees and mitigate its effect on our business performance. Therefore, I am pleased that good headway was made on both objectives as we also helped our customers manage the virus risk on their work sites. I am especially proud that in typical NACG fashion, we applied a fast and firm restraint to our costs. Eliminating all discretionary spending and very closely managing all third-party support expenses. This close stewardship of costs rather than the government federal wage subsidies rewarded us with a nicely profitable quarter despite a greater than 60% sequential fall in our revenues and the toughest operating environment we have ever experienced. We also hit our free cash flow target, which along with the call of a convertible debenture, allowed us to reduce net debt by over 10%. With that introduction, I will now hand over the call to Joe 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 nine. before I talk about our outlook using slide 10. So over to you, Joe.

Thanks, Martin. Looking at slide two, I am pleased to report that our team promptly responded to pandemic and put in place safeguards to ensure workplace hygiene, physical distancing, and isolation and contact protocols while maintaining our industry-leading safety results. When you consider our operating environment and the use of camps, Bussing and Transportation Needs, Sanitizing of Equipment and Offices, and Adjusting to Communicate with Over 900 Employees While Maintaining Social Distance, the speed, efficiency, and effectiveness of how our team responded was simply stated excellent. We will continue our diligence in both workplace hygiene and safety to ensure everyone gets home safe. Moving on to the business update on slide three, Faced with a previously unimaginable scenario of production cutbacks, negative oil prices, and a worldwide pandemic, our operations, maintenance, and support teams demonstrated the resilience of our company by rolling up their sleeves and getting to work. Ensuring the health of our workers was critical to us, and then we immediately turned to addressing our rapidly changing customer needs. Our strong oil sands customer alliances combined with our safe and low-cost operations allowed us to identify opportunities to increase fleet usage and efficiency on one site while demobilizing completely off another, allowing for the mutual benefit of improved fleet utilization and reduced customer costs. Similarly, in our startup of a coal management contract in Texas, we were not only able to achieve a smooth and orderly transition, we were able to complete on time and add significant cost savings. On time and under budget are always good ways to start a project, but achievement during pandemic and across borders is a true testament to the strength of this team. While we rapidly adjusted to our changing environment, our corporate strategy remains intact. Our focus on strong long-term relationships in oil sands showed that the mutual benefits we expect from improved customer alliances. We continue to have tender opportunities and are optimistic on potential awards before the end of the year, that will provide increased geographic and commodity diversity. We continue to increase vertical integration and external sales potential of our equipment maintenance business. Lastly, we react promptly with our capital spend and cost restraints to ensure we live within our means. Moving on from the bottom of slide three and into slide four, you'll see the operational plan for 2020 remains unchanged from what was presented at the end of last quarter. We expect our customer first mentality, safe low cost provider reputation, and client alliance relationships will put us at the front of the client callback as we begin to ramp up out of the Q2 business trough. The need for lower cost and improved efficiency only further enforces the value of both our internal and external maintenance services. Our new component rebuild facility got up and running in Q1, improved cost and efficiency during Q2, and we'll continue ramping up through year end to provide low cost, high quality components, initially supporting our internal needs and growing into next year with capacity for additional external revenue. Along with the lower cost component rebuilds, we continue to perform Second Life whole machine rebuilds and have completed our second ultra class truck, which is being commissioned this week. These whole machine component rebuilds have an immediate impact on reduced sustaining capital spend, but the income statement benefits will show more as they depreciate over the whole of the asset life and those further benefits increase the more units we build. To date, we have completed whole machine rebuild on a couple dozen or so of our larger machines and have current capacity to meet about 10% of our internal component demand. So we're just getting started. To close out my brief comments, I'd like to take this opportunity to personally thank all of our employees, clients, shareholders, partners, and other stakeholders that continue to support and show confidence in our business. I believe our results continue to prove the naysayers wrong and demonstrate the resilience and adaptability of our business. In response to those doomsday theorists we heard from in March and April, Mark Twain said it best when he said, the report of my death was an exaggeration. With that, I'll turn the call over to Jason for details on our financial health.

Thanks, Joe, and good morning everyone. I'll start with our top line on slide five. Revenue for the quarter of $71 million was $100 million below last year's Q2 as we suffered the full impact of COVID-19 in the quarter. Our quarter was dominated by site access issues and, as Joe mentioned, the correlated demobilization and mobilization that comes with that. Demobilization and subsequent mobilization are usually done in a scheduled manner. but the pandemic required quick execution and much of our quarter was spent responding to changing situations at the mine sites. All said, revenue decreased by 60% from Q2 2019. When just looking at 2020, we were down by 64% from the first quarter and then looking at specific months, we are more than 70% down in early Q2 from revenue levels in January and February. While the resiliency of the oil sands mines was on full display during Q2 as production was not halted, the access restrictions did have a serious revenue impact for our quarter. Of specific note, bitumen throughput at the Fort Hills mine was reduced in Q2 2020, which resulted in lower demand and our equipment being transitioned to the Millennium mine. The time required for the transition meant less revenue in the quarter. The NUNA Group of Companies was less impacted by the pandemic but did experience general delays in site access as they commenced their busy season in June. Lastly on revenue, external maintenance and our mine management contracts were not noticeably impacted and partially offset the year-over-year decreases as these business lines continue to grow. Gross profit margin of 30% reflected an efficient operational quarter, albeit on a much smaller scale than originally anticipated and under unprecedented circumstances. On-site operations personnel reacted swiftly to the realities facing our customers and costs incurred were exclusively reserved for specifically requested support and service. Required heavy equipment was operated effectively with minimal idle time and immediate discretionary cost constraints were put in place to minimize employee layoffs while maintaining positive profit levels. Included in the gross profit margin was depreciation of 16.3% of revenue for the quarter. While still generally comparable to the expected run rate of 14%, The depreciation percentage was slightly higher due to the exaggerated impact of straight line depreciation on fixed assets during such a low revenue quarter. Direct general and administrative expenses in the quarter were $3.5 million, equivalent to 4.9% of revenue. This spending was lower than Q2 2019 spending of $6 million, but higher than the previous 3.4% of revenue. The 4.9% illustrates the low revenue in the quarter but was aided by austerity measures put in place in late Q1. The primary initiatives of the G&A reduction were mandated reduced work hours and the complete halt of all discretionary and non-essential spending. Adjusted EBITDA of $31.9 million was a $5.2 million decrease from Q2 2019. and reflects the wide-reaching impact of the COVID-19 pandemic offset by our strict discipline to limit indirect project costs and G&A spending to essential costs only. Adjusted earnings per share for the quarter of 45 cents was comparable to the prior year based on the provided commentary plus the temporary wage subsidy program, which I'll touch on in a moment. as well as lower interest costs. Cash-related interest expense for the quarter was $3.7 million, representing an average interest rate of 3.6% as we continue to benefit from both reductions in posted rates as well as competitive rates in equipment financing we were able to secure in the quarter. Lastly of note, adjusted EPS was impacted for the and David Brunetta. This is a full quarter by the April 6 issuance of 4.6 million common shares as part of the redemption of our 5.5% debentures. This issuance was offset by share purchases of 1.2 million shares. These transactions resulted in our weighted average number of common shares for the quarter being 28.8 million shares versus the Q1 average of 25.6 million shares. We'll touch briefly on the Canada Emergency Wage Subsidy with a summary provided on slide. As disclosed in detail in our financial statements, net income includes approximately $11 million of salary and wage subsidies received under the program. These subsidies are presented with their correlated employee expenses in both project and equipment costs, as well as general and administrative expenses. These subsidies reimbursed us for a portion of the wages we paid and greatly helped in our efforts in retaining our workforce. As noted in the simplified slide, the program essentially reimbursed us for 20% of the all-in employee costs, which in turn allowed us to maintain 20% of the headcount level we may have otherwise had to reduce either temporarily or permanently. From our perspective, the program has worked effectively and better positions us moving forward as we look to ramp up activity levels. Moving to slide seven, I'll summarize our cash flow. Stated simply, free cash flow in the quarter of $11 million was the compilation of the adjusted EBITDA of $32 million offset by sustaining capital of 14, cash interest paid of 4 million, and the timing impact of changes in other balance sheet items. Sustaining maintenance capital was heavily constrained in the quarter based on the much discussed macro environment and consistent with cost of sales validates the variable nature of our capital spending program. As referenced on the slide, Free cash flow was heavily impacted in the quarter by the build in both capital inventory and capital work in process as we continue to advance our internal component rebuilding processes. Moving to our balance sheet on slide eight. Liquidity of $135 million is the mid-year watermark based on steady free cash flow plus the impact of approximately $25 million of additional equipment financing in Q2. This equipment financing was secured at low interest rates and allowed us to increase liquidity as funding was directed to the credit facility. On a trailing 12 month basis, our senior leverage, which includes the equipment financing, was 2.1 times, well below our covenant of 3.0. And to close out on slide eight, slide nine, I'll briefly touch on the capital returns. As at June, return on invested capital was 10.2%. Impressively, this is actually slightly up from the 9.9% posted in Q1 as adjusted EBIT for the quarter of $19.5 million was up year over year. And with those financial comments, I'll pass the call back to Martin.

Thanks, Jason. And now turning to slide 10 to talk about our outlook, which covers the balance of the year. As I explained last time, our customers either limited or denied us access to some of our core Ausans mine sites starting around mid-March. This allowed them to manage virus risk more effectively by either operating with the fewest people possible were bringing forward maintenance turnaround activity. Also, for the first time, we saw production cut back at an all-signs mine as physical storage for the product became a real issue, with the virus also creating a sharp decline in oil demand. While our 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 had the ability to move the committed volumes between operations. This occurred during the quarter, but there was a two-month time lag as we needed to negotiate a contract amendment and transfer the equipment fleet from the first site to the second. Therefore, as we predicted, most of the disruption to our business was felt in Q2, and we still anticipate that our all-signs operations will normalize as the year progresses. Nuna was less impacted, with their active seasonal work just getting started late in the quarter. Also, as Joe mentioned, we commenced the operation of a second coal mine by the middle of the year. Our EBITDA range for the year is now $140 to $170 million, and we expect to produce another $20 to $40 million of free cash flow in the second half of the year, with most of that likely to occur in Q4. Therefore, free cash flow could be more than $30 million higher than last year, and adjusted EPS about flat, which would be quite an achievement in this extraordinarily tough year. We are also making good progress in our quest to diversify our business, such that we still expect to have around 40% of our EBIT come from outside the all signs as early as 2022. We hope to have positive news on that front in this third quarter. I will end with a comment on our stock price, being that we have produced $1.14 of adjusted earnings per share in the first six months of the year, with over half of that time being ravaged by the virus pandemic. We have clearly demonstrated the resilience of our business model, our ability to cut spending to protect profit margins and free cash flow, in the face of extreme adversity. Yet our stock price has a seven pound line. I will now hand the call back to the operator, Denise, for the Q&A session. Thanks.

Ladies and gentlemen, to ask a question, please press star then the number one on your telephone keypad. We'll pause for just a moment to compile a Q&A roster. Your first question comes from Yuri Link with Canaccord Genuity. Your line is open.

Good morning, guys. Morning, Yuri. Morning, Yuri. Martin or Joe, just can you give us some sense of the revenue recovery cadence as we work through the quarter and any early observations on July? Joe, you want to take that?

Yeah, I think we see our sites coming back other than the one where the one train was shut down. So where the train was shut down at the Ford Hills site, the public information has said that it was going to be shut down through 2021. And recent announcements from the owners suggest it could be earlier. We're still anticipating that. being the public date of 2021. But we do see other sites that have brought turnarounds forward starting to ramp up just starting this month and we think can be back to I'd say close to full levels by Q4. And so we kind of expect that ramp up to occur overall across the business from really right now through October and then We think our winter season is going to be as busy as all our winter seasons where we're pretty fully engaged. Does that cover what you're looking for?

Yeah, that's good. And then I guess on the guidance that you've issued, does the EBITDA guidance include further wage subsidy benefits above and beyond the $11 million received in the quarter?

Yeah, it does. We're hoping or expecting a similar amount in the six months, right? So in Q3 and Q4. But I'd say, and Jason explained it well, that we're spending a lot of our money retaining people. Our business is recovering, but we still have a lot more people than we need for the workload. So it's really a retention tool that's working very effectively, but there's costs associated with it, right? So... Jason William Veenstra

We still expect to qualify. Given how far qualified we did in the 60-70% range, we still will qualify for the 30%. We are still getting through some of the nuances of the new qualification, but it seems actually easier to qualify periods 5 and onwards. We expect to qualify and our estimate, like Martin said, is about the same as Your next question comes from Dane Billick with CIBC World Markets.

Your line is open.

So I guess maybe just starting off in activity in the back half of the year, is there anything you can share on how you expect activity to ramp? I guess what I'm trying to get at, is it fair to think Q4 will be busier than Q3 from an EBITDA perspective, excluding any weather impacts?

Joel, you take it down again if you don't mind.

Yeah, I think it's... That would be our normal. I think that's going to be the same even with the ramp up that we'll have a slightly higher Q3 or Q4 than Q3.

Okay. And then maybe just following up on the same thing, you know, you mentioned Q3 free cash flow is going to be closer to a break-even. What's driving that? Is that largely just you guys reactivating equipment or is it working capital considerations or anything else?

Yeah.

I'm just going to say it's predominantly the ramp up of those sites and then also the preparation on the maintenance side for the winter work which really starts at the end of Q4 but continuing through Q1 next year. So there's a big ramp up in work as we go through the year but there's also a larger ramp up of having fleet available to be utilized come Q1 next year.

Understood. And then I guess maybe one more question for you too, Joe. Just following up on your earlier comments on Fort Hills, just to confirm, the current guidance doesn't bake in any Fort Hills activity for the back half of the year? And then secondly, if it did resume operations, how much of a tell would that be? Or is it more of a 2021 story still?

We don't have anything at Fort Hills projected of any significance through the end of this year. And then even if operations started up late in this year, we don't think the demand for our services would necessarily start up this year. It would likely be next year. So it would likely be Q1, Q2 next year because they have mined in advance having one train down. So they are a bit buffered from their contracting needs right now.

Gotcha. Okay, that makes sense. That's good, Colin. Thank you. And then just last one for me, and I'll turn it back. Any goalposts you can share on one-time costs associated with the mobilization of equipment off of Fort Hills?

Yeah, in order of magnitude, it's, you know, a few million dollars, Dane. Obviously, it's part of the noise of Q2 kind of behind us. We did, at the end of March, have to make determinations as well, so part of that was in Q1, but it's in the single-digit millions of dollars and it's not inexpensive to move this fleet around.

That makes sense. Thank you. I appreciate the call, guys. I'll send the call back.

Again, to ask a question, please press star 1 near touchtone phone. Your next question comes from Maxon Fitches with National Bank Financial. Your line is open.

Hi, good morning, gentlemen. Hi, Max. Hi, Max. Michael, I was wondering if you have these numbers kind of off the top of your head in terms of, you know, the 60% yield near decline in revenue How much of that is in relation to restricted access to sites versus production for attainment versus weather? So we're just trying to gauge better how to think about the forthcoming quarters in terms of revenue progression.

Yeah, I would kind of say about 70% due to site access issues, maybe 20% due to the production cutback and 10% due to a pretty wet June actually. So that's kind of the way I'd look at it. Okay, fair enough.

And then in terms of the site access right now, Martin, do you mind providing some color in terms of if that has fully normalized or there are still some frictions for you guys?

It's not fully normalized. There's one site in particular where there's maintenance turnarounds going on still. So we're discussing with the customer the time frame for us to re-engage that site. We expect that to gradually occur during Q3 such that in Q4 we should be back to more normal as Joe mentioned. So it's a progression. I think we get there by Q4.

Okay, that's helpful. And then I'm just curious to see your views around Client behavior, have we seen some of the pressure for pricing concessions, things like that, that we would have seen in 2014? Just maybe in your color there.

Yeah, definitely. Obviously, the oil price collapsed. Plus, trying to manage the virus made things very tough for our customers. I really sympathize with them. So we engaged in discussions on pricing, sure. and as usual we've done our best to give back some concessions on price and that's taking into account in the outlook. Okay, thank you.

And then your comment around Muna and potentially some opportunities in Q3, do you mind maybe commenting on the business development environment right now? Obviously some of the commodities Outside of the oil are doing quite well right now, so do you mind maybe commenting on that?

Yeah, I'll speak in general. I think I've learned in the past not to speak about specific projects. In-house, we've got several bids, several opportunities that we're developing from a business perspective, all for commodities other than oil. You know, as you mentioned, obviously, gold is doing extremely well right now, so you would expect activity in that area. So we're hopeful. I think our cost structure can be used in other areas, as we've demonstrated in the past. So, you know, we're bidding away and developing these opportunities and we really hope that we'll have some good news to share shortly. Okay.

And my last question is just on capital deployment thoughts. I mean, obviously NCID is part of that, but do you mind maybe commenting in terms of where the focus is? I mean, fully realizing that right now it's focusing on some of the post-COVID environment, but in the more normalized sort of backdrop, what are the priorities?

Yeah, so obviously in the current environment, there's a certain amount of distress. So I think there will be some opportunity for us to pick up some assets at good prices. So we'll be opportunistic in that approach. Otherwise, as you mentioned, I think we're fortunate that we'll be in a position to both continue NCIB and reduce debt. Taylor DePace purchases according to the price of the stock and use excess cash to lower debt in the absence of any distressed asset purchases. But you could see some things in that area.

Right. And I guess, Martin, I mean, here you talk about assets specifically sort of assets with, you know, four wheels or you're talking about companies. I mean, how is that sort of environment? Are there any and many others.

If we can pull off a deal or two like that, we'll certainly look at it. It's something we're engaged in. Okay, that's very helpful. Thank you very much. Thank you, Max.

Your next question comes from Devin Schilling with PI Financial. Your line is open.

Hi guys, good morning. I know in the past you guys talked about a large project, I believe in Nunavut, that you guys were shortlisted for. Any updates here or is everything around this project on hold at the moment?

No, I think we're hopeful our project goes ahead, Devin. We always were hopeful, with just some delays in terms of permitting and approvals. I believe a lot of progress has been made this year and we can see some positive news. That will be a really big shot in the arm for Nuna and obviously it will benefit us too. We're hopeful, very hopeful that will go ahead.

Just to touch a little bit on your guys' revenue visibility right now from some of your key clients. Are you guys currently scheduling work a couple weeks out or have talks kind of progressed where things have stabilized a bit more now where I guess you're looking a couple months out instead?

No, we have a certain amount of backlog which we can plan months in advance on the sites with Black fully engaged on Devon. There aren't many discretionary projects going on right now. Not much spot work. So to the extent they pop up, then yeah, that's a shorter term planning type style. But we have a backlog, you know, a backlog of work that keeps us engaged for months. Okay, great.

There are no further questions to get up at this time. Let's just call back over to presenters.

Thank you for joining us today. We look forward to speaking to you next time.