North American Construction Group Ltd

Good morning, ladies and gentlemen. Welcome to the North American Construction Group earnings call for the first quarter ended March 31, 2022. At this time, all participants are in listen-only mode. Following management prepared remarks, there will be an opportunity for the 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 for any other participant without the participant permission. The company wishes to confirm that today's comment contained forward-looking information and the actual result could differ materially from the conclusion. Forecast or projection contained in a forward-looking information. Certain materials, factors, or assumptions are applied in a drawing conclusions or in the making forecasts or projections that are reflected in a forward-looking information. Additional information about those material factors is contained in the company's most recent management discussion and analysts with available on CEEDAR and EDGAR as well as on the company's website at nacg.ca. I will now turn the conference over to Mr. Joe Lambert, President and CEO.

Thanks, Rayne. Good morning, everyone, and thanks for joining our call today. I'm going to start with our Q1 2022 operational performance before handing it over to Jason for the financial overview, and then I will conclude with the operational priorities and outlook for 2022 before taking your questions. First off, I want to state up front that you're going to hear about what I call booming market issues in which during these times of high demand and high commodity prices, we face skilled labor shortages and inflationary pressures. I can assure you we are not complaining, and we fully understand that booming market issues are much more desirable than the alternative. Secondly, and as an overall theme for today, our outlook remains unchanged as we believe our long-term contracts, transparent client relationships, and long-standing experience together with our well-maintained fleet will serve us well in managing through these inflationary times. With that, I'll get into the deck starting off on slide four, where we have had a slight uptick in our total recordable rate, but remain close to our industry-leading target frequency of 0.5. And we'll be focusing our efforts on further developing our green hand new hire training programs, reducing hand and lifting incidents, and prevention of high potential injury events. On slide five, we show the diversification of our business across commodities and customers. NACG is often categorized by others as an oil field services company or as an oil and gas business, and the fact is we are neither. We are a heavy construction and mining contractor working across multiple commodities with multiple clients across three countries. Half of our EBIT comes from four investment-grade companies mining bitumen-rich sand which we have been working for continuously since their inception, including two that we have working relationships dating back to the 70s. We see our business diversification as a strength and are perplexed that some reports still highlight consolidation as a risk to our business. We believe the current business diversification has allowed us to achieve a true win-win in reducing customer, commodity, and geographic risk while maintaining margins and improving utilization of the smaller end of our fleet. As such, we are looking to grow in all areas and expect to maintain this diversification for many years to come. Our backlog has a similar split, which supports our plan going forward. Moving on to the Q1 operational performance shown on slides 7 through 10. In summary, while Q1 was slightly below our own expectations due to the previously mentioned market issues, we see recovery around the corner and several areas of results and trending which we believe signal a positive future. To demonstrate these positive trends, I would like to speak to four specific points highlighted across these four slides. Number one is, with the exception of the first two quarters of the pandemic, our business has shown consistent profit and growth by almost every measure. Our year-on-year and even quarter-on-quarter results are becoming far more consistent and reliably profitable. We expect this trend to remain while continuing to post consistent and improving quarterly results moving forward. Secondly, as highlighted in many of these graphs and associated descriptions, we have ample opportunity, capacity, and abilities to improve upon these results. Third, and probably the least obvious in these slides, is the growing and stabilizing effect of our equity-accounted partnerships. From our indigenous partnerships with NUNA, the Miccosuke Group, and Dene North, to our component remanufacturing partnership with Great Supply, and our Red River Valley Alliance working on the Fargo Moorhead project, Our partnerships continue to grow, smooth out our seasonality, and provide profitable diversification to NACG. The fourth and last on the list, posting consistent results in high single-digit positive CAGR trends, doesn't really make for front-page headlines, and some would even call us boring. While my ego may take a bit of a hit, our shareholders and balance sheet will certainly benefit with continued stable profitable growth. With that overview of Q1 operations, I will hand over to Jason for the financial summary.

Thanks, Joe. This quarter's brief financial review begins on slide 12. Total combined revenue for the quarter of $237 million was $45 million ahead of Q1 2021. The $237 million sets another record for our company as it very narrowly beat the Q4 2021 mark of $235 million, less than a 1% difference. Across a wide variety of financial metrics, Q1 2022 was incredibly consistent to Q4 2021, albeit under much different circumstances. As Joe will touch on later, the primary driver for what otherwise could have been a notably higher revenue achievement for our wholly owned businesses is the ongoing heavy equipment technician shortage in the oil sands region. Although difficult to gauge exactly, we estimate that this factor alone reduced our top line potential by approximately $15 million. The revenue that was achieved in the quarter was driven by a broad listing of mine sites and business lines, which are all showing strong demand for our services. The re-mobilized fleet at the Fort Hills mine again had another full quarter of operations, and we remain very excited to be operating on that site, especially when comparing to those time periods of not being there. As everyone is aware, the outlook in the oil sands region is robust. And we experienced this firsthand this quarter as the focus on production means our equipment is critical to our customers' success. Revenue from our joint ventures of $60 million was the key driver of the record as it beat Q4 2021 by 11% as the continued volumes at the gold mine contract in Northern Ontario were coupled with the increasing prominence of our Miccosu joint venture and initial progress made on the Fargo-Moorhead Flood Diversion Project. The combined gross profit margin of 13.7% is actually exactly the same as Q4 2021, but was influenced by a different range of factors, and most notably, and as mentioned, by the short workforce shortage in the skilled trades. Several secondary drivers impacted this quarter's margin, including the timing impact of rate escalations, which lag based on published index values, workforce availability in January due to high COVID-19 Omicron cases, and the early onset of spring breakup in late March. Moving to slide 13. Adjusted EBITDA of $58 million was slightly down from last year on the factors just mentioned. The margin of 24.4% reflecting total combined revenue is again a solid achievement across many business lines, but with realistic improvements within our grasp. Included in EBITDA is direct general and administrative expenses, which were $5 million in the quarter, equivalent to 2.8% of revenue. As always, G&A's spending remained disciplined in the quarter, but, and again, similar to Q4 2021, benefited from a specific receipt received from a Fargo-Moorhead joint venture. Excluding this recovery, G&A was 4.6% of revenue which is indicative of the level we see moving forward with DGI as part of the mix. Going from EBITDA to EBIT, we expensed depreciation equivalent to 14% of revenue, which is reflective of the depreciation rate of our entire business. When looking at just the wholly owned entities and our heavy equipment fleet, the depreciation percentage for the quarter was 17.3% of revenue, and reflected an effective and very active use of our fleet during, at times, a very cold quarter. Both of these measures compare fairly consistently to the Q4 2021 measures of 12.3% and 16% as we establish run rates for our diversified businesses as well as our important ultra-class fleet. Adjusted earnings per share for the quarter of 51 cents was driven by $24.7 million from adjusted EBIT net of interest and taxes. Our overall interest rate was 4.5% in the quarter, and we incurred a $4.5 million cash expense. Additionally, and of note, we booked approximately $750,000 of interest through our equity earnings, primarily in our Fargo joint ventures, which will have interest expense as they incur debt leading up to initial milestone payments from the authority. Moving to slide 14, I'll briefly summarize our cash flow. Net cash provided by operations of $45 million was produced by the business with the difference between this figure and the $58 million of EBIT being cash interest paid, of course, in the quarter and cash being managed by our joint ventures. Sustaining maintenance capital of $34 million was primarily dedicated to the maintenance of the existing fleet as we made our way through another very busy winter season. Working capital drew cash of $28 million and had a material impact on free cash flow in the quarter. Pausing for a moment on free cash flow, I'd like to point out again that operationally, this quarter was very similar to Q4 2021, which was a quarter where we posted positive free cash flow of $48 million. The difference in free cash flow of these two quarters of nearly $60 million highlights the impact of working capital and our joint ventures. Our understanding of the temporary nature of these timing impacts is why we remain confident in the full year range of $95 to $115 million. I'll end with slide 15. Total capital liquidity of $225 million reflects our strong position as we continue to benefit from the legacy of disciplined investment in the years past. On a trailing 12-month basis, our senior leverage ratio, as calculated by our credit facility, remains at 1.5 times. Net debt levels increased $13 million in the quarter due to the aforementioned free cash flow performance. And with those comments, I'll pass the call back to Joe.

Thanks, Jason. Looking at slide 18, this slide summarizes our priorities for 2022. I discussed most of these items separately on the following slides, but wanted to highlight three areas that will be particularly important to progress in Q2. First and foremost, we are and will continue to be laser focused on contract administration in regards to the application and accuracy of contract escalation clauses, and in particular, the impact of OEM and vendor equipment parts price increases on our equipment costs. Although this process is transparent in that our clients have the same or similar OEMs and vendors, the current parts price increases are the most volatile we have seen in decades and will require attention to preserve the intended objective of matching incurred costs to the impact on our equipment and labor rates. Secondly, We need to continue to develop, attract, and retain our skilled maintenance tradespeople to continue to improve fleet utilization. As I explained in detail in the last call, NACG has an extensive and comprehensive program to continue to expand both our Atchison and field-based maintenance workforce. As an example of this progress, since our last call just over a couple months ago, we have added approximately 20% more employees into our apprentice programs. Our shop expansion with additional remanufacturing capacity and services and a central telematics control room will be completed in the next few weeks and will allow for growth in our bench hands program and machine health monitoring for our current around 200 real-time connected assets. The third area of focus detailed on the following slide 19 is our ongoing efforts to ensure a well-planned and smooth startup of our Red River Valley Alliance Fargo Moorhead project. The project is progressing well and we expect to commence earthworks this summer. The equipment fleet has been procured, design work and planning are approaching construction ready status, and hiring of field staff and workers will commence around quarter end for Q3 start for earthworks. I really look forward to the latter half of the year when we can start providing progress reports on the actual construction activity. Moving on to slide 20. You will see our bid pipeline remains strong, and we expect to continue to have success in all commodity areas. My focus here is on the top two rows, as these are the tenders most likely to proceed, whereas projects in the pre-tender phase can at times be budgetary pricing. In comparison to the last time we presented in February, we added two new projects to the preferred opportunities and extensions, including a massive multi-site regional tender in oil sands, and a new reclamation project for an existing diamond mine client. On the second row, we removed two projects, the estimated $125 million oil sands tender we won and announced in mid-March, and a smaller reclamation project at Northwest Territories Diamond Mine that NUDA won. We also added to the project's inactive tender phase a recently released RFP in oil sands. We expect to continue to receive summer work packages over the next month or so for quick turnaround in work before the end of the quarter. On slide 21, our backlog sits at $1.6 billion, and we continue to replenish and win our fair share of work across all resource sectors. What I believe are key takeaways on this slide is that our backlog is roughly proportionate to our diversification target, demonstrating both confidence and sustainability of our diversification efforts, and lastly, but possibly most importantly, we achieved a backlog in excess of $1 billion just one short year ago, and you don't have to squint too hard at the bid pipeline to see opportunity to exceed $2 billion in backlog before the year is out. Slides 22 to 24 highlight some key areas of our progress on sustainability, including emissions reductions, inclusivity and diversity, and indigenous partnership. These three slides provide a great summary of the progress we have made in all these areas, but I would point anyone with more interest to our two 2022 Sustainability Report released with our Q1 results and available on our website for a more detailed description of the progress we have made and targets we have set. On slide 25, we have provided our unchanged outlook for 2022. Performing to plan and generating free cash flow in this range will allow for meaningful capital allocation to debt reduction, share purchases, and growth via bolt-on, M&A, or fleet additions. We doubled the dividend last quarter, and with the opportunity to continue to improve profitability, diversification, and backlog, we believe our shares continue to be undervalued. As I stated previously, we will continue to explain our business better and pull all the valuation levers we can to address this issue in shareholder-friendly ways. With easing of COVID-related travel restrictions, we intend to spend more face time with existing and potential investors to reinforce our compelling business value propositions. On my final slide 26, the top two charts demonstrate our consistent high performance relative to peers, and the lower one shows why we renewed our NCIB and continue to see our share repurchases as the most efficient use of capital. That's all for my slides. As many of you would know, I usually like to add a bit of theme or some analogy to represent our current business environment. But when NACG is in a situation where we have great demand across all of our diverse markets, and several important areas we need to execute well on in the next several months, the response is built into our culture. And that response is head down and let's get to work. With that, I'll open up for any questions you may have.

Thank you. To ask a question, please press star one on your touchtone phone. If you wish to withdraw your question, you can press the pound sign. Once you have completed your question and would like to return to the queue, please press star one. After a brief pause, we will begin the Q&A section. Your first question comes from Tim Monacello from ATB Capital Markets.

Hey, good morning, everyone. Good morning, Tim. I was just curious if you could elaborate a little bit on the sort of billion-dollar opportunity that's in the preferred opportunities and extensions category of slide. What is that? I don't know. You know what I'm talking about.

The big red button on the bid pipeline?

Yeah, that big red button, please.

Yeah, so they're combining four different sites and bidding it on a five-year deadline. program of all their bulk earthworks. We received a tender, I can say, a few weeks back. It's got a bit of work to be done on it, but it's really amalgamating a lot of different contracts we have and aligning the timing on them and setting them all out five years from now. The value is actually bigger than that dot, but we believe there's some overlap with some of our current work.

Okay, so the There's really nobody else that could bid on this because you already have existing contracts in place that would overlap the scope of this contract.

We believe some of that volume in there is already committed to us for the next two years.

Okay, that's helpful. And the second question that I had was just around the heavy equipment technicians. Obviously, you talked a little bit about how that was undersupplying Q1 and that impacted results. Can you just give us an update on your progress in hiring heavy equipment technicians and when you think you might see capacity at a level that you can hit your potential?

We've adjusted pay, Tim, in April, and we're starting to gain ground on that already. We've made some moves in February which kind of stopped the bleeding and stopped the poaching And now I think we're back in a position. It wasn't huge numbers, like single digits, but everyone really hurts us. And a lot of it isn't in our own headcount, but also what we call direct service providers, which are individual contractors. And with those guys crossing the street because of rage rates, and we've just had to match those pricing and get them back. So, you know, I think by the end of this quarter, we're going to be a lot more stable and and hopefully growing on the HET side.

Okay, and then last one for me. I was just wondering if you could give an update on how the Fargo Moorhead project's going.

Yeah, you know, we haven't broke ground yet, Tim, but all the planning and design work is progressing. And like I said, we've got the fleet procured, so it's really Q2 is the last quarter of prep, and Q3 we get into the dirt, so... There's a big focus, and our guys have spent a lot of time there, and will continue to. We've got a great team on site to do the work, and we're just looking forward to getting it started.

Okay, great. I'll turn it back. Thanks.

Again, to ask a question, please press star 1 on your touchtone phone. Your next question comes from Brian Fass from Raymond James. Your line is open.

Yeah, good morning, everyone. Morning, Brian. As you get underway on the Fargo Moorhead project, could you just talk about opportunities that you are seeing beyond that project, I guess, in the U.S.?

You know, that project is kind of standalone, but certainly with more experience in P3 and infrastructure, and I think, you know, we've got strong relationships with a lot of partners. We think that as more infrastructure jobs come out and have a large earthworks component to it, we're going to have more opportunities. I think we've, you know, everyone's heard of big spend bills coming out, but, you know, the projects really aren't that well known yet, and it really takes a bit of time for that design work before those packages come out. So I would expect it to be maybe start seeing more of a P3 or 2 in our bid pipeline here in the next 12 to 18 months.

Okay, thanks for that. And then could you just quantify the amount that margins were impacted by the lag and rate escalations? And do you expect to catch up in this quarter, or is this something that will play out throughout the year?

I don't have the exact number in front of me. You know, if I was guessing, and it is a guess, Brian, it would probably be in the range of 3% to 5% impact this quarter, somewhere in there. I think we will see that transitioning over Q2 as we have application of our escalation clauses in our discussions. And hopefully have that all back by Q3.

Okay, I appreciate that. And then one last one. Is there any update on the Springbank water diversion project around timing or anything? Or I guess you guys might know just as much as we know here.

Yeah, we chose to decline on that bid, Brian. It was divvied up and awarded a lot of work prior to subcontractors, and it just didn't fit our risk profile, and the amount of earthworks we were going to be able to self-perform was minimal.

Okay, I appreciate the caller. Thanks.

You bet.

Your next question comes from Maxime Suchet from National Bank Financial. Your line is open.

Hi, good morning, gentlemen. Morning, Max. Firstly, just wanted to start maybe with the visibility on the summer programs in terms of what are the clients telegraphing and is the fact that obviously they're privileged in production right now, if that could be negatively impacting potential opportunity for you guys or how should we think about that?

We're still seeing summer packages come out. Actually, I think I highlighted one. that's in the second column of our bid pipeline. And they can often come out, Max, as late as end of May for starts in June and July. So I really don't have a sense of the overall summer activity other than we've seen a pretty steady stream of items coming in. This major regional bid may have pushed some of those tenders back, too, because this is taking a lot of focus on those procurement teams that are tendering these four particular sites. So I really don't have a full-on sense of where the summer is other than it looks reasonable, and I expect it to be a good summer.

Okay, that's helpful. Thank you. And then I just wanted to circle back to Fargo. And in terms of obviously given all the inflation concerns and so forth, I was curious if there are certain procured items where you can hedge, and I'm trying to think about steel, things like that, so if you can maybe just comment in terms of risk mitigation strategies to make sure that costs don't escalate.

Because of the longevity of that project, I don't think any near-term fluctuations are going to change, but there is a massive risk matrix provided on this project where escalations are priced in, anticipated escalations. And it'll have been done with historical averages. And although this year might look a little different, we've already got the equipment. So we know that. And I don't think we're going to see a lot of wage escalation in that area necessarily. But I don't know enough about the bridge side of it and the road construction. I just know I've seen the risk matrix and how cost escalations are put in, and it's very reasonable. And with the longevity of that contract and they used historical averages, you know, if it was just a two-year construction or a one-year construction, I'd say there might be risk. But when you're looking at six years of main construction and 29 more years of O&M, you know, I think using historical averages is probably appropriate.

Okay, fair enough. Thank you. Thank you for that. And my last question, just in terms of the thought process around, you know, capital allocation, you know, share buybacks versus M&A, just, you know, the comments that sometimes we hear back is given the fact that it's a relatively liquid stock, obviously, you know, share buybacks, you know, constrain and can amplify, you know, sort of moves up and down. given the liquidity. Just curious in terms of how do you balance that thought process between share buybacks and M&A? And maybe that's more of a later sort of stage question in the year versus right now, but maybe any color there. And I guess that's for both Joe and Jason. Thanks.

Yeah, from my standpoint, Max, at any point in time, we're looking at our share price and our multipliers. And, you know, if we can't see accretive deals out there and we're far better buying ourselves, then it makes sense to buy our own shares. You know, we've had good churn on our shares. And even with the amount of buyback we've done over the years, our shares still churn pretty good and maintain, I'd say, an average kind of turnover of a share base. And, you know, in M&A, we're looking for accretive acquisitions, which, you know, we think We can find some smaller bolt-ons and vertically integrated businesses that fit us well and would be very low risk and accretive, and that's what's shown in that capital allocation. But we continue to believe that these share prices, you know, we're the best buying town often.

Okay, fair enough. Thank you. That's it for me.

Your next question comes from Yuri Link from Mechanical Genuity. Your line is open.

Good morning.

Good morning, Yuri.

You mentioned a bit of a recovery on the Fargo Moorhead project. Was that a success fee? Is that what you're talking about there? And any way you can quantify it?

Yeah, I can take that one. It's called many things. URI success fee is fine. We did, it's in about the $3 million quantum because we, you know, the difference between 2.8% GNA rate and 4.6, I think, which we think is our run rate. If you back calculate that, it's about a $3 million improvement in our GNA line. So that's order of magnitude. And it's not a, It's not a fee we anticipate seeing moving forward.

And that's just a recovery of what it costs you to bid the project?

Is that how we... Yeah, typically when you're shortlisted on these jobs, there's a stipend if you're unsuccessful at the end of that shortlisting. And if you are successful like we were, you price that repayment because it's a significant bidding cost by all parties in this. And you price that repayment in your success feed.

How are discussions with your customers in terms of passing along some of the inflationary pressures that you're seeing out there?

I think they're going well. We've just got into a lot of them, but we certainly have customers who want to help us make sure we have the manpower available to operate our fleet and understand the cost. They have HET issues just like we do. They have the same parts price increasing. So it's very well known. And as a key, I think we're kind of the tier one contractor on every site we're on. And we would get a lot of focus from the contracts and procurement and operations team in supporting us to make sure we can get the people uh, to do the work we need to do there. And, you know, they understand the cost increases cause they see it as well.

I would imagine with parts prices rising, um, it's, it's helpful for, for DGI. Uh, how does the dynamic work there?

Absolutely. I mean, there, that, that side of it's good. I'd say on the bad side, some of the shipping costs and that have gone a little crazy too, but, uh, Overall, I think the demand on used equipment and cores from DGI will continue to be high.

Good, good. Okay. Nice quarter, guys. We'll turn it over there.

Thanks, Yuri.

Thank you. And this includes the Q&A section of the call. I will pass the call over to Joe Lambert, President and CEO for closing. Oh, excuse me. We have a new question.

No worries.

We have a new question from Richard Denley from Land Force Partners.

Good morning. Jason, you mentioned in the quarter-to-quarter comparison of free cash flow the importance of the JV and working capital. Would you go into the color behind the working capital and explain that a little, please?

Yeah, so working capital, obviously, it's very detailed in our financial statement notes. In the quarter, particularly with the escalation issue and the inflation, we definitely were collecting a little less accounts receivable. and paying out pretty significant costs through accounts payable. So, you'll see accounts receivable and payables both being impacted there. And then, of course, inventory was $10 million of the $20 million delta, and that is fully related to our rebuild program where we have several haul trucks being constructed and scheduled for sale here in Q2. So, You know, the $20 million negative working capital was really those factors.

Okay. Thank you.

Thanks, Richard.

Thank you. And there's no further questions at this time. You may continue.

Thanks, Rain. And thanks again, everyone, for joining us today.

Thank you. And this includes the North American Construction Group, Q1 2022 conference call. You are now disconnected.