Earnings Call Transcript - NOA Q2 2021

Operator, Operator

Good morning, ladies and gentlemen. Welcome to the North American Construction Group Earnings call for the Second Quarter ended June 30, 2021. 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 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. The Company 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 those material factors is contained in the Company's most recent management's discussion and analysis, which is available on SEDAR and EDGAR as well as the Company's website at nacg.ca.

Joe Lambert, President and CEO

Thanks, Rebecca, and good morning, everyone. I'm going to give a brief high-level overview of the quarter, turn over to Jason for the financial details, and then we'll close with a deeper dive into a few areas of our business and finish up with the outlook ahead of us before opening it up to any questions you may have. While I'm excited to talk today about our solid Q2 operational and financial performance, I am even more eager to share with you the milestones achieved this quarter, which are integral to our future success and reinforce the confidence we have in our overall corporate strategy. In particular, the progress made through items such as the major contract wins, the DGI acquisition, continued indigenous partnership growth, expanding internal and external maintenance capabilities, progress on our sustainability plans, increasing market diversification, growth, record backlog, record free cash flow projections, record low senior leverage ratio, and increased overall opportunities with line-of-sight to achieve or exceed our strategic goals. I will talk more in-depth on these impressive milestone achievements later on in the deck. These achievements were accomplished during a quarter where we had the largest impact on our workforce due to the pandemic. As stated in my shareholder letter, the third wave impact in Fort McMurray had a 70% increase in positive cases and close contacts requiring quarantine than any previous quarter. Thankfully, our pandemic plan minimized the spread of the virus in our workplace and employee recoveries were better than average. However, the loss of the available workforce in Q2 is estimated to have had a 5% to 10% negative impact on fleet utilization and top-line revenue. With that brief preamble, I'll touch on our safety performance on Slide 4 before Jason goes into the financials. Our Q2 total recordable injury rate improved significantly from Q1, and our trailing 12 months is now back within our target range. We are continuing our focus on high hazard areas and improved communications to offset pandemic protocols. We do expect continued relaxing of pandemic protocols as infection rates decrease and vaccinations increase. However, we expect some protocols will continue through year-end. With those opening comments, I'll pass the call to Jason for our financial review.

Jason Veenstra, CFO

Thanks, Joe. Good morning, everyone. We'll begin the financial review on Slide 9. Revenue for the quarter of CAD140 million was CAD69 million ahead of last year's Q2, which was, as we all know, an unprecedented quarter and proved to be a difficult quarter to compare against. The year-over-year variance represents virtually a 100% improvement in revenue and generally came in as expected.

Joe Lambert, President and CEO

Thanks, Jason. On Slide 15, you'll find our current operational priorities for 2021. This slide summarizes our objectives, and I will walk through the topics in the slides that follow and finish up with our outlook. Slide 16 highlights the milestone win of a major infrastructure job in our Red River Valley Alliance with partners, Acciona and Shikun & Binui. As the largest infrastructure project in company history, we are prioritizing the planning, staffing and pre-mobilization work to ensure a smooth project startup. We believe this project win and a smooth start could provide us additional experience we can leverage when tendering a similar earthworks flood diversion project in Alberta that we expect to come out in RFP before the end of this year. On Slide 17, you will see some highlights of our recent acquisition of DGI Trading. At approximately one month post close, I am happy to report the business transition and the integration has progressed smoothly, and we see future opportunity for growth as core machines and components have demonstrated to be the most economical method to support internal growth and likewise, provide increased external maintenance sales opportunities.

Operator, Operator

Your first question comes from Aaron MacNeil with TD Securities.

Aaron MacNeil, Analyst

You touched on your prepared remarks, but I'm just curious to know what's your batting average on the diversified projects? And I'm also curious to know how you're identifying projects that you put in your bid pipeline slide. So are you only bidding on stuff you think you have a high probability of winning or are you pursuing a whole bunch of stuff and seeing what sticks? So just kind of trying to get a sense of that.

Joe Lambert, President and CEO

I would like to begin by saying that we have a comprehensive system for tracking business development in the resource industry. This system follows projects from their conceptual stage through exploration, feasibility, development, and permitting. We assess whether these projects align with our fleet and usage, which guides our decision to submit a prequalification or request for proposal when they become available. In terms of pursuing projects, we evaluate how they align with our strategy, the availability of our fleet, and access to other fleets, taking into account size and duration. When it comes to our win percentage, it's challenging to pinpoint due to the ever-changing market dynamics. Some bids never get awarded, and there are projects we track for many years that never receive permitting. Once a bid arises and we submit an RFP, we generally have a good understanding of our competitors and where our strengths may lie. For instance, we lost two jobs in Quebec where we assumed a remote workforce would be necessary due to limited access, but our experienced partners disagreed, leading us to revisit that risk. This illustrates how factors outside of fleet availability can provide competitors with a commercial edge. When analyzing our bid pipeline, estimating our likelihood of winning projects accurately at 10% or 40% is quite difficult. While I can provide insight on individual projects, a broader estimate remains elusive. I hope that answers your question, Aaron.

Aaron MacNeil, Analyst

Yes, that's great. Maybe a more specific question then related to the gold project. I assume the answer is yes to the first one but do you see it as a reference for bids on future work? And then if the answer is yes. Is there enough work in that area that it could become a second core area for you and somewhere where you constantly have a level of activity?

Joe Lambert, President and CEO

Well, when we won the Ontario gold mine project in our Nuna joint venture, we highlighted what we thought was our advantage there, both with Nuna and our experience. The very strong indigenous partnerships that Nuna has in regions in addition to being Inuit owned, and felt we could bring that in other areas and I believed in the last quarter or two, I've also highlighted that we felt there is a job in Saskatchewan to be coming up, where the procurement team had actually asked us to bid under that same joint venture arrangement because they felt it would be stronger for us. And we've actually received our first RFP from that project. And we'll be submitting a bid as the same joint venture structure as we have in Ontario gold mines. So I do believe it's provable, we'll see as far as winning this job. That would be a pretty good success ratio if in two bids with our Nuna JV, we win them both, so that would bode well for us. But I think that structure of our experience, Nuna's experience, the combined fleet efficiency, the manpower efficiency, and the indigenous relationships is a pretty powerful, along with being a safe, low-cost provider. It's a pretty compelling RFP we're going to put together.

Aaron MacNeil, Analyst

Fair enough. And final question for me, just bringing it back to the core business. The scope and volume increase of that announcement with the Mikisew partnership last week was pretty large in the context of the original agreement. So I guess I'm just wondering at a higher level across your oil sands customers, when you talk to them, are you getting the sense that they're sort of playing catch-up right now given the reduction last year? And if that's the case, how long do you think this surge in activity might last before things start to normalize? Or maybe you'd characterize it completely differently. So just trying to get your sense of how you're seeing the oil sands outlook in general?

Joe Lambert, President and CEO

I believe it's clear that the demand is significantly higher than last year due to the pandemic downturn. Looking ahead, I observe a stronger long-term demand. This has led to clients recognizing the value of establishing longer-term partnerships with us. As demand continues to grow, clients want the reassurance of working with someone they trust and value. Consequently, I expect to see more long-term commitments from our clients as they seek to secure their agreements in response to increasing demand.

Operator, Operator

Your next question comes from the line of Yuri Lynk with Canaccord Genuity.

Yuri Lynk, Analyst

I wanted to ask a bit more about the DGI acquisition. Can you provide any insights on the expected revenue or EBITDA margin profile for that business? Also, is this primarily a cost synergy opportunity for you, or are you focusing more on revenue synergies as you consider additional moves in Australia related to DGI?

Joe Lambert, President and CEO

I'll let Jason take the first part, and I'll answer the second. As far as the...

Jason Veenstra, CFO

Yes, I'll just pull up the slide, Yuri. So as far as revenue versus cost, we've said about 25% of DGI sells into us. So that would be a cost synergy to us. You can see from the EBITDA multiple that we disclosed of three times, we're kind of in the CAD8 million EBITDA impact range. Some of that will come through cost savings, as I said, about 1/4 of that, and then the remainder will just hit our revenue and cost. There should be virtually zero depreciation in margins in the 30 to 40 range, like a part supplier would normally enjoy. So much different business model than us, but we'll be definitely accretive and I would say, is not indicative of our M&A typical targets. This is a vertical integration, move. Joe can elaborate more on strategy, but those are some of the high-level figures.

Joe Lambert, President and CEO

I believe it is too early to measure some of these aspects, but I definitely see potential synergies and opportunities in the overlap of our businesses, especially regarding vertical integration. To elaborate, DGI's ability to access used components globally and their expertise in locating these parts is extremely valuable to us. For instance, if a component fails in a piece of equipment like an engine or transmission and used cores are not readily available, we may have to purchase new ones, resulting in significant cost differences. Having a partner who can locate those used cores and is committed to our business is beneficial for both component sourcing and whole machines. Historically, DGI has been a major provider of used whole machines for second-life rebuilds, which we find very valuable. I have mentioned previously that rebuilding whole machines for a second life is done at 50% to 60% of the cost of new ones, while often providing better warranty coverage on our components compared to new units. On the flip side, DGI is currently undertaking around 25% of their work in Alberta. We see opportunities to cross-sell or offer our clients access to DGI, as well as assist them in equipment teardown in our facilities or support in the field where our maintenance personnel are already present. While I do not have precise quantifiable details yet, I am confident that as we move forward, we will uncover these synergies and opportunities as we collaborate more closely with DGI.

Yuri Lynk, Analyst

Okay. That's helpful. Second and last one for me, maybe just for Jason. I wanted to clarify, are you saying now that the depreciation is going to be in the high teens on an annualized basis going forward? And if so, are you able to help us at all with revenue guidance, some kind of revenue range, so we can better model depreciation and amortization, given it's a pretty large expense item?

Jason Veenstra, CFO

Yes, I would say it's trending in that direction. Since the Aecon acquisition in 2018, we've experienced steady increases in depreciation as a percentage. I believe high teens is a reasonable estimate for modeling, which you can then adjust against gross expenses based on revenue. Our core business, as reported in 2019, provides a solid framework for understanding what our core fleet can achieve, making it a useful revenue profile to consider. What will be particularly noteworthy is the equity accounted revenue, which we anticipate will comprise 30% to 40% of total revenue in 2022. Additionally, for equity accounted investments, depreciation should fall within the 5% to 10% range. Therefore, we may observe significant differences in depreciation between our joint ventures and our core fleet. I hope this information is helpful for your modeling, as that is the trend we are currently observing.

Operator, Operator

Your next question comes from the line of Bryan Fast with Raymond James.

Bryan Fast, Analyst

Just on the big project win in the U.S., could you talk about your strategy in expanding in the U.S. markets? And do you think that this project win opens up similar P3 type opportunities?

Joe Lambert, President and CEO

I think that for both the U.S. and Canada, we are particularly interested in large infrastructure projects that involve significant earthworks. Although these projects do not come in a steady stream, they do arise, such as the flood diversion project in Calgary that I have mentioned for five years and finally seems to be progressing. This project includes some road and bridge work, but the bulk of it involves earthworks, which presents opportunities for our participation in infrastructure jobs. We are also focused on hydro projects and roadworks related to flood diversions that include earthworks. Of course, we will keep looking at mine management opportunities in the U.S. that have been successful for us, and we will consider those as well. Does that address what you were asking, Bryan?

Bryan Fast, Analyst

Yes, you bet. And then just further on that to that contract win, how much of the contract award is slated for the construction portion of the project and then how much is tilted towards the O&M part of the contract?

Jason Veenstra, CFO

About 65% of the total, which was approximately CAD2.2 billion, was allocated to the construction aspect of the project, and the remainder pertains to other elements.

Bryan Fast, Analyst

Okay. And then just on labor supply issues. Beyond the impacts of what's happening with COVID, has it been difficult to source labor in this market?

Joe Lambert, President and CEO

We've always faced challenges and continue to do so while we implement various practices to improve maintenance. We haven't encountered many issues with operations and operators. The ongoing challenges, aside from the pandemic, include limited travel. When we bring people in from different locations and conduct fly-in, fly-out operations, there aren't many convenient flights available. Consequently, people are reluctant to travel. For example, if it takes 25 hours to get from the East Coast to northern Alberta for just a week off, that poses a significant challenge. However, I believe that as travel restrictions ease in the coming months and we see an increase in flight availability to more destinations, access will improve moving forward.

Operator, Operator

Your next question comes from the line of Tim Monachello with ATB Capital Markets.

Tim Monachello, Analyst

So first one is just on the utilization. In one of the slides you showed the utilization progression through the quarter, and looks like it's been trending down, April, May and June. Just wondering around that square with the commentary in the MD&A saying that June was a pretty strong quarter relative to the first two months of the quarter? Sorry, strong months relative to the first two months of the quarter?

Joe Lambert, President and CEO

I'm not sure what the numbers for April, May, and June are. Do you have those, Jason?

Jason Veenstra, CFO

Yes, I'll just pull them up here.

Joe Lambert, President and CEO

I know the 53 that was the average of the quarter is the average of the month, but...

Jason Veenstra, CFO

Yes, we experienced strong momentum throughout June, although utilization in June was lower compared to May, as depicted in the graph on Slide 21. We achieved efficiencies in our planning and managed to direct the available equipment toward work, which resulted in a significant increase in profitability. However, we anticipate an improvement in utilization starting in July and continuing beyond.

Joe Lambert, President and CEO

I wouldn’t place too much emphasis on month-to-month accuracy, Tim. When we transition into Fort Hills, for instance, there are several weeks spent moving equipment between sites, which affects operational opportunities. In June, for instance, while we might not have faced the challenges of the third wave, we were mobilizing our fleet, and that can significantly impact any given month.

Tim Monachello, Analyst

Okay. I guess, more importantly, would just be, are you seeing pretty strong rebounds into the third quarter?

Joe Lambert, President and CEO

Yes, absolutely. What I would hesitate to say is that I saw that for the second quarter too. And we were talking in April, and we were coming off the second wave. We're at the trough after the second wave and vaccinations were rolling out, really didn't anticipate that third wave at all. And for it to actually not only be a third wave hit us, but to hit us worse than the other two of them there combined. So I hesitate to jump out in front and say too much but in general, yes, if things progress as planned with the vaccinations and decreasing cases and opening up, yes, we would fully expect that to happen, Tim.

Tim Monachello, Analyst

Okay. Great. And is that basically the one pivotal factor which underpins the range in your EBITDA guidance for the year?

Joe Lambert, President and CEO

Yes, I would say so.

Tim Monachello, Analyst

I understand. My second question is regarding Fort Hills. Suncor reported its results today and maintained the production guidance for Fort Hills for the year. One of the reasons they noted was the difficulty in securing third-party contractors, which suggests a tightening market that aligns with the contract extension we observed in the oil sands after the quarter. What are your observations regarding pricing dynamics? Is the market for equipment quite tight?

Joe Lambert, President and CEO

There is considerable demand for large equipment, although we can't be certain if clients may choose to defer projects to balance their needs. From the requests for proposals, we are definitely experiencing increased demand. A key observation is that the second quarter usually sees our lowest margins from a project perspective since our contract escalations and negotiated rates typically take effect in the latter half of the year. On the cost side, our labor burden in the first half of the year is generally higher than in the second half, which does have some impact. Therefore, we expect some improvement in pricing due to escalators that come into play in June, as annual escalations in contracts are usually applied in the second half of the year.

Tim Monachello, Analyst

Okay. Got it. Do you think across the remainder of your portfolio in the oil sands, you could see some similar expansions to contracts?

Joe Lambert, President and CEO

Yes, we see opportunities to extend terms. Over the next year, we may have better chances to extend those Master Service Agreements and secure the related commitments. So, yes.

Operator, Operator

Your next question comes from the line of Maxim Sytchev with National Bank Financial.

Maxim Sytchev, Analyst

Joe, I guess, operationally, we've had obviously some strange weather. How is that shaping? Any impact or negative impact on how you're ramping up through Q3?

Joe Lambert, President and CEO

I don't believe the weather has had as significant an effect as the pandemic. In Alberta, the weather mostly depends on which month you receive rainfall during the summer, whether that's June, July, August, or even throughout the summer. However, we do not anticipate anything out of the ordinary. It might be wetter in June compared to July, or heavier rain in July than in August. Overall, I do not foresee any weather-related impacts. I should clarify that I don't make weather predictions either. That said, we haven't observed any notable weather impacts this year when looking at the longer term, whether comparing quarter-over-quarter or year-over-year data.

Maxim Sytchev, Analyst

Okay. That's helpful. And then just wanted to circle back to the Fargo project. Was wondering if you don't mind, maybe, first of all, talking about the risk profile of this project and how you're managing that part. And then maybe the second part is a question to Jason in relation to how we should be thinking about revenue progression between T-0 and for the next couple of years just from a modeling perspective?

Joe Lambert, President and CEO

On the first part, Max, I believe it's similar to any other project, with the main difference being our strong emphasis on planning. This includes getting people and equipment in place, ensuring the fit, and having the right gear available on time with qualified operators. Above all, it's about effective planning and being prepared for changes by having backup plans. Our focus is on assigning experienced and skilled individuals to the job and conducting the necessary planning. This is an earthworks project; while it may be a significant public-private partnership in North Dakota, it remains another dam construction project for us. We aim to prioritize proper planning and scheduling for personnel and resources, setting up training programs to develop skilled operators and mechanics, and anticipating potential issues such as weather challenges or other unforeseen circumstances.

Maxim Sytchev, Analyst

And there is no issue in terms of shifting people around right now, right, despite, obviously, challenges with the border and things like that?

Joe Lambert, President and CEO

We have current North American employees at other sites who will be moving to this one. I don’t believe we will have any problems recruiting or finding skilled operators or staff in those areas. We have done extensive recruiting through our U.S. coal mine management contracts across the U.S., so we have a solid understanding of that marketplace.

Jason Veenstra, CFO

Yes, I guess, just off the top, obviously, revenue for this project will go through equity accounting, Max. So be careful where you put it as far as revenue projections. Very little revenue we expect to recognize this year upon financial close in Q4. The lion's share, 75% of the CAD650 million will be over the four years of 2022 through 2025, with the biggest year being 2024. So it will continue to escalate in '22, '23 and then '24 is what's modeled as the biggest year and then comes down in 2025. And then outside of that, there's a couple of years of inspection before substantial completion and then the O&M contracts. So definitely a lot of activity in those critical years '22 through '25.

Maxim Sytchev, Analyst

Okay. That's helpful. And then the last question, there was a remark in terms of capital allocation and potential dividend increase. Just curious if you don't mind maybe talking about how you think about that as a percentage of, I don't know, net income or free cash flow? What are the parameters that you are using internally to drive your decision-making on that side?

Joe Lambert, President and CEO

All right. Those would be the parameters and, Max, every fall we have our Board meeting, where we review our dividends, and we'll be having that discussion coming up, and we'll share that outcome with you guys when it comes.

Operator, Operator

And your final question comes from the line of Richard Dearnley with Longport Partners.

Richard Dearnley, Analyst

I am intrigued with the Fargo-Moorhead contract. Who, in general, were you bidding against there? It's intriguing that a Spanish-Israeli and Canadian company would win a contract in the U.S., and maybe I just don't understand the contracts. Could you talk about that?

Joe Lambert, President and CEO

Sure. This started with multiple consortiums. Generally, every team involved in this process consists of various groups of construction professionals with significant experience. Eventually, it was narrowed down to three teams, one of which was ours. I think it can be a bit misleading to focus solely on where companies are headquartered. For instance, Acciona recently celebrated its 20th year in North America, and Shikun & Binui has also been operating throughout the continent. Many large international construction firms may have a specific headquarters, but they possess extensive experience in North America. Ultimately, it comes down to the technical proposal, execution, and pricing, along with our specific experience in certain areas that we believe helped us succeed in that project.

Operator, Operator

Okay. This concludes the Q&A section of the call, and I will pass the call over to Joe Lambert, President and CEO, for closing comments.

Joe Lambert, President and CEO

Thanks, Rebecca, and my thanks to all of you for joining us today and for your continued interest in our growth and diversification journey. I'm very excited about the opportunity to advance the business this year. And obviously, we all hope and expect to be a much healthier and more stable environment going forward. Thanks again.

Operator, Operator

Thank you. This concludes the North American Construction Group Q2 2021 conference call. You may now disconnect.