Earnings Call Transcript - NOA Q2 2020

Operator, Operator

Good morning, ladies and gentlemen. Welcome to the North American Construction Group Earnings Call for the Second Quarter ended June 30th, 2020. At this time, all participants are in listen-only mode. Following management’s prepared remarks, there will be an opportunity for analysts, shareholders, and bond holders 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 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 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 SEDAR and EDGAR as well as the company's website at nacg.ca. I will now turn the conference over to Martin Ferron, Chairman and CEO. Please go ahead.

Martin Ferron, CEO

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 worksites. I'm especially proud that in typical NACG fashion, we applied a fast and firmer strength to our costs, eliminating all discretionary spending and very closely managing all third-party support expenses. This closed 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 in 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 on slides five to nine, before I talk about our outlook using slide 10. So over to you, Joe.

Joseph Lambert, President and COO

Thanks Martin. Looking at slide two, I am pleased to report that our team promptly responded to the 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, busing and transportation needs, sanitizing the 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 the 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 start-up of a coal management contract in Texas, we were not only able to achieve a smooth and orderly transition, but 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 a pandemic and cross 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 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 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 call back list as we begin to ramp up out of the Q2 business trough. 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, improved cost and efficiency during Q2 and will 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 and component rebuilds have an immediate impact on reduced sustaining capital spend, but the income statements 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 are 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 theories 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.

Jason Veenstra, CFO

Thanks Joe and good morning everyone. I'll start with our topline on slide five. Revenue for the quarter was $71 million, down $100 million from last year's Q2 due to the full impact of COVID-19. Our quarter was marked by site access challenges, including the related demobilization and mobilization efforts. Typically, these processes are scheduled, but the pandemic forced us to act quickly, and much of our quarter was dedicated to adapting to changing circumstances. Overall, revenue decreased by 60% compared to Q2 2019. In 2020 alone, we saw a 64% decline from the first quarter, with early Q2 revenues more than 70% lower compared to January and February. Although the resilience of oil sands mines was evident as production continued, access restrictions significantly affected our revenue. Notably, bitumen throughput at the Fort Hills mine was reduced, resulting in lower demand and our equipment being moved to the Millennium mine, which took time and impacted revenue. The Nuna Group of Companies faced fewer pandemic-related challenges but experienced general site access delays as they began their busy season in June. On the revenue front, external maintenance and mine management contracts remained relatively unaffected and helped mitigate overall decreases. Our gross profit margin stood at 30%, reflecting an efficient operational quarter, although on a much smaller scale than expected. Our on-site teams reacted quickly to customer needs, and costs incurred were for specifically requested support and services. Heavy equipment was used effectively with minimal downtime, and we put in place immediate cost constraints to reduce potential layoffs while maintaining positive profit levels. The gross profit margin included a depreciation of 16.3% of revenue for the quarter, which is slightly higher than the expected 14% due to the impact of straight-line depreciation in a low revenue environment. Direct, general, and administrative expenses for the quarter were $3.5 million, which is 4.9% of revenue. This was lower than the $6 million spent in Q2 2019, but higher than the previous 3.4% of revenue. The 4.9% reflects low revenue but was supported by austerity measures implemented in late Q1, such as reduced work hours and cutting discretionary spending. Adjusted EBITDA was $31.9 million, down $5.2 million from Q2 2019, reflecting the widespread effects of the COVID-19 pandemic, counterbalanced by our strict control over indirect project costs and essential G&A spending. Adjusted earnings per share for the quarter were $0.45, similar to the prior year when considering the temporary wage subsidy program and lower interest costs. Cash interest expense for the quarter was $3.7 million, with an average interest rate of 3.6% due to reductions in posted rates and favorable financing terms we secured. Additionally, adjusted EPS for the full quarter was affected by the issuance of 4.6 million common shares on April 6 as part of redeeming our 5.5% debentures, which was offset by repurchasing 1.2 million shares. Consequently, our weighted average number of common shares for the quarter was 28.8 million, compared to 25.6 million in Q1. We’ll briefly discuss the Canada emergency wage subsidy, as detailed on slide six. Our net income includes approximately $11 million of wage subsidies from the program, showcased alongside employee expenses in project and equipment costs as well as general and administrative expenses. These subsidies helped us cover a portion of the wages paid, significantly aiding our ability to retain our workforce. Essentially, the program reimbursed us for 20% of total employee costs, allowing us to keep 20% of our workforce intact that we may have had to reduce otherwise. From our standpoint, this program has been effective and puts us in a favorable position as we look to increase activity levels. Moving to slide seven, I will summarize our cash flow. Free cash flow for the quarter was $11 million, composed of adjusted EBITDA of $32 million, offset by sustaining capital expenditures of $14 million, cash interest paid of $4 million, and timing impacts from changes in other balance sheet items. Sustaining capital was significantly limited this quarter due to the broader economic environment, and this aligns with the variable nature of our capital spending. Free cash flow was notably impacted by increases in both capital inventory and capital work in progress as we advance our internal rebuilding processes. Moving on to our balance sheet on slide eight, liquidity stood at $135 million, bolstered by steady free cash flow and around $25 million in additional equipment financing secured during Q2 at low interest rates. Our trailing 12-month senior leverage, including the equipment financing, was 2.1 times, well below our covenant of 3.0. In closing out slide eight and moving to slide nine, our return on invested capital was 10.2% as of June, slightly improved from 9.9% in Q1, as adjusted EBIT for the quarter rose year-over-year. With these financial comments, I'll hand the call back to Martin.

Martin Ferron, CEO

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 oil sands mine sites starting around mid-March. This allowed them to manage virus pace more effectively by either operating with the fewest people possible or bringing forward maintenance turnaround activity. Also, for the first time, we saw production cut back at an oil sands mine as physical storage for the product became a real issue, where the virus also creating a sharp decline in oil demand. While our mining 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 that there was a two-month time lag 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 fell in Q2, and we still anticipate that our oil sands operations will normalize as the year progresses. Nuna was less impacted with our active seasonal work just kind of 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 million to $170 million. And we expect to produce another $20 million to $40 million of free cash flow in the second half of the year, but 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 is about flat, which would be quite an achievement in this extraordinarily tough year. We're 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 oil sands 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, given that we had produced $1.4 of adjusted earnings per share in the first six months of the year, with over half of that time being impacted by the virus pandemic. We have clearly demonstrated the resilience of our business model and our ability to cut spending to protect profit margins and free cash flow in the face of extreme adversity, at our stock price as a seven number. I will now hand the call back to the operator, Denise, for the Q&A session. Thanks.

Operator, Operator

Your first question comes from Yuri Lynk with Canaccord Genuity. Your line is open.

Yuri Lynk, Analyst

Good morning guys.

Martin Ferron, CEO

Good morning Yuri.

Jason Veenstra, CFO

Good morning Yuri.

Yuri Lynk, Analyst

Martin or Joe, could you provide an update on the revenue recovery trend as we progress through the quarter and share any early insights for July?

Martin Ferron, CEO

Joe, do you want to take that?

Joseph Lambert, President and COO

Yes, we are seeing our sites beginning to recover. It’s important to note that there was a train shut down at the Fort Hills site, which has been reported to be closed through 2021, although recent updates from the owners indicate it might reopen sooner. We still expect the public date of 2021 to hold. However, we have other sites that have expedited their turnarounds and are starting to ramp up this month. We believe they can approach full capacity by the fourth quarter. Overall, we anticipate this ramp-up to take place from now until October. We also expect our winter season to be as busy as usual, with high engagement levels. Does that address your question?

Yuri Lynk, Analyst

Yes. Yes, yes, 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?

Martin Ferron, CEO

Yes, 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 on retaining people. Our business is recovering, but we still have a lot more people and we need for the workload. So, it’s really a retention tool. It’s working very effectively, but it’s cost associated with it, right? So, it’s in the mix, but it’s certainly not a direct order to the bottom-line.

Yuri Lynk, Analyst

No, I'm just trying to square the revenue recovery with the if you're going to if you expect to get benefits in the back half of the year, then wouldn't your revenue have to be down 30% or more year-on-year in each quarter, and is that in line with what you're expecting?

Martin Ferron, CEO

Jason?

Jason Veenstra, CFO

Yes, we still expect to qualify here. Based on our previous qualifications in the 60% to 70% range, we are confident about the 30%. We're still navigating some aspects of the new qualification, but it appears to be easier to qualify for periods five and beyond. So, we anticipate qualifying, and our estimate, as Martin mentioned, remains consistent with what we achieved in the first three and a half months.

Yuri Lynk, Analyst

Okay. Okay, guys, I'll turn it over. Thanks.

Martin Ferron, CEO

Thanks Yuri.

Operator, Operator

Your next question comes from Daine Biluk with CIBC World Markets. Your line is open.

Daine Biluk, Analyst

Good morning everyone.

Martin Ferron, CEO

Good morning Daine.

Daine Biluk, Analyst

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?

Martin Ferron, CEO

Joe, can you take it on again, if you don't mind?

Joseph Lambert, President and COO

Yes, I believe that's our typical pattern. I expect that trend to continue, with Q4 slightly outperforming Q3.

Daine Biluk, Analyst

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

Martin Ferron, CEO

It's mainly yes. Go ahead, Joe.

Joseph Lambert, President and COO

I was going to mention that it's mainly the increase in activity at those sites, along with the preparations for winter maintenance work, which starts in Q4 and continues into Q1 next year. There is a significant increase in work as we progress through the year, but there is also a greater increase in fleet availability to be utilized in Q1 next year.

Daine Biluk, Analyst

Understood. I have one more question for you, Joe. Just to follow up on your earlier comments about Fort Hills. Can you confirm that the current guidance does not include any core sales activity for the second half of the year? Also, if operations were to resume, how significant would that benefit be, or is it more of a 2021 issue?

Joseph Lambert, President and COO

We don't have anything significant projected at Fort Hills through the end of this year. Even if operations were to start up late this year, we don't anticipate the demand for our services to begin until next year, likely in Q1 or Q2. They have mined in advance with one train down, so they are somewhat buffered from their contracting needs at this time.

Daine Biluk, Analyst

Got you. Okay. That makes sense. That's good color. 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?

Jason Veenstra, CFO

Yes. The cost is a few million dollars. It was part of the fluctuations we experienced in the second quarter, which is now behind us. At the end of March, we also had to make some decisions, so a portion of that was accounted for in the first quarter. The total is in the single-digit millions, and relocating this fleet is quite costly.

Daine Biluk, Analyst

Got you. That makes sense. Its good color. Thank you. Appreciate the color guys. I'll turn the call back.

Martin Ferron, CEO

Thanks Daine.

Operator, Operator

Your next question comes from Maxim Sytchev with National Bank Financial. Your line is open.

Maxim Sytchev, Analyst

Hi good morning gentlemen.

Martin Ferron, CEO

Good morning Max.

Jason Veenstra, CFO

Hi Max.

Maxim Sytchev, Analyst

Martin I was wondering if you have these numbers kind of on the top of your head, in terms of the 60% year-on-year decline in revenue how much of that is in relation to restricted access to sites versus production curtailments versus weather? So, we're just trying to gauge better how to think about the forthcoming quarters in terms of revenue progression.

Martin Ferron, CEO

Yes, I would kind of say about 70% is site access issues, maybe 20% due to the production cut back and 10% due to a pretty wet June, actually. So, that's kind of the way I'd look at it.

Maxim Sytchev, Analyst

Okay, fair enough. Martin, could you provide an update on whether site access has fully normalized or if there are still some challenges you're facing?

Martin Ferron, CEO

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 timeframe for us to reengage 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 in Q4.

Maxim Sytchev, Analyst

Okay. No, that's helpful. And then just curious to see your views around client behavior. Having seen sort of the pressure for pricing concessions, things like that, that we would have seen in 2014? Just maybe any color there.

Martin Ferron, CEO

Yes, definitely. Obviously, the oil price collapse, plus trying to manage the virus, made things very tough for our customers. I really sympathize with. 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.

Maxim Sytchev, Analyst

Okay. Thank you. And then your comment around Nuna 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 there?

Martin Ferron, CEO

Yes, I'll speak in general. I think I've learned in the past not to speak about specific projects. So, yes, in house, we've got several bids, several opportunities that we're developing from a business perspective of commodities, other than oil. 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, we're bidding away in developing these opportunities, and we really hope that we'll have some good news to share.

Maxim Sytchev, Analyst

Okay. And my last question is just on capital deployment thoughts. I mean obviously, NCIB 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?

Martin Ferron, CEO

Yes. So, obviously, in the current environment, there's a certain amount of distress. So, I think there'll 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. So, we'll tailor the pace of 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.

Maxim Sytchev, Analyst

Right. And I guess, Martin, I mean, here, you talk about assets, specifically sort of assets with full yields or you're talking about companies. I mean how is that sort of environment? Are there any distressed situations that could be of interest to you?

Martin Ferron, CEO

Yes. Again, I'm not going to speak to it specifically, but the virus and the oil price situation has caused a lot of distress, and it wouldn't be surprising to see parts of businesses or individual assets come up for sale at decent prices. So, as I mentioned, if we can pull off a deal or two like that, we will certainly look at it. It's something we're engaged in.

Maxim Sytchev, Analyst

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

Martin Ferron, CEO

Thank you, Max.

Operator, Operator

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

Devin Schilling, Analyst

Hi guys. Good morning. I know in the past, you guys have talked about the RD project, I believe in Nuna that you guys were shortlisted for. Any updates here? Or is everything around this project on hold at the moment?

Martin Ferron, CEO

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

Devin Schilling, Analyst

Okay. Can you provide an update on your revenue visibility from key clients? Are you currently scheduling work a couple of weeks in advance, or have discussions improved to the point where you're now looking at a couple of months out?

Martin Ferron, CEO

No, we have a certain amount of backlog, which we can plan months in advance on the sites we're back fully engaged on, Devin. There are many discretionary projects going on right now, not much spot work. So, to the extent they pop up, then, yes, that's a shorter term planning-type style, but we have a backlog of work that keeps us engaged for months.

Devin Schilling, Analyst

Okay, great.

Operator, Operator

There are no further questions queued up at this time. I turn the call back over to presenters.

Martin Ferron, CEO

Well, thank you for joining us today. We look forward to speaking to you next time. Thanks.

Operator, Operator

This concludes the North American Construction Group conference call. You may now disconnect.