Earnings Call Transcript - NOA Q4 2023

Operator, Operator

Good morning, ladies and gentlemen. Welcome to the North American Construction Group Conference Call regarding the Fourth Quarter Ended December 31, 2023. 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 & 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 Joe Lambert, President and CEO.

Joe Lambert, President and CEO

Thanks, Joanna. Good morning, everyone, and thanks for joining our call today. I'm going to start with a few slides showing our 2023 operational performance before handing it over to Jason for the Q4 financial overview and then I'll conclude with our 2024 operational priorities, our bid pipeline, outlook for 2024, and finish up with our capital allocation plan before taking your questions. On Slide 3, our record Q4 safety performance contributed positively in achieving a trailing 12-month total recordable rate of 0.29, which is the second-best annual rate in company history and remains well below our industry-leading target frequency of 0.5. We will continue to focus our efforts on further advancing our training, systems, and processes to identify and eliminate hazards and health risks in our business. On Slide 4, we highlight some of the major achievements of 2023. The MacKellar acquisition was the obvious major accomplishment during the year. And with the strength of the Australian resource industry and the strength of our own team down there, I'm confident our Australian businesses will be highlighted in our annual accomplishments for many years to come. Our Fargo-Moorhead flood diversion project completed its ramp-up for its first full year of construction in 2023, and we enter our largest year of earthworks construction in 2024, with confidence in our productivity and our overall project plan. Our telematics system continues to provide more detailed and meaningful operations and maintenance data every day, and the 95% reliability is an impressive achievement. Also impressive is the $5.3 million of maintenance savings achieved in 2023 and systems operating costs more than 30% below budget. We are targeting to have this same or similar telematics system tested in Australia in 2024, with full rollout expected to commence in 2025. And last but not least, we successfully completed our Ontario gold mine construction project through our NAN JV partnership and have several active bids in the Ontario and Quebec regions. Slide 5 captures all of our financial highlights for the year and the 17% to 28% year-on-year increases include only a Q4 of MacKellar contributions and a negative contribution from Nuna. I'm already eager to see what this slide looks like this time next year with a full year of MacKellar contributions and a Nuna return to operational excellence. On Slide 6, you will see our EBITDA and EPS results for the last 5 years which I hope you agree is an impressive trend and one that we expect to continue. When people try to tell me how risky and volatile our resource-based business can be, I'd like to point them to graphs like these and remind them this is what was achieved with a pandemic in the middle. On Slide 7, we have updated our calculation methodology and added our Australian fleet to our utilization graphs. One of the inherent benefits in the Australian market is the 5% to 15% upside utilization potential when demand is strong. We remain on track and confident in our ability to hit our Canadian target range of over 75% by the end of this year, and we'll also be looking to similarly increase our Australian fleet to over 85% during this same period. With that, I'll hand it over to Jason for the Q4 financials.

Jason Veenstra, CFO

Thanks, Joe, and good morning, everyone. To start, I will provide brief context regarding the MacKellar transaction which closed effective October 1, 2023. As disclosed in our financial statements, the overall purchase price for the MacKellar Group was $383 million which included $394 million of PP&E which in our case, is the heavy equipment fleet. This overall purchase price included $14 million of cash which MacKellar had in their bank accounts on close. And when factoring $35 million of equipment we purchased after October 1, the all-in cost was $405 million and consistent with expectations. EBITDA generation to-date is slightly higher than initial expectations and confirms the less than 2.75 multiple we disclosed last July. The transaction and gross spending were fully funded with debt, with approximately 70% of this debt being senior secured and 30% being vendor provided. At the time of announcement in July, we had targeted net debt leverage of 1.8x by the end of 2023 and are very happy to have slightly beat that target. We've had an excellent first few months with MacKellar and are looking forward to further integration and reporting progress in the months to come. Our teams are in daily dialogue between Canada and their Australian counterparts with weekly and monthly processes starting to become routine. Moving to the financials and some brief commentary. On Slide 9, the headline EBITDA number that exceeded $100 million for the first time in our company's history was driven by a full quarter of MacKellar results. It exceeds our previous record by about 20% and exceeded Q3 by 70%. All business units contributed to this result with the exception of Nuna which we will discuss later and is a metric, among many, that our diversification efforts make us stronger and more consistent. Moving to Slide 10 and our combined revenue and gross profit. As we will have now for 4 quarters, MacKellar will provide step changes in quarter-over-quarter variances. On a total combined basis, we are up $83 million quarter-over-quarter. MacKellar and DGI, which we combine as Australia in our results, were up $128 million which could have been higher if the rainfall in November and December had been less severe. This rainfall impact can be seen in Australia's equipment utilization which almost hit 85% in October but fell to the mid-70%s in November and December. This positive variance was offset primarily by lower equipment utilization in the oil sands region. Our share of revenue generated by joint ventures and affiliates was a net $10 million lower than Q4 2022. The Fargo-Moorhead project had an excellent operational quarter and achieved the progress metrics and milestones required of the project's schedule. In addition, we had positive contributions from the continued growth of top-line revenue from rebuilt ultra-class haul trucks and excavators owned by our joint venture with the Mikisew. More than offsetting these positives, the completion of the construction project at the gold mine in Northern Ontario led to lower quarter-over-quarter revenues within the Nuna Group of Companies. Combined gross profit margin was 18.4%, despite the challenges experienced by Nuna and again, reflects the strength of a diversified business. As both Joe and I have alluded to, losses at 3 specific mining projects within the Nuna Group of Companies had a direct impact on margins. Joe will expand in his comments for Nuna moving forward but from a financial perspective, excluding these project losses, would have yielded an overall margin of approximately 20%, given the impact of $7.5 million. Gross profit margins benefited both from the operations in Australia, which are higher than 20% in the quarter, which is normal course and from ML Northern whose fleet lowers our internal cost as well as generates strong margins from services provided to external customers. Moving to Slide 11. Record adjusted EBITDA was consistent and reflective of the revenue commentary. The 25% margin reflects an effective operating quarter with a positive trend from the Q3 margin of 22%, indicative of where we see our business operating at. Included in EBITDA are direct and general and administrative expenses which, when excluding one-time acquisition costs, were $12.8 million in the quarter, equivalent to 3.9% of revenue and remained under the 4% threshold we've set for ourselves. MacKellar runs a similar G&A profile and is not expected to change our G&A burden as a percentage of revenue. Going from EBITDA to EBIT, we expensed depreciation equivalent to 11.8% of combined revenue which reflected the depreciation rate of our entire business, including the equipment fleet at the Fargo-Moorhead project. When looking at just the wholly owned entities and our heavy equipment in Canada and Australia, the depreciation percentage for the quarter was 12.8% of revenue and reflected the addition of the Australian fleet and an overall efficient productive use of equipment in the quarter. Adjusted earnings per share for the quarter of $0.87 was $0.23 down from Q4 2022 as the impacts of higher interest are factored in with EPS, with the project losses at Nuna being particularly impactful to EPS at approximately $0.20. The average interest rate for Q4 was over 8.5% as we are up from the Q3 rate of 7%. This effective interest rate is the highest we've paid in a long time, is a compelling indicator for us to look to pay down debt in 2024. Moving to Slide 12, I'll briefly summarize our cash flow. Net cash provided by operations of $161 million was generated by the business reflecting EBITDA performance and working capital collection, net of cash interest paid. Free cash flow was $111 million as sustaining capital of $41 million was invested in the fleets in both Canada and Australia. Moving to Slide 13, our PP&E of $1.1 billion is up $450 million from September 30 on the $430 million worth of MacKellar assets we purchased. Net debt levels ended the year at $721 million, an increase of $326 million in the quarter as the $405 million of net debt incurred related to MacKellar was offset by free cash flow generation. Net debt leverage and senior secured debt leverage ended at 1.7x and 1.4x, respectively and are considered reasonable levels 3 months after a transformative debt-funded acquisition. And with that, I'll pass the call back to Joe.

Joe Lambert, President and CEO

Thanks, Jason. Looking at Slide 15, this slide summarizes our priorities for the year. I'll speak to the MacKellar integration and growth in detail on the next slide, so I'll jump to the second point. This area of focus is our ongoing efforts to win strategic projects for our business. As we look to sustain and grow our infrastructure business, we'll need to win infrastructure work as our Fargo-Moorhead flood diversion project reaches completion. Although this project is several years away from completion, the tender qualification and the RFP process can take 1 to 3 years, depending on the size and complexity of the projects. As such and with a strong potential U.S. infrastructure project in the bid pipeline, we believe this year's priority should be to qualify as part of a team on one major infrastructure project. The second part of this priority is to win a meaningful project that uses our smaller mining assets that are currently underutilized in our oil sands business. We have several active tenders in both Canada and Australia that would utilize these smaller assets and we expect to win one of these projects this year. Item 3 prioritizes continued expansion of our operational and maintenance expertise. We will prioritize new technologies such as our telematics system and continuing to in-house and vertically integrate our maintenance services and supply, including a near-term focus on identifying and sharing best practices between our Canadian and Australian businesses. We believe this prioritization and focus will continue to lower cost and improve equipment utilization, resulting in increased competitiveness and likelihood in winning the tenders mentioned in the previous item 2. The final area prioritizes returning Nuna back to operational excellence and setting it up for growth and consistent performance. This work commenced earlier this year and I am confident in the changes made that Nuna will be back on its feet in time for their big summer projects and growing off a much stronger and stable foundation before the end of the year. Slide 16 shows some key milestones in our MacKellar integration plans, much of which I have discussed previously. Two points I would like to make are as follows: One, the transition team headed by our COO, Barry Palmer, is now resident in Australia and the integration has progressed smoothly and on plan. The second point which has been a pleasant surprise is that the Australian marketplace has shown to be even better than originally contemplated. As an example, and as you would have recently seen in our press release last week, we were awarded a 5-year $500 million contract extension at a major metallurgical coal mine in Queensland. That contract extension was achieved through direct discussion with the customers and awarded 15 months before the original term expiry date. These alliance-type contracts with long-term commitments and early negotiated renewals show real strength in both the commodity markets and the client relationships. When you combine these market strengths with the higher fleet potential utilization in Australia, it's easy to see the potential to improve returns on not just our underutilized smaller-sized assets but also increase the longer-term returns and internal competition for even our larger mining assets. There is meaningful time and cost to ship our big assets halfway around the world but the opportunity to optimize returns on our assets in lower-risk, longer-term contracts will be compelling and should provide a healthy internal competition for assets. Slide 17 illustrates a strong bid pipeline with the addition of Australian tenders and continued interest from long-term non-oil sands contract tenders. Although we truly believe our oil sands demand will remain strong for many years to come, we also see those big blue diversified dots and continued strong heavy equipment demand in Australia as opportunities to further diversify and reduce consolidation risk. On Slide 18, our pro forma backlog sits at $3.3 billion with the award of the Queensland major metallurgical coal mine and the award of the regional oil sands tender, offset by our normal quarterly drawdown from executed work. The $3.3 billion backlog is the highest in company history and provides improved confidence and predictability in our business, especially in our Australian business. On Slide 19, we have provided our updated outlook for 2024. The outlook is mostly unchanged except for some timing-based reclassification of sustaining capital to growth and some growth capital additions supporting recently announced project awards. Lastly, on Slide 20, capital allocation is always a focus for me and our projected free cash flow range of $160 million to $185 million gives us flexibility in that regard. Deleveraging presents an attractive opportunity at current interest rate levels and is our default choice. However, should share price drop to where we believe the risk-weighted return is higher, we have an established history in engaging in share repurchases where we see value in that for our shareholders. The MacKellar integration is a focus for 2024, but we continue seeking growth opportunities, whether organically or through acquisition, that likewise generate superior risk-weighted returns and accretion. Any and all options compete for our capital allocation and this is something we analyze continually in seeking to always be opportunistic in directing our cash flow in a way that maximizes value. With that, I'll open up for any questions you may have.

Operator, Operator

First question comes from Yuri Lynk at Canaccord.

Yuri Lynk, Analyst

Let's talk about Nuna a little bit. It sounds like you're expecting the issues that you encountered in the fourth quarter to be contained to the fourth quarter. But can you just elaborate on that, like when do these 3 projects wrap-up? And do you expect any spillover into Q1, Q2?

Joe Lambert, President and CEO

No, I think that's an accurate assessment, Yuri. These projects are mostly complete, with just a little bit of work remaining on one or two of them. I don’t expect any issues moving forward since we have implemented new leadership. The challenges we faced were primarily related to risk management, especially in working with junior miner clients, changes in management, and contract administration. These are areas where we excel. We were fortunate to have strong personnel available to take over and confidently manage those systems and processes going forward. I'm optimistic about this, especially since this is typically a slower period for Nuna. Their activity usually ramps up in the second and third quarters with summer work, mostly in the north. I believe that with the changes we've made, the past issues will be resolved quickly, and I fully expect our summer projects to proceed as planned.

Yuri Lynk, Analyst

You're also in your shareholder letter, you talked about the seasonal earnings pattern pro forma the MacKellar acquisition. Is 20% of EBITDA in the first quarter going to be typical going forward? It seems a bit low to me. I'm just wondering if there is anything else beyond that.

Joe Lambert, President and CEO

Yes. Again, I think you're accurate there, Yuri, that we've got a little bit of an unusual year this year. I think we will be more consistent between quarters. But this particular year, like I just said, Nuna's big quarters are Q2 and Q3. Same in Australia. So, the Australian cyclone season is in the summer which is our winter. So they're usually impacted operationally more in Q4 and Q1. And then, with our biggest construction year at Fargo, the summer is also the biggest part of that Fargo job. So, even though we had a good-sized construction year in 2023, it's even bigger in Fargo this year and there's more infrastructure construction, like bridges and roadwork that occurred during Q2 and Q3, whereas our previous earthworks is more year-round. And then, we've just had a bit of a slower winter this year in oil sands even, and we're shuffling around some equipment in Q1. So, it is going to be more consistent between quarters, but the lower Q1 this year is, I believe, a one-off.

Yuri Lynk, Analyst

Okay. And just a follow-up to that one. I mean which quarter is going to be the largest? Q3?

Joe Lambert, President and CEO

I think so going forward. But we're going to have projects that come and go too, Yuri, that depending on when they end. I think we're going to be within 1 or 2 points between quarters going forward. But obviously, if there's a new project start or stop in any one quarter, it can distort a year. But generally, I would say it's going to be very consistent.

Operator, Operator

Next question comes from Maxim Sytchev at National Bank Financial.

Maxim Sytchev, Analyst

Joe, I was wondering, if you don't mind, please, expanding a little bit on the comments you made in your shareholder letter talking about some of the oil sands work right now transitioning to maintain rental fleet. And kind of similar, what you are seeing in Australia. Yes, do you mind providing a bit more color on that?

Joe Lambert, President and CEO

Yes, in the regional tender, we provided pricing for unit rate work as well as for maintained rental equipment and operated and maintained rental equipment. Traditionally, the unit rate work was awarded, but this year, around half of our large trucks are being rented or are part of maintained rentals with operators instead of unit rate work. The client feels that they have some surplus assets in certain areas, so they prefer renting on an individual basis rather than through unit rates, and they believe this approach helps reduce their costs. We respect that decision and hope it proves beneficial. We're pleased to support this change, which resembles what's occurring in Australia. While this may slightly reduce our top line revenue, the difference is not significant. This reflects a contracting philosophy where clients aim to use their assets more efficiently to cut costs, and we're happy to be part of that process.

Maxim Sytchev, Analyst

Okay. But I guess, yes, structurally, how should we think about this? Is it more visibility but better return on invested capital on the assets from your perspective? Or where do you think it doesn't really make a significant financial difference at the NOA level?

Joe Lambert, President and CEO

I think the main difference lies in the risk. In unit rate work, you take on more risk related to productivity, which can be impacted by factors like weather. Therefore, I would argue that the downside risk is considerably lower. However, I do agree that visibility is reduced due to the contract structure, with three-year commitments and only one-year obligations, rather than due to any change in philosophy regarding unit rate work.

Maxim Sytchev, Analyst

Okay, understood. And then, another comment talking about sort of the TAM in Australia being dramatically larger than Canada for your type of work. Do you mind maybe expanding a little bit in terms of how you came up with that number? And at what point that could be potentially realized? I mean, I presume it's a long-term, obviously, opportunity but maybe if you can provide any brackets, that would be helpful for us.

Joe Lambert, President and CEO

Are you referring to the 10x market item there, Max?

Maxim Sytchev, Analyst

Yes.

Joe Lambert, President and CEO

Yes. We gather that information from industry statistics in the Australian mining sector, particularly regarding contracted work and coal mine data, highlighting a significant marketplace with a greater tendency to contract mining. In the two main operations we handle, we are the sole operators, and our client is not adjacent to us, which illustrates the distinct nature of this marketplace. It's a vast resource sector, quite similar to Canada. However, a key difference is that producers in Australia prefer to invest their capital in increasing production or discovering new deposits rather than in owning heavy equipment like we do. This creates a much larger and more robust market. As I mentioned before, discussing the coal market, there are 50 mines, but we are only involved in 6, presenting a fantastic opportunity in a thriving marketplace.

Maxim Sytchev, Analyst

Okay, that's super helpful. And then one last quick question for Jason, if I may. In terms of the rollout of ERP, do you mind providing like some milestones in terms of when it should be sort of up and running and how you're testing this and so forth?

Jason Veenstra, CFO

Yes, the go-live date is the most important date for us, and we have targeted September 1. The project team is currently fully engaged and operating at peak capacity. This process of implementing an ERP system is generating a lot of excitement within our organization. If everything goes as planned, the transition should be quite smooth. We also expect to see some margin improvements after the go-live, which we anticipate will be more evident in 2025.

Maxim Sytchev, Analyst

Okay. And sorry, just a clarification, are you kind of capitalizing expensing? What are you doing from an accounting perspective?

Jason Veenstra, CFO

Yes, we would capitalize, but it's not a significant amount. We're talking in the $1 million to $2 million range for this. We're essentially doing a cut-and-paste or copy-and-paste. We're not relying heavily on external resources for this, so it's different from what you typically see in an ERP implementation.

Joe Lambert, President and CEO

Yes, I would add, Max, that MacKellar was actually in the process of bringing this, actually this exact same system online at the time when we purchased them. So, they really had already started progressing this ERP transition even before we bought the company.

Operator, Operator

Next question comes from Aaron MacNeil at TD Cowen.

Aaron MacNeil, Analyst

It looks like you've got a thermal coal mine contract that comes up for renewal in 2025. Do you see any regulatory hurdles or broader issues with demand for thermal coal that might prevent your customer from giving you that similar 5-year contract extension that you just obtained from the met coal customer? And ultimately, I'm just trying to understand how you're thinking about the outlook for met coal versus thermal coal in Australia.

Joe Lambert, President and CEO

Based on the industry information I've observed, I believe that the demand for coal, especially in Queensland, is robust and long-term. I don't foresee any challenges in renewing contracts at these coal mines. Most of them are already permitted and typically have permits that extend for multiple decades. There is no need for re-permitting, and to my knowledge, no operations are facing that kind of risk. In Queensland, approximately 90% of coal is exported, primarily to a very strong and high-demand market in Asia and India. This coal mainly competes with Indonesian coal and is significantly better in terms of efficiency, burn quality, price per BTU, and cleanliness. Thus, I am confident that we will not experience any negative effects on that market. While carbon footprints are decreasing, the need for electricity continues to rise. According to data from the Queensland Coal Mining Associations, there is a strong demand expected for the next two to three decades.

Aaron MacNeil, Analyst

Makes sense. I don't want to put words in your mouth, but could we potentially see a renewal in the near term on that site as well?

Joe Lambert, President and CEO

Yes, for sure.

Aaron MacNeil, Analyst

One more question, it's probably for Jason. Are the costs to move or revenues associated with the move of assets contemplated in the 2024 guidance? Like you mentioned in the prepared remarks that there's the potential to move the smaller assets, either within Canada to Australia.

Jason Veenstra, CFO

Yes, they are. We expect that shipping costs will be capitalized through the MacKellar Group, given the low cost reflected on our balance sheet for the actual cost of the units being shipped. The revenue anticipated in Canada does allocate some allowance for units coming out of the region. Thus, it is accounted for in our guidance, although we haven't specified it in our forecast.

Operator, Operator

Next question comes from Kevin Gainey at Thompson Davis.

Kevin Gainey, Analyst

Congratulations on the fourth quarter. Could you provide more details about the recent bid pipeline in Australia and what your thoughts are as you look ahead?

Joe Lambert, President and CEO

Into that bid in particular? Is that what you're asking?

Kevin Gainey, Analyst

Yes, yes.

Joe Lambert, President and CEO

Yes. I think we see continued opportunity. That bid was the second phase of a 5-year contract, which we extended for another 5 years. We have a long-standing relationship with this customer, and I believe that these types of contracts are common, especially in the Queensland coal fields. I think there are chances to secure more of these contracts at other sites where we see growth. This is part of the bid pipeline you would observe in Australia. Additionally, in Western Australia and other regions, we are beginning to see increased activity. While gold and iron ore have traditionally been the strong sectors in Western Australia, there are emerging copper markets, and we currently have one of those in our tender pipeline. Overall, we have a very robust bid pipeline.

Kevin Gainey, Analyst

Could we also discuss the first quarter? Has it started off slower for MacKellar and for the oil sands in general?

Joe Lambert, President and CEO

Yes. I mean, this is kind of what I was talking to Yuri about earlier is that we're having a little bit more slower of a winter but I think the biggest reason why Q1 is different is the addition of MacKellar. So, MacKellar is a lot more consistent year-round. But their rainy season is summer which is our winter. So, their November to February is slower than the rest of the year. So, that's taken us to more counter-seasonal Q2, Q3. Nuna has always been that way. And then we see Fargo, even though last year was big, it was predominantly all earthworks, and it was very year-round work. It is a little higher in the summer. But this summer will be much higher just because there's a lot more concrete work and bridge construction which has to occur in the summer. And so, all of those factors just push our top line more into Q2 and later.

Kevin Gainey, Analyst

And maybe for Jason, just a bit on the forecast for D&A in '24, maybe cadence as well about that, as I look at the model.

Jason Veenstra, CFO

Yes, we touched on that too. We expect to be in the 4% range on reported revenue moving forward. We've had some questions on the Q4 metric which did include $6 million of acquisition costs in the quarter. So, Q4 is not indicative of our run rate. But I think for modeling purposes, 4% is still where we expect to be in 2024.

Operator, Operator

Next question comes from Sean Jack at Raymond James. Please go ahead.

Sean Jack, Analyst

So quickly, just wanted to switch over to the acquisition point that was talked about earlier. Overall, do you expect in Australia that there are any more sort of material acquisitions that you guys could make that would be able to be done at the multiple point that MacKellar was done? Or is that kind of standing as a pretty unique deal for you guys?

Joe Lambert, President and CEO

I believe there may be additional opportunities, but they would need to be particularly attractive since we have significant potential for internal growth. Therefore, if we were to pursue an opportunity, we wouldn't be willing to pay any substantial premiums, as we are quite confident in our ability to develop from existing sites.

Sean Jack, Analyst

Right. Okay, that's great color. And then looking forward, obviously, you guys got a lot of stuff to do or just a process ahead of you on your plate for the integration. Like, when do acquisitions actually and bolt-ons become a priority or something that's very realistic? Is that maybe far deeper into 2024 or is that actually an opportunity in the coming months here?

Joe Lambert, President and CEO

I think small bolt-ons can happen fast. If there were big acquisition opportunities, historically, they've taken us many months, years. MacKellar was a 2.5-year process. So, even if we had one on the desk today, it'd probably be 2025 or later kind of thing, unless it's small bolt-on acquisitions. Those things, ML Northern, DGI, we were able to process pretty quickly. And so, our focus will be on the MacKellar integration this year. And regardless of what acquisition activities occur, I think we'll be able to maintain that focus for the year and get that integration done smoothly.

Operator, Operator

Thank you. We have no further questions. I will turn the call back over to Joe Lambert for closing comments.

Joe Lambert, President and CEO

Thanks, Joanna. Thanks again, everyone, for joining us today. We look forward to providing the next update upon closing of our Q1 2024 results in early May. Thanks.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect. Have a good day.