North American Construction Group Ltd. (NOA) Q4 2018 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the North American Construction Group Earnings Call for the Fourth Quarter and Year-Ending December 31, 2018. [Operator Instructions]. 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. I would now like to turn the conference over to David Brunetta, Director of Investor Relations.

Good morning, and good morning to everyone and thank you for joining us. Welcome to the North American Construction Group's 2018 fourth quarter and year end conference call. I would like to remind everyone that today's comments contain forward-looking information. Additionally, our actual results may differ materially from expected results because of various risk factors and assumptions. For more information about our results, please refer to our December 31, 2018 management's discussion and analysis, which is available on SEDAR and EDGAR. On today's call, Jason Veenstra, Executive Vice President and CFO, will begin by reviewing our fourth quarter results; Martin Ferron, Chairman and CEO, will then provide his comments on our outlook and strategy. Also with us on the call today are Joe Lambert, President and Chief Operating Officer; Barry Palmer, Senior Vice President of Operations; and Rob Butler, Vice President of Finance. After management's prepared remarks, there will be a question-and-answer session. I now turn the call over to Jason.

Thanks David and good morning everyone. As mentioned, I'll provide a summarized financial overview of Q4 along with some brief commentary on our overall 2018 cash flow and will close with the status of Nuna acquisition and our purchase of the heavy equipment fleet in the middle of Q4. Starting with the financials. Top line revenue for the quarter was $131 million, $49 million higher than 2017. This 60% year-over-year increase is indicative of strong activity in the oil sands was driven by the mine site work at the Millennium, Mildred Lake and Kearl mines. Consistent with the producers' public comments, this performance illustrates their persistent focus on throughput at their operating mines despite the outside noise and market volatility. The $131 million of revenue includes $24 million from the M&A transactions we completed in mid-Q4 which I will touch on later. The comparable Q4 revenue of $107 million represents a substantial increase in revenue of over 30% and reflects the demand we are experiencing in the oil sands. In addition to the consistent production we are witnessing first hand from our customers, several factors contribute to the strong volumes in Q4 when comparing to last year. Number one and most importantly, the contracts stability related to term contracts we announced during 2018 has had a positive and incremental impact on overall work generated. On our contracted sites, the customer visibility and access to our equipment is providing higher utilization as work gets completed outside of the core contracted volumes. Secondly, when compared to 2017, we had and earlier ramp up of our winter works program at the Millennium and Mildred Lake mines. And third, an early stage heavy civil construction project at the Kearl mine has had a material impact on 2018 results. Outside the oil sands, civil construction work at the Highland Valley copper mine continued to generate steady revenue and was slightly higher on a quarter-over-quarter basis as the contract was signed in September 2017. External maintenance revenue was also slightly up quarter-over-quarter, the move into our new maintenance and rebuild facility here in mid-November was seamless from a revenue perspective and we remain on a positive trend on what is an important diversification stream for us. Moving to the expense side, where we always start with capital depreciation, because it is such an important expense for us as a heavy equipment operator. Appreciation was $18.2 million for the quarter, or 13.9% of revenue and was down from the 2017 level of 14.4%. This depreciation level reflects the benefits of higher utilization in operating hours as well as our maintenance initiatives which are extending the useful lives of the fleet and the major components. With these positive trends in both revenue and depreciation, gross profit achieved in the quarter was $18.3 million, a 14% margin. This dollar level compares very favorably to the $12 million posted in the prior year, a 50% year-over-year increase. The 14% margin we posted was slightly unfavorable to the 14.6% margin we posted in 2017. The decrease in margin is explained by the cost we incurred as part of the unavoidable impact of onboarding 181 heavy equipment assets and the related personnel right in the middle of our winter season ramp up. In addition, the two month of Nuna results had an impact on margin given this is their seasonally slower time. Excluding the one-time onboarding impact and Nuna seasonality, gross profit margin was over 16% for the quarter and on a like-for-like basis, significantly exceeded 2017 performance. Below gross profit, G&A expense excluding stock-based compensation was $8 million for the quarter, higher by $2.3 million from 2017. This increase was driven by higher short-term incentive cost associated with our strong 2018 results, as well as the one-time legal and consulting expenses required for our acquisition activities. When excluding M&A activity, our G&A run rate of 5% of revenue is indicative of the level we expect moving forward. Of a specific note in the quarter, the stock based compensation expense of $2.5 million was less severe than Q3, and nonetheless was incurred due to our continued stronger share price and its impact on the carrying value of the liability award plans. Interest expense of $3.4 million for the quarter was consistent with expectation given the debt financings we have put in place. We remain very happy with the credit facility and equipment financing we have arranged and continue to operate with an overall cost of debt under 5%. Before we look at net income and EPS, I'll touch on the adjusted EBITDA margin of 21.7%. As mentioned, Q4 was impacted by the November onboarding of the heavy equipment fleet. Excluding these onboarding impacts, Q4 EBITDA margin was over 24%, again a full 2 percentage points ahead of 2017, which is consistent with the operational excellence trend line we are on. The full synergies in the oil sands from our recent fleet acquisition are on schedule for 2019, but are not fully reflected in the short-period of operations in 2018. In spite of this, full year 2018 EBITDA of 24.8% establishes another profitability watermark gained over the past five years of improvements and reflects the continuous drive for productivity and efficiency. EBITDA of 28.4% million results in a full year EBITDA of $101.8 million and compares to the 2017 equivalent of $63.1 million and 21.6%. In particular and for emphasis, this outstanding increase in margin of over 2 full percentage points is a testament to incredible job done by operations over the past 12 months and do not reflect the full year impact of Nuna and the operation of our increased operating fleet, which is now a fleet of over 625 heavy equipment assets. Regarding net income, we recorded $2.7 million of earnings compared to similar $2.5 million last year. The $6.1 million improvement in gross profit was offset by $3.1 million of one-time G&A acquisition-type cost and the stock based compensation. The remaining $3 million is increased interest and deferred taxes, both incurred as a result of higher gross profit levels. The positive net income equals basic earnings of $0.11 per share over the quarterly average of 25 million shares. When factoring in the one-time expenses previously mentioned, this is a quarterly EPS level of over $0.20 per share. To close out the financial review, I'll briefly summarize our free cash flow performance. For 2018, we generated $102 million in adjusted EBITDA. As provided in the MD&A, sustaining capital expenditures totaled $53 million for the year and when factoring in positive working capital of $14 million, and other smaller cash impacts, this netted the business $60.7 million of free cash flow. This cash flow generation was primarily used for two purposes; approximately $20 million of cash was used on a net basis to fund growth capital and $15 million was used to purchase back our share. The remaining cash was used to pay down debt throughout the year or was left on the balance sheet at year-end as we ended the year with over $19 million of cash on hand. To close out, I'll provide a quick status of our acquisitions, both of which were fully financed using our credit facility. Consistent with the time needed to fully close transactions, the Nuna acquisition which was executed on November 1 formally closed last week and the purchase price of $42.8 million as reflected in the financials did not change noticeably from the $42.5 million price that was announced back in September. The fleet purchased on November 23, remains on target to fully close in Q1 as it goes through normal closing conditions. These two transactions did not have a noticeable impact on Q4 EPS. We are looking forward to reporting a full quarter in Q1. The fleet purchase will become part of standard reporting, but the Nuna acquisition will provide some complexity as a few of the entities did not qualify for proportionate consolidation and their profits will be reported to equity earnings. Once we have a full standalone quarter to report, this will be much easier to walk stakeholders through. The other complicating factor that we'll need to address in our results is the seasonal rebalancing that will occur as a result of our ownership interest in Nuna. As Martin will highlight, year-over-year comparisons moving forward, will need to be completed with this in mind as the majority of Nuna's profits come in Q2 and Q3 during the busy season in Northern Canada. As has been mentioned, these acquisitions were financed through our $300 million credit facility and we appreciated the commercial support from all the members of the syndicate during a very busy Q4.We closed out year with $100 million of liquidity available under our facility and over $50 million of room for additional capital leases. Based strictly on our bank definition of debt to trialing EBITDA, the leverage ratio of 2.9 compares favorably to our allowed limit of 4.0. On the next 12 month basis, our total debt leverage ratio net of cash is 2.2 and the senior leverage ratio which governs our credit facility and excludes both the convertible debentures and the mortgage is at 2.0. As we mentioned in the disclosures yesterday, we plan to use free cash flow to delever and fully expect our senior leverage to trend back below 2 in 2019. And with those comments, I'll turn the call over to Martin.

Thanks, Jason, and a very good morning to everyone. As we look back, I will always remember 2018 as a transformational year for us in which we invested in significant growth by M&A activity to complement an already robust organic growth plan. Of the two M&A deals, we announced during the year, did not close until very late in the period, they did not contribute much in the way of EBITDA, to what was another stellar year of financial improvement. For the full year, we grew revenue and EBITDA by 40% and 61%, respectively, against stated targets of 15% for both, the follow-on from 37% and 18% growth in these measures during 2017, therefore the exciting benefits of the two acquisitions will be realized starting in 2019, which will believe will allow us to continue our hopefully impressive record of maintaining strong growth. I will return to this theme, but first I want to highlight other notable achievements of 2018. Firstly, and most importantly we preserved our top-tier record of safety performance, with our total record of injury rate again coming in, well below 0.5. As the management of safety hazards is a crucial aspect of achieving overall operational excellence, I'm very pleased with our performance. Second, we further improved our profitability with basic earnings per share coming in at $0.61 a share. This number was much nearer $1 a share before the mark-to-market accounted for our liability based deferred stock based compensation and the one-off M&A related expenses that Jason took us through. Third, the construction of our new heavy equipment maintenance and office facility here in Edmonton, was completed ahead of time and on-budget, such that we moved in during November. Fourth, we build our backlog of contracted work to over $1.2 billion, from less than $0.1 billion at the start of last year. We expect this trend to continue in 2019. Fifth, we bought back nearly 1.3 million shares at an average price of $7.44 under our latest NCIB taking total repurchases to over 10.7 million shares at a dividend adjusted average price of about $4.70 since we initiated the buyback in 2013. Sixth, we closed the acquisitions of an ownership stake in Nuna Logistics in November, providing us with excellent revenue diversification outside our core oil sands market. The majority ownership position in Nuna is held by Kitikmeot Corporation, who have already really impressed us with their business acumen. Last but not least, we closed the second acquisition involving over 180 heavy equipment assets on November 23 and onboarded more than 450 personnel, pursuing three significant contracts and were fully operational by November 26. As part of this transaction, we entered a new and exciting excusive partnership with Mikisew Group of Companies which is directly owned by the Mikisew Cree First Nation, who are the largest of five Athabasca Tribal Council Nations. So, now turning back to our growth prospects of 2019. We currently anticipate the improvement to be around 75% for revenue and about 60% for EBITDA which we trust you will consider to be impressive numbers. These expected increases could then propel our basic earnings per share to over $1.60 for the year which will be quite an achievement for a company who was making steep losses not so long ago. Due to the magnitude of this improvement, we believe it's prudent to provide an estimate of EBITDA proportionality by quarter during the year, which we presently assess as 30%, 20%, 22% and 28%. The main variables impacting this assessment for the first half of the year, are the timing of spring break up and the pace that we can schedule maintenance and repairs for some of the acquired multiple assets. Also, the busiest quarters for the work linked to our ownership stake in Nuna are Q2 and Q3 and so this is completely counter-seasonal to oil sands operations. Additionally, for this assessment it is important to note the term contracts we have in hand allow more even scheduling of work throughout the year for cost optimization purposes. At the anticipated level of profitability for 2019, we expect to print EBIT margins near the construction industry leading levels, as well as returns on both capital and equity. The latter could be over 20%, which is a subject I'll cover in more detail in my Annual Letter to Shareholders which should be available this afternoon. We have tremendous operating leverage in our business, such that our SG&A expenses will likely trend towards 5% and then plus 4% before liability related stock based compensation as we continue to grow. As far as capital spend and allocation is concerned for 2019, we expect to fund up to $90 million on sustaining capital, using the previously announced one-time spend or including a previously announced one-time spend of $20 million on the recently acquired heavy equipment assets. This one-off expenditure will enable us to improve uptime and utilization of the bought assets later in 2019 and beyond. The rest of our considerable operating cash flow after interest and dividend payments will be allocated between debt reduction and growth capital with the former getting priority. We are committed to lowering our debt by $150 million over the 2019 to 2021 period which is a task made slightly easier by the recent Federal government announced accelerated depreciation schedules for capital assets. Due to the situation, we now do not expect to pay cash taxes until 2021. Beyond 2019, we couldn't believe that we have the cash flow and growth prospects to keep maintaining a double digit compound annual growth rate in both revenue and EBITDA while also achieving our debt reduction target. This belief is supported by the fact that much of our forward works the next three to five years is contracted, a link to strong and unwavering production from several oil sands mines. This is a significant change for the mainly spot contracting world of prior years. Having this large backlog of work allows us to more effectively plan our activities especially equipment maintenance and should lead to margin expansion even without price escalation. To close, I would like to commend my extremely talented and committed team of personnel. Basic principle of my leadership philosophy is that a chief executive should publicly take 100% of the blame when things go wrong in a company, and always share most of the credit when things are going according to plan. | Well, my confidence level for the future remains extremely high mostly because I can totally trust my amazing team to maintain our strong performance and growth. I could not be prouder of them especially for the professional and friendly way they welcome hundreds of new employees into our fold in November and quickly introduced them to our unique culture. We are now firing on all operational cylinders, and I'm super excited about what 2019 and beyond will bring. With that, I would like to turn the call back to Denise, the operator for the Q&A session.

Thank you. [Operator Instructions] Your first question comes from Yuri Lynk with Canaccord Genuity. Your line is open.

Martin, how is the acquired Aecon gear been relative to your initial expectations in terms of you know how it's performed, productivity and maintenance – or I guess the maintenance CapEx is unchanged, but because it's been pretty well as expected?

We knew we'd have to spend a significant sum of $20 million catching up on maintenance and repair. I think it's fair to say that the equipment was in worse condition than we expected. But we still think the $20 million we know will cover this situation.

And does that impact the – I think you had targeted previously, correct me if I'm wrong about $30 million of external maintenance revenue at the new facility. Does that have any bearing on that number?

Yeah, the $30 million target is one that will take us a couple of years, maybe three years to achieve and we're in the middle of trying to balance our internal need for maintenance right now with external work. There is a lot of external work opportunity. But also plenty of internal need, so the balance is quite tricky, but we're managing it well, so that's the status there, Yuri.

Shifting gears, interesting press release at the end of last year on the option to acquire some ultra-class trucks which you've never used before. What's the thinking behind that and then what would you be using those trucks for?

They are very useful for earthmoving activities especially all of them a little. So, once we got the opportunity to exercise that right, we looked at our need for a fleet given the tremendous workload that we see and we believe that with need for more assets beyond what we picked up for the earlier acquisition. So, we were glad to take some other – what turns out of be a reasonable price we believe.

That's it from me. I'll hop back in the queue. Congratulations on a good quarter.

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

Martin, I was wondering if you don't mind just quantifying what was the EBITDA contribution for the acquired assets in Q4 if it's possible? Because I think you said it was de minimis, right?

De minimis is the right word less than a million dollars.

Okay, so it was all organic. Excellent. And then do you mind maybe, because I think it's right about now where you are getting visibility on summer construction work, Martin, do you mind maybe just commenting on how that's shaping up?

Oh, really well, especially, we bat on the Fort Hills mine sites and just trying good activity schedule there. Also you know Syncrude have got a major expansion project (MIS) which we'll be bidding on, so it's shaping up really well even during in late February.

Okay, and then I think in the past we talked a little bit about the LNG optionality for you guys just trying to think how is the bidding environment for that particular project going right now?

We don't believe we'll be participating in that Max for a couple of reasons, one is that we're too busy doing the other things that make us good margin. And second, we don't think we have much of a change if we did bid it. So, we'll save our ammunition for other things that we believe will serve us better.

Okay, I guess is it a question of just how competitive the environment in that marketplace?

Yeah, I think that project is one a lot of companies want to get their name on. We'd like to get our name there too, but at a decent margin and I don't think the two things are probably achievable.

Okay that makes sense. And then, do you mind maybe commenting on Nuna now that you have it under your belt in terms of initial impressions and you know the ability to obviously capitalize that business potentially better and how much of an opportunity that could be down the line for you guys?

We're really impressed. We closed the deal. It was a quiet time for them. So, we've had the opportunity to spend some time visiting them and really again to totally understand the business. I think we got some really super bidding opportunities which we can help them with. There is one in particular that we're bidding together. So, in the past they didn't have access to heavy fleet, so now they do and I think that's going to open up some great opportunities for them that they couldn't pursue previously.

Okay, that's helpful. And maybe last question for me, I mean obviously very pleased to see the share price kind of aligning with the prospects. And now that you have a bit of better multiple, how does that enter your thinking around you know incremental M&A whether its tuck-in or something bigger. I mean I understand that obviously your priority is to deliver, but if – how do you square the EBITDA multiple environment right now for you?

You know me Maxim, I'm shy about talking about the stock price so – when the Annual Letter comes out, that we'll share this afternoon, I'll have some commentary in there on it. So, while the EBITDA multiple has risen a little bit, it's still well below peers. Plus the earnings multiple is around 9, right? To me that seems more like an EBITDA – earnings multiple, so we still think – we think there's a bit [indiscernible] in the stock price. If that doesn't occur, we'll always be looking at allocation of capital as we've done in the past. We've committed to latter, but wouldn't hurt my feelings if we spun a bit more money buying some more share, as if we got the opportunity. So, it will always be a balance, but we'll address that carefully.

Okay. That's very helpful. Thank you very much. That's it from me.

Thanks Max.

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

Hi guys. Congrats on another great year here.

Thank you, Devin.

Question here on your integration and just kind of maybe give a bit of timeline on how long do you think it will be to have everything fully integrated? And should we kind of expecting higher equipment costs over this period?

In my prepared remarks, you know with this acquisition of the heavy fleet, I mentioned that we closed the deal. We funded the deal on November 23, on boarded 450 people and took possession of 180 odd assets and we had them operational in three days, right. So that's just staggering performance by our operating team. Obviously, we've got to spend a bit of money to bringing the fleet up to our operational standards. So that will take a bit of time of several months. We'll contribute to incremental EBITDA on 2020, so that integration went extremely well because it was mainly an asset deal with a lot of operating personnel in the field. Then the Nuna acquisition, the integration is ongoing. The biggest task in front of us is to bring them on to our enterprise system, which will ease our reporting. And we don't schedule to get that done within a two to three months here. So that's the comment we have on that. Does that answers your question, Devin?

Yeah. No, that's helpful. And I guess if we look at you guy's – try and get debt reduction here, are you guys still looking at $50 million straight line or is this going to be more from a and market spend weighted, do you guys have color there?

We'd like to keep some flexibility there, right, so we set $150 million over three years. You know going back to Maxim's question, could be that we might spend a little bit of money this year on share buyback for example, right, so over $150 million is over the three years.

Okay, perfect, Martin. That's it for me and congrats on another great quarter guys.

Thank you, Devin.

Your next question comes from Ben Cherniavsky with Raymond James. Your line is open.

Good morning, guys. Most of my questions have been answered. I just thought maybe – I thought you can give just a little more clarity on the SG&A line. How much in dollars were the sort of headwinds that you noted? Because I think as you recognized that was – it never seemed a little higher than we would have expected, just given the leverage in revenue or can you just walk through that in little more detail?

Ben, Jason here. A little over $1 million was in that G&A and that's what gets us back to that 5% run rate outside of the stock based. And really that was around some of the overheads required on that quick transition with Aecon as well as legal and consulting fees, so that sort of order of magnitude for Q4.

So it was mostly the Aecon transaction or taking your remarks you said something about Nuna as well coming onboarding with Nuna that had impact of G&A.

There is no onboarding cost for Nuna. But there was just legal and accounting fees associated with that transaction, so that's in the $1 million.

Okay. So $1 million sort of an all-in number for transactional costs in M&A?

That's right.

Okay. That's helpful. Thanks very much.

Thanks Ben.

[Operator Instructions] Your next question comes from Richard Dearnley with Longport Partners. Your line is open.

Good morning. The Aecon assets when they transferred to you, what was their utilization as you all would measure?

Richard, to be honest with you, we didn't even look at that. It was an asset transaction that we just had in mind what we could achieve with the assets. This really didn't interest us. So we didn't look at it.

I see. And I take it that you would classify them as heavily used?

Yeah. I guess that's a reasonable description.

And you said the EBITDA contribution was less than $1 million. What was the revenue contribution in the fourth quarter?

Well, we mentioned in the prepared remarks $24 million from the additional fleet as well as the Nuna, vast majority of that was the additional fleet. So in the $20 million range and as was mentioned profitability in those five weeks was very low given just the onboarding impact. We turned it over very quickly, but their courses going to be profitability impacts when you bring on a fleet of that size. So that's why such a low EBITDA margin in those five weeks.

And run rate interest rate expense as you stand on the ground now for 2019?

Yeah. We've indicated in our comments around 5%, a little less than that. In our IR deck on our website as well, you'll see it there that that does have the benefit of 0% vendor financing in there, but as an enterprise we are under 5%.

And it sounds like the maintenance facility needs expanding already?

Well, we are certainly super busy right now. So it wouldn't be out of the question that will happen at some point. We've got a lot more assets now when we decided to build a facility and the demand of external services is much, much higher, so it could be.

Good. Thank you. Great year.

Thank you, Richard.

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

Hi, Martin. Can we just go back on the CapEx for the year? I want to make sure I got written down here $90 million sustaining which includes $20 million on the Aecon assets, is that right?

Yeah. Plus that is sustaining, but really it will drive EBITDA improvement in 2020 right, as we get more utilization of the assets, but for sake of argument, I'd still call it sustaining.

Okay. So that would imply you know sustaining CapEx going forward would be less than $90 million, I guess?

Yeah.

And I know you want to maintain some flexibility especially to buy back shares and whatnot, but I mean what should I be modeling this year for growth CapEx?

I would say around $20 million – another $20 million.

Okay. And then there was a quick mention about Nuna potentially having some of its results via an equity pick up. Can we just get some details on that and how we should be modeling Nuna?

Yeah. I can take that one, Yuri. So we picked up an interesting about 20 entities within the Nuna Group of companies. And from a top-line perspective about 15% of those we don't have a controlling interest in essentially, and therefore need to be reported through that equity earnings line. And we feel in Q1 when we have some more substantive results from Nuna and the noise gone on that would be able to walk people through, but the majority will come through just regularly proportionately consolidated. Our ownership stake shown in revenue and all of the line items, but a small portion you'll see come through equity earnings.

And your envision grossing that small portion up to EBITDA or it's still to be decided? I mean, when you report your adjusted EBITDA, would you be grossing that up?

Yeah. We'll be looking to include that in adjusted EBITDA.

Just trying to make my modeling life easier.

Yeah. I know.

Okay. That's it from me guys. Thanks.

Thanks a lot.

Your next question comes from Glenn Primack with TPG Capital. Your line is open.

Good morning, Martin.

Good morning, Glenn.

I'm looking forward to reading the letter. Give us a targeted goal for your ROE or return on capital?

As high as possible. We benchmark it. As I mentioned ROE is going to be over 20% if we hit our numbers. So that's a pretty solid number right there. I like to get a return on capital up to the same level right. So above 20% for both would be quite an achievement.

Yeah, because that should drive your multiple as well. I mean you guys done a phenomenal job with your team. Most of my questions have been answered. But on the maintenance side, give a cost advantage over the dealer group that are our in the region?

We believe we do especially with our shop here in Edmonton. The cost of doing business here is a lot less than in Fort McMurray. Personnel costs are lower. Yeah. I think we certainly do have an advantage.

Okay. Because the five-year payback on slide seems kind of conservative then?

Well, we're always conservative, Glenn.

Okay. Just the slides in general, I mean it's the first time I've seen them on a conference call that's transformational as well. What was the debt reduction goal again by 2021?

$150 million.

Okay. Great. That's it. Looking forward to reading the shareholder letter. Thank you.

Thanks a lot, Glenn.

There are no further questions at this time. I'll turn the call back over to Mr. Ferron.

Okay. Thanks for joining us today. We look forward to talking to you again in the near future. All the best.

This concludes the North American Construction Group Conference Call. You may now disconnect.