North American Construction Group Ltd. (NOA) Q4 2019 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Welcome to the North American Construction Group Earnings Call for the Fourth Quarter and Year-ended December 31, 2019. [Operator Instructions]. 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 forecast or projections that are reflected in the forward-looking information. Additional information about those material factors are contained in the company's most recent management's discussion and analysis, which is available on SEDAR and EDGAR as well as on the company's website at nacg.ca. I will now turn the conference over to Martin Ferron, Chairman and CEO.

Thanks Carol, and a very good morning to everyone. In the final months of 2018, we closed two significant acquisitions, involving the onboarding of many hundreds of heavy equipment items and field personnel. We moved into a new combined fleet maintenance facility and office complex and took delivery of the first few ultra class trucks bought from a customer. Therefore, clearly, 2019 was going to involve a massive integration challenge for us. But despite this, we set ourselves a stretched safety target and forecast of 60% improvement in both adjusted EBITDA and EPS from 2018 levels. While I'm truly delighted to report that we vetted all of these objectives, in spite of the negative impacts of the provincial oil production curtailment program, the very poor condition of some of the acquired equipment and abnormally bad weather conditions in the key months of March and August, I am as proud of this performance as anything else I've been associated with during my 40-year plus career.The driving force behind these achievements was our President and Chief Operating Officer; Joseph Lambert who is a true master at his craft. So it is thoroughly right in fitting that Joe first takes us through slides two to four of our annual results presentation, which can be found in the investors section of our website. These slides cover safety and business highlights, together with operational objectives for 2020. Our CFO, Jason Veenstra will then cover financial highlights as shown on slide five to eight. And I will talk about our outlook and diversification strategy on slides nine to 13 before the question-and-answer session. So over to you, Joe.

Thanks, Martin. I appreciate the kind words. Obviously, I am surrounded by great operations, maintenance and support teams that deserve the credit far more than I do. I'm especially proud of our safe safety results as shown on slide two. For our team to improve upon already industry-leading results by doubling the workforce hours since 2017 is an accomplishment that requires a focus from every level of organization. My sincere thanks to all our employees for continuing to ensure everyone gets home safe and for believing in and striving for zero harm.For our business highlights on Slide 3, I will leave the detailed numbers for Jason to expand on, and will focus on what I believe are some nice achievements. The following is the list of achievement that have occurred since Q4 2018. We achieved significant expansion of our oil sands fleet through the asset acquisition of a competing company. We achieved significant expansion of our nonoil sands fleet through purchase of a JV interest in Nuna Logistics. We expanded into ultra class fleet with purchase of 31 used trucks from an oil sands producer.During the year, we added to this fleet with the purchase of two additional used units at near asset salvage value. We also performed a second life rebuild out of Caterpillar 797 ultra-class truck, starting from a bare frame and completed for less than half the price of new, definitively demonstrating the long-term value of this fleet acquisition.To load this new large truck fleet, we bought and rebuilt a used 800-tonne hydraulic shovel, and just recently purchased a new 800-tonne hydraulic shovel, complete with a long-term client usage commitment. Overall, the value of our ultra class assets has more than tripled year-over-year and our utilization has exceeded initial investment targets.In June of last year, we were awarded our first U.S. mining services contract to manage a Wyoming coal mine and here recently added a five-year Texas coal mine management contract that will transition under our management by the end of Q2. We also successfully integrated our ERP system into both Nuna and the Wyoming coal operations. As many of you would know, ERP systems are notorious for wrecking havoc on businesses. And our IT team successfully converted two business entities onto our ERP system without missing a beat.Lastly, we expanded our maintenance facilities to perform more component and home machine rebuilds and provide room for our expanding external maintenance services. In 2019, we more than doubled our Acheson shop manpower and our year-on-year external maintenance revenue. We believe we are well on our way to meeting or exceeding our expected $30 million of annual external maintenance revenue we projected upon building our main shop and offices. With that list of achievements behind us, I would now like to direct you to the last of my slides, Slide 4, where I would like to give a bit of an overview of our 2020 operations focus.First, safety is and always will be the soul of our company, and we will never be satisfied until we achieve and sustain 0 harm. Even with our strong performance and possibly because of that strong performance, we need to ensure we do not allow complacency and continue to maintain a chronic sense of unease in our review of safety within our business. On the operating front, we're all about getting most out of our assets with lower costs and higher utilization. On utilization, we are focused on our historically slower Q2 and Q3, looking to leverage off Nuna's countercyclical business and also expand on our Alberta summer civil works. We believe we'll be successful in bidding and winning a joint project with Nuna in 2020 demonstrating additional market access for both companies. We will also engage our business development estimating teams to aggressively pursue increased utilizations for the smaller end of our fleet in Alberta summer construction projects.On the cost front, we will continue to look at engaging our expanded maintenance skills to reduce the equipment costs. We will do this by lowering use of external vendors, self-performing more component home machine rebuilds, expanding our use of technology for operations and machine health monitoring and expanding external maintenance works to take advantage of the economies of scale available.With that, I'll turn the call over to Jason for our financial results.

Thanks, Joe. Good morning, everyone. Getting right into the financials, I'll start with the top line on slide five. Revenue for the quarter of $189 million was $58 million above last year's Q4, in which we had approximately five weeks of operations of the fleet we acquired in late November 2018. As Joe mentioned, we finished the year strong with all business lines being positively influenced by both our organic and acquisition growth. The posted quarter-over-quarter growth of 45% was primarily due to the acquired fleet, which had operating hours for the full quarter as opposed to five weeks last year. In particular, the acquired fleet provided step change in increments at the Fort Hills and Aurora mines. Further contributors to revenue growth were the newly purchased Ultra class fleet operating at the Millennium mine as well as strong customer deliveries of rebuilt equipment in December. Offsetting these increases was less scope at the Kearl mine, quarter-over-quarter, as Q4 2018 was exceptionally busy, given the timing of the mine plan.It should be noted that while 45% year-over-year is an impressive growth story, reported revenue was negatively impacted by a combination of both the type of work we completed in the oil sands during the quarter as well as the change we made in accounting for Nuna this quarter. I'll pause briefly on the Nuna change for a moment. Effective November 1, 2019, all Nuna revenue and costs will be reported in equity earnings, which we're confident will improve the clarity around June results for our stakeholders as 100% of new results will now be contained in that line on the income statement. This means for 2020 and moving forward, reported revenue will not include any new revenue and the readers and stakeholders of our financial report should take this change into account. As a reference point, reported annual revenue in 2019 included $37 million from Nuna or 5% of the total annual revenue. When looking at our total annual reported revenue in 2019 of $719 million, the achieved revenue represents a 75% year-over-year increase. Breaking down the 75%, the largest share of roughly 35% can be attributed to the full year of operating the heavy equipment fleet.And 15% can be attributed to the ultra class truck fleet fleet acquired and commissioned throughout 2019. The reported $37 million from our ownership interest in Nuna contributed 8% of the reported year-over-year increase, but it's actually 15% when factoring in revenue included in the equity earnings in 2019. So when we look at the 75% year-over-year increase, and when excluding the roughly 60% contributed through acquisition growth, net organic year-over-year growth of 15% was driven by several factors.Strong overall utilization of our legacy fleet, primarily in Q1 2019, an early winter ramp up this year at the Aurora mine, the expansion of our external maintenance offering in 2019 and the operations support contract at the coal mine in Wyoming, which commenced in Q2.Offsetting these positives was a year-over-year decrease at the Highland Valley Copper mine and the impact of unusually consistent and heavy rainfall in July and August in the Fort McMurray region, which we estimated to have impacted revenue by approximately $20 million.Gross margin for the quarter of 13.2% of revenue was slightly down from 14% during the same period last year. The decrease in margin was driven by a reduction of tailings pond support activity and less-than-optimal operating conditions at certain mines. Additionally, margins continue to be impacted by increased repair and maintenance costs related to the acquired fleet. Depreciation of 15% also impacted gross margin and was slightly higher than last year's rate of 13.9% on high component change out activity this quarter.The low gross profit, general and administrative expense, excluding stock-based compensation, was $7.6 million or 4% of revenue. As mentioned in the past, this percentage level is our generally expected run rate and reflects the operating leverage in our heavy equipment business, which requires minimal incremental G&A when adding top line revenue.Before we look at net income and EPS, I'll touch on the strong adjusted EBITDA of $47.8 million. The adjusted EBITDA margin of 25.2% in the quarter was, as mentioned, heavily impacted by mix of work and operating conditions, but compares favorably to the Q4 2018 margin of 21.7% on stable G&A costs and the diversified businesses of external maintenance and mine management services, bringing in higher margins.Below adjusted EBITDA of $48 million, interest expense of $5.5 million for the quarter and cash related expense -- cash related interest of $5 million were both identical to Q3 and relate to the debt financings we've put in place to fund growth. We remain very pleased with the flexibility and terms of the credit facility and capital lease financings, given we've operated at an overall cost of debt under 5% for the entirety of 2019. It should be noted that our leverage ratio at the end of the year caused us to drop a level in our credit facility rate, which will provide upside in 2020.Below interest, we have routine income taxes of $2.4 million, which gets us to the adjusted net earnings of $9.7 million compared to $4.6 million last year. These earnings generate adjusted EPS of $0.38 for the quarter, which is 2.1 times the comparable earnings last year of $0.18. This is a $0.20 year-over-year improvement and can be quickly summarized on a per share basis by the $0.32 increase in adjusted EBIT, offset by the $0.08 and $0.04 increases in interest and taxes.Moving on to Slide 6, I'll summarize our cash flow, cash generated from operations in the quarter prior to winter working capital was $45 million compared to $27 million last year. The business generated this $45 million which is net of $5 million of cash interest from the adjusted EBITDA of $48 million. Sustaining net capital expenditures totaled $24 million.This quarterly spending was made up exclusively of routine capital maintenance and is generally consistent with Q3 and compares reasonably well to the depreciation expense of $28 million. Strong free cash flow in the quarter of $54 million was generated from adjusted EBITDA less sustaining capital and did benefit from a $37 million change in working capital driven by both routine, AR and AP balances as well as the timing of cash balances held in our joint ventures.Moving on to the balance sheet on slide seven. Liquidity over $100 million has remained relatively stable over the past three years, as we've put applicable debt instruments in place to fund our growth. On a trailing 12-month basis, our senior leverage ratio, as calculated by our credit facility has decreased as expected to 1.7 times, well below our covenant of 3.0. As Martin will touch on, this achievement gets us below our stated threshold of 2.0 with our outlook continuing to trend downward. To close out, I'll briefly touch on the capital returns that our business is generating, which are shown on slide eight. As at December 31, return on invested capital was 9.6%. Invested capital of $587 million is a doubling from 15 months ago, and is a 112% increase from the start of 2018. Our current invested capital is comprised of approximately 70% debt and 30% shareholders' equity, which is consistent with last year's profile as both figures grew proportionately during the year. Adjusted EBIT of $71 million, which is the basis for the numerator generates the 9.6%, which caps an impressive four-year trend, which we see continuing and was in line with expectation we had for the year of between 9% and 10.5%. And with those financial comments, I'll pass the call back to Martin.

Thanks Jason. I'm now turning to slide nine, which is my favorite in the whole deck. I can talk about it for hours, but these are the key points. Firstly, we are, without doubt, in strong growth mode, with EBITDA growing by more than 3 times and EPS by almost 7 times at the midpoint of the outlook range for 2020 compared with 2017 actuals. This growth is being achieved while maintaining conservative debt levels with both our senior debt and net debt to next 12 months EBITDA ratios being lower entering 2020 than they were beginning in 2018. Arguably, about $25 million of the sustaining capital spend in 2019 could have been categorized as growth capital as a span will boost EBITDA in 2020. $20 million of that was entirely one-off in nature leading to lower expected sustaining capital in 2020.Next, we are within reach of the exciting dual targets of $200 million of EBITDA and $2 of EPS for 2020. Free cash flow will be considerably higher in 2020, with $85 million at the midpoint of the range.Although we did not conduct an NCIB in 2019, we spent over $10 million of cash to mitigate the dilution from stock-based compensation vesting. This figure being greater than our spend on NCIBs in 2015, '16 and '18. Due to our backlog of firm earthworks volumes on account of seasonal contributions from Nuna, our quarterly results are becoming more even. And so we expect that each quarter in 2020 will have similar revenue and EBITDA.Moving now to Slide 10, which provides a bridge from 2019 free cash flow to our range for 2020. Hopefully, this is self explanatory, and needs no further comment other than, obviously, higher EBITDA and less sustaining capital spend will lead to more free cash flow.Next to Slide 11, which is my least favorite in this set, as it shows that our stock trading multiple seem almost inversely correlated to our performance. I mentioned earlier that we will potentially increase 2020 EPS sevenfold from 2017 levels, and yet our stock price is only around 2x higher. This is a very frustrating situation as it makes it very difficult to do accretive transactions, especially M&A when all possible targets trade at higher multiples than us, I'll cover this in more detail in my latest annual letter to shareholders, which has been posted to our website and, hopefully, will be available on SEDAR today.Our high free cash flow for 2020 and likely many years ahead will allow us to pull many levers to improve our trading multiples, including deleveraging, organic growth dividend increases and further NCIBs or exactly all of these steps. One strategic avenue, which also may lead to better trading multiples is diversification. And this topic is covered on Slides 12 and 13. We are very pleased with our purchase of a 49% stake in Nuna Logistics and believe that we can help grow this entity significantly, as increased mineral extraction occurs in Northern Canada.As Joe mentioned, we recently won our second management contract for a coal mine in the U.S.A., this time in Texas, with both contracts requiring no capital spend. Our equipment maintenance capabilities, especially large asset rebuilds are also attracting customer retention outside the oil sands. For example, we are in the process of delivering two rebuilt ultra-sized trucks to a diamond miner via winter road that Nuna built and maintains.Our new component rebuild facility, which recently opened will enhance this equipment-related diversification move. It may come as a surprise to some investors that around 25% of our EBIT was earned from outside the oil sands in 2019, and we have the potential to grow this to around 40% in the next few years. We remain committed to providing our oil sands customers, innovative and high-value mining solutions, but we'll also apply this approach to other natural resource extractors to drive a sensible and defendable level of diversification.With all that said, I'll now pass the call back to Carl for the Q&A session.

[Operator Instructions]. Our first question comes from Yuri Lynk from Canaccord Genuity. Please go ahead.

Good morning, gentlemen. Appreciate the detailed guidance, Martin. Just want to dig in a little bit on revenue, given the accounting change at Nuna I make sure I've got this straight. Should we be taking about $37 million off of your reported 2019 revenue as kind of an apples-to-apples base to think about 2020 revenue?

Yes, your, Jason. Yes, that's exactly why we gave the specific numbers. So yes, that's exactly right.

Okay. And any what type of growth rate should we expect on the pro forma revenue? Should it mirror the kind of the 15% EBITDA growth that you're forecasting? Or will margins be a little better.

Margins could be a little better, but I use the pro rata approach that we mentioned.

Okay. And another clarification on Nuna. Are you I assume you'll be in the EBITDA that you report, you'll be grossing up Nuna's equity earnings up into EBITDA?

Yes, we had in our MD&A, we added a specific table for that to kind of set the foundation for 2020. So we'll be adding depreciation, interest and taxes back to get to a proper EBITDA number.

Okay. Last one for me before I turn it over. Just on the revenue diversification, can you provide a little more color, Martin, on how you get to that, I know it's, I think, a few years away, you said that you might be able to get to 40% outside of the oil sands from 25. Does that is that premised on acquisitions? Or is that organic? Or how do you get there?

So no acquisitions a lot it so. It's all organic. We believe that we can grow Nuna significantly, working with them on large contracts, which we're currently bidding for nonoil sands projects. So Nuna's going to be a big contributor to that 40%. But we picked up two coal mine management contracts over the last few months and obviously, are hopeful of adding to that. They're very rich in EBIT because the as I mentioned in my prepared remarks, they don't require any capital. So they're great contributors to that EBIT picture. And then but again, as I mentioned, the rebuild program is really taking off. And I think external customers are becoming extremely interesting in adding these type of assets to their fleets. So all these things plus some others probably will contribute to that diversification effort.

I'll leave it there. Thanks, guys, and good quarter.

Our next question comes from Ben Cherniavsky from Raymond James.

Just maybe looking for a little clarification around some of the commentary, I think it was in the MD&A about your gross margins, and you referenced the tailing -- reduced tailings pond activity and suboptimal operating conditions at certain mines and also the repair and maintenance costs. Can you maybe just elaborate on what those variables, what their impact was? And break them down potentially in terms of the -- maybe if you can quantify, even just or estimate the impact on the gross margin. So we know as we go forward, whether or not these are things we should be taking account of for 2020?

Yes. I'll try and give a qualitative assessment of that, Ben, and then Jason will chip in with some numbers perhaps. So yes, the first point Q4 was impacted by a less favorable work mix this year. You might be aware that in Q4, for the last few years, we've done a lot of MFT, that's mature fine tailings hauling for customers. Because of our innovations with our fleet, that's probably our highest margin activity through the crews.So unfortunately very little, if any of that work occurred in Q4 this year because customers got behind another earthworks programs and asked us to focus on them instead. So that impacted margin. We still are fixing up the fleet acquired from a competitor. Most of the way through that, but during Q4, we were still at it. So as mentioned previously, that's impacted our results. And those are the main items that impacted the gross margin. What do you say, a couple of hundred basis points?

Yes. That's right.

It was going to -- my assessment without looking at it in detail, Ben.

Our next question comes from Daine Biluk from CIBC World Markets.

Just to maybe start off from a high-level perspective, how is the operating environment unfolds at the beginning of the year for your core oil sands business. Any weather or other challenges you can speak to?

For this year? No, I think ...

For this year, correct.

Yes. So the weather is been pretty cold than a normal day. So we're plugging away with our programs. Obviously, it's the end of the quarter that matters when spring breakup arise and how abrupt it is. We're hoping to get the best over the end of Q1 as well as the start.

Perfect. Understood. Okay. You talked a little bit before, but nice to see the mine management award in Texas. Could you maybe discuss the opportunity outlook to sign additional mine management contracts? Is it something we could see -- where we could see additional awards in 2020?

Yes. We were tracking some potential additional opportunities. As I said earlier, we picked up 2 in a few months. So we're hopeful of picking up more, we'll see. They're nice contracts to add to the mix for us.

Right. Okay, good. Shifting gears to some of the more R&M side. For the new component on a rebuild facility, how much of the work that is currently ongoing would be third-party versus your own fleet?

This is Joe, Dan. For 2020, it will probably almost entirely be our own fleet, we're ramping up and we'll actually assume my guess is plus 90% of what we do. We might have some capacity toward year-end for some external, and we might do some one-offs, but I would assume, as we ramp up this year, that it's almost entirely consumed within our own fleet.

Okay. Understood. And then maybe just kind of as a second secondary follow-up. For your 10 days R&M facility. I recall you guys benchmarking that as having a five-year payback, would the component facility have a similar returns profile?

I would expect it's actually slightly faster.

Okay, great. Nice. Last question for me, and I'm guessing it's probably still to it's probably way too early to talk about this, but I try for the term contracts with Syncrude set to expire in 2021, has there been any negotiations to date on recontracting those? And if those are to be recontracted, could that be a late 2021 event? Or is it more likely to close closer to the expiry date?

Yes. If we look at what's happened in the past in terms of contract renewals, generally within, say, six months at the end of the contract, we'll start-up the dialogue with the customer. So we're hopeful of renewing those contracts. I think they're very happy with the work that we're doing. So no reason to believe that we can't extend those.

Okay, great. Well appreciate the call guys. I will turn the call back.

[Operator Instructions] Our next question comes from Richard Dearnley from Longport Partners. Please go ahead.

Good morning. The Aecon equipment, did you recapture any make good payment due to the deteriorated quality?

No, we did not, Richard. I must say, we tried but we were unsuccessful. But we're still very happy with the outcome of the acquisition. We knew some of the equipment would be in poor condition, but it turned out to be more, but such is life. We move on and it doesn't impact our outlook for 2020 and beyond.

Right. And I suppose, you called out a joint bid with Nuna on a large contract, is that the Northwest territory road you were specifically talking about?

No. These are two other resource projects in the north. So we've actually got a couple of bids that we've been working on with Nuna. I can't get into details on them because they are active events. But there are projects that Nuna could not have done on our own in the past. They had to bring in partners. And we're, obviously, a very strong partner for them in these efforts. So it's great to be able to tap these potential revenue synergies.

Did the road contract ever get awarded?

Yes, I believe we did this time last year. Obviously, we did not win that one.

Right. And in the coal, of course, there are probably different contracts. But in general, when you get a management contract for a mine what are you doing? And are you using any of your own equipment?

Richard, it's Joe. We're managing the whole of the mining activities. We don't utilize our own equipment. The clients generally supply all of the assets. And I think what's been attractive to the clients is because you're managing the assets and the biggest cost incurred is actually in the maintaining of those assets. There are demonstrated skills and abilities in managing large equipment assets has brought us into this area and given us this opportunity. So really, this is just continuing what we do. It's load, haul and dump of -- overburdening coal and maintaining a fleet and planning and scheduling. So it's not an unusual activity for us. It's unusual that we don't own the assets.

Our next question comes from Devin Schilling from PI Financial.

Just hoping to get a little bit more color when you gave this 2020 outlook here in regards to the production curtailments and how you guys are seeing this -- how it could potentially impact these numbers on the upside or downside in your forecast here?

So production numbers you said?

Production curtailment effects.

Oh, well, we think that situation now will ease, hopefully, as the year progresses, obviously, after learning from last year, while we bake that into the range. So I'm not expecting any deterioration because of that program.

Okay. No, that's helpful. And then just to clarify, you guys have maintenance and repairs on the acquired fleet. Did you guys say that was completed at the end of the year here? Or there's still a little bit that might roll into Q1?

Yes. Pretty much. I'd say 90%, 95%. So we're almost through it.

We have no further questions in queue at this time. I'll turn the call back to Martin for closing remarks.

Thanks. And thanks to everybody, for joining us today and your continued interest in our growth journey. I remain really excited about our business and look forward to another very successful year in 2020. Speak to you next time. Thanks.

Thank you. This concludes the North American Construction Group conference call.