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North American Energy Partners Inc. (NYSE:NOA)

F3Q10 Earnings Call

February 02, 2010 8:30 am ET

Executives

Rod Ruston - President & Chief Executive Officer

David Blackley - Chief Financial Officer

Chris Yellowega - Vice President of Operations

Kevin Mather - Vice President of Supply Chain & Estimating

Bernie Robert - Vice President of Corporate Affairs & Business Strategy

Kevin Rowand - Director of Strategic Planning & Investor Relations

Analysts

Matt Duncan - Stephens Inc.

Greg McLeish - GMP Securities

Bert Powell - BMO Capital Markets

Theonie Filarinos - Raymond James

Bill Highland - Ridgecrest Capital Partners

Adam France - 1492 Capital Management

Kalpesh Patel - Jefferies & Co.

Tatyana Thibodeau - ClearBridge Advisors

Todd Garman - Peters & Co.

Operator

Good morning ladies and gentleman. Welcome to the North American Energy Partners, fiscal 2010 third quarter earnings call. At this time all participants are in a listen-only mode. Following managements 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. I advise participants that this call is also being webcast and currently on the company’s website at www.nacg.ca.

I will now turn the conference over to Kevin Rowand, Director, Strategic Planning and Investor Relations of North American Energy Partners Inc.; please go ahead, sir.

Kevin Rowand

Good morning ladies and gentlemen and thank you for joining us. On this morning’s call we will discuss our financial results for the three and nine months ended December 31, 2009. All amounts are in Canadian dollars.

Participating on the call are Rod Ruston, President and CEO; David Blackley, CFO; Chris Yellowega, Vice President of Operations; Kevin Mather, Vice President of Supply Chain and Estimating; and Bernie Robert, Vice President of Corporate Affairs and Business Strategy.

Before I turn the call over to Rod, I would like to remind everyone that statements made during our prepared remarks or in the Q-and-A portion of the conference call, with reference to management’s expectations or our predictions of the future are forward-looking statements.

All statements made today, which are not statements of historical facts, are considered to be forward-looking statements. Certain material factors or assumptions were applied in drawing a conclusion or making a forecast or projection as reflected in the forward-looking information.

The business prospects of North American Energy Partners are subject to a number of risks and uncertainties that may cause actual results to differ materially from a conclusion, forecast or projection in the forward-looking information. For more information about these risks, uncertainties and assumptions, please refer to our December 31, 2009, management’s discussion and analysis, which is available on SEDAR and EDGAR. As previously mentioned, management will not provide financial guidance.

At this time I will turn the call to our CEO, Rod Ruston.

Rod Ruston

Thank you, Kevin and good morning ladies and gentlemen. Thank you for joining us today. I’m pleased to report that operating performance was stronger during the third quarter as demonstrated by our results; $44 million of consolidated EBITDA in the third quarter, and $95 million on a fiscal year-to-date basis.

This result demonstrates a few important facts. First, it clearly shows that even without the gold rush like construction activity, the recurring work involved in servicing and the existing mining operations of the major oil sands players in the region is significant, necessary and ongoing. This all depends on the long term sustainability of our oil sands centric business model.

Secondly, it demonstrates our ability to work with our customers and maintain our strong focus on cost control through the economic downturn; and finally, it demonstrates the payoff from significant investments we’ve made in our equipment fleet, systems and people over the last few years.

During the period from early 2005 to October 2008, when oil sands construction was booming, we focused on three things; building a well balanced equipment fleet that can effectively service the demand of the full construction contract of services, installing systems for proper maintenance and management of that fleet that will ensure it’s ability in the harsh climates and terrain of North Alberta, and training our people to be effective managers and operators, who understand the business, can work with the customers and to drive execution of that work with the strongest possible focus on safety and quality.

As a result, we’ve been able to maintain tight discipline when it comes to bidding new business, and during project execution we’ve been able to rely on our highly capable project team to ensure good equipment utilization and high quality product.

Our technically strong project execution has been fully supported by our safety performance, which has reached new levels of excellence through our concerted effort to introduce a new modern safety management system out of the few years, and cost control mechanisms, which have allowed us to achieve a $4.3 million reduction in G&A expense in the quarter. As a percentage of revenue, third quarter G&A was 6.7%, compared to 7.4% during the same period last year.

Now looking briefly to our segment results; heavy construction and mining revenue was down 7% in the third quarter, and down 16% year-to-date, compared to the same periods last year. The declines in both periods reflect lower project development revenues as a result of reduced development activity in the oil sands.

Recurring services revenue in the third quarter was up 20% compared to the same period last year. On a year-to-date basis, recurring services revenue was comparable to last year, in spite of the first quarter shutdown of CNRL due to plant commissioning and reduced contractor activity at Syncrude due to plant maintenance.

The third quarter growth in our recurring services business reflects increased activity at shale sites and their unused three year master services contract, and increased services to Suncor under the Albian 12 month mining services contract, which was due to expire in December 2009. This contract has since been renewed for an additional 12 months, and has been expanded, requiring us to provide additional capacity. Third quarter growth in recurring services also reflects increased activity at CNRL as we returned to plan production levels under the 10 year overburden removal contract.

Turning to Piling, revenues for both the third quarter and the year-to-date periods continue to be negatively impacted by weak commercial and industrial construction markets, and by the reduction in high volume oil sands projects. We expect to face continued strong competition for the available work in this sector in the near and mid term. However, our expansion into the Ontario market is expected to help offset reduced activity in the commercial market in the west.

We’re seeing more encouraging results in our pipeline segment, where activity started to pickup as we get underway with two new pipeline contracts in British Columbia. [McTavish] North Loop project, which is the first phase of Spectra Energy’s two phase expansion plan, was temporarily delayed by warmer than average November temperatures in Northern DC.

We developed a revised plan for the customer incorporating this weather delay and we expect the project will proceed to completion on schedule. Our performance on this contract will be a key factor in our negotiations to secure the second phase of this project, which is scheduled for construction this summer. Overall, we are pleased with our third quarter and year-to-date results, and we believe that we are performing well in the midst of challenging economic conditions.

At this point, I’ll call on David Blackley, to provide a more detailed third quarter financial results.

David Blackley

Thank you, Rod and good morning everyone. I’m going to review results for the third quarter ended December 31, 2009, as compared to the third quarter ended December 31, 2008.

Reduced volumes in our three segments continue to put downward pressure on our top line results during the period. Consolidated revenues of $222.7 million were down 14% from last year. However, our gross margin was very strong at 21.3%, up from 19.7% last year. This in-turn helped us achieve a gross profit of $47.4 million on our revenue.

Turning to operating income; in the third quarter we generated operating profit of $30.9 million or 13.9% of revenue, up from an operating loss of $2.2 million last year. Excluding the impact of goodwill impairment, last year’s operating profit would have been $30.5 million or 11.8% of revenue.

The improvement in operating margin reflects the improved gross margin and reduced G&A expense as a percent of revenue. The $4.3 million reduction in G&A was driven by our determined efforts to lower cost and improve our business processes. We also achieved net income of $0.57 on a diluted per share basis in the third quarter, up from a net loss of $0.41 per share last year. Backing up the impacts the various non-cash items, we would have posted net income per share of $0.40 in the current period, versus $0.59 last year on a diluted per share basis.

Turning to capital; total equipment additions for the third quarter amounted to $33.9 million. Sustaining capital expenditures were $3.1 million, and the remaining $30.8 million of new equipment was growth capital, which arrived late in December, and was immediately put to work. In terms of financing, $28.7 million of total equipment additions was financed through operating leases, leaving $5.2 million of cash capital expenditures during the quarter.

Looking at liquidity; under our $90 million revolving credit facility, we had $20 million of outstanding and un-drawn letters of credit to support performance guarantees on our customer contracts, leaving approximately $70 million of borrowing availability as of December 31, 2009. Our cash position at December 31 was $96 million, which was slightly down from $99 million at the beginning of the fiscal year.

That summarizes our third quarter results. I will now turn the call back to Rod to tell you about our outlooks.

Rod Ruston

Thanks David. At this time a year ago, some comments raised doubts and concerns surrounding the viability of the oil sands region, and consequently of our business, given the price of oil. We responded to their statements by reiterating our business strategy and emphasizing the stability of our recurring services business, which is based on both, the nature of oil sands mining and our strong relationships with every major producer.

I’m pleased to note, that our results since then have proved that point. Let me try to elaborate on why we anticipate the stability of recurring services business will continue to strengthen. First, the resource and the customers we deal with: the oil sand is a large viable resource that can be developed in a cost effective, safe and environmentally conscious manner, but this is not a place for the faint hearted or the fly by night.

Look at some of the major players making significant investments in the oil sand region; Exxon, Shell, Canadian Natural, Suncor, Total, Husky, ConocoPhillips, Contango, the list goes on. This is a business with strong established operators who are committed for the long term. You don’t invest the kind of time, effort and money these organizations have committed to walk away when the oil price fluctuates.

Second, the environment in which we operate. This is a region where temperatures vary over the year from plus 90 degrees Fahrenheit, to minus 50 degrees Fahrenheit, where equipment is operated in conditions ranging from highly abrasive sands to water logged [musgage] and frozen tundra.

Understanding how to execute work successfully in conditions likes these is crucial to our success, and only comes through decades of experience. Our customers understand these challenges and know that North American is one of the best operators in the industry. That is, not just anyone with a truck and a loader is going to be able to operate in these conditions.

Finally, operational efficiency: Operational flexibility is a key success factor in any business. If your business is tied to a singular course of action, your at risk if the business environment changes. Using contractors provides our customers with operational flexibility, which they want as part of maintaining their competitive cost position.

In our extensive and diversified fleet of equipment, and our operational presence on the sites of every major producer in the oil sands, enables us to provide them with the flexibility at a competitive price. We provide the ability for the customer to increase production capacity, because we have the equipment big enough to fit into the customer’s production fleet, and the trained operated that understand the customer’s operational requirements.

We provide the customer with the ability to build roads and bridges on site, because we have to the expertise and equipment necessary to do this type of work as well. Our strategy has always been to offer excellent service at a fair price based on the risks associated with the work. For greater work certainty, that is longer contracts, we offer lower margins, and we believe that clients understand and respect this approach.

It is this long term sustainability of the oil stands as an end market, coupled with our ability to meet the unique needs of our customers that has helped us build and maintain a strong base of recurring services revenue. This is in an area of our business that we expect will continue to be a driver for us as the existing oil stand operations grow, and as new projects come online.

The recurring revenue is not the only part our business, we’re also a construction contractor, as well as a mining contractor and we see opportunities in the oil stand related project development side of our business starting to look more promising. Progress continues on the construction of Imperial Oils Coal Mine, and Shell’s Jet Line Mine, both of which have been under construction continuously since 2008.

Announcement from Suncor, ConocoPhillips and Husky, that their respective projects will commence construction in 2010, and more recently indications by CNRL, that a green light for Horizon Phase II and the Curby deep project are anticipated late this year. All single are returned to more favorable market conditions and increasing demand on service providers and construction contractors.

These announcements bode well for all our divisions. These are positive developments in themselves, but I want to emphasize what we see as another positive development, that is that we expect the phase of oil stands development will remain quite orderly. We view this as a positive, because it results in a more stable business environment. We see a more ordered market as a benefit to all stakeholders.

Turning to our Piling business, we expect that weak commercial and industrial construction markets and strong competition for contracts will continue to put pressure on revenue and margins for the balance of the year. However as I said previously, we are seeing opportunities on the oil sands related project development side of our business starting to look more promising, and all of our divisions stand to benefit from this activity.

As evidence to this, I am pleased to say that as I speak, we are driving the first of several thousand piles on Exxon’s coal site. Our recent acquisition in Ontario is also ramping up. We are bidding infrastructure projects, and making inroads with potential clients in that region. We expect that the initiative to open shop in Ontario will somewhat offset the reduced size of the commercial construction markets in the west.

We expect their margins in this segment will continue to be tighter as the market is more competitive, but we also expect the continued positive contribution from our Piling team. However in pipeline, we have two new contracts and will be working on these for the reminder of the fiscal year while we continue to look for additional opportunities.

Overall, while the market conditions remain weaker than we’ve seen in the past, and increased competition to contracts continues to put pressure on our revenue and margins, we see opportunities in all areas of our business. One opportunity in particular is the environment. Stakeholders are demanding more stringent environmental standards for oil sands development, and the government has responded with increased regulation.

Oil sands produces already spend large sums, but directly on remediation of minded out areas, and implementing effective environmental controls, and indirectly on research into new technology. We as an organization have already been heavily involved in the environmental remediation of oil sands with many years of mine reclamation under our belt.

However, we say that the demand for services is going to increase as a result of both the Alberta Government requiring faster rehabilitation of timing responds, and through the desire of produces to reduce their overall footprint. With this in mind, we have developed some strategic relationship with other organizations, which went couple with their own capabilities and enabled us to offer a service to our customers to meet the government parameters for remediation of timing bonds.

This is still very much work in progress, but we are excited about the enormous potential in this area. Another key area of focus for the company is cleaning up our balance sheet. As you will be aware, we have 200 million of bonds due for repayment in December 2011. At the same time, we have CAD $90 million revenue and considerable cash available for use in our business.

We are currently looking at opportunities to restructure our debt and have engaged advisors in this regard. We have not reached any conclusions as to the best strategy at this time, but we are cognizant of the considerably improve debt market conditions, and expect access these markets as part of the strategy.

So as we look forward, our focus will remain on safe and cost effective execution of the work we have, on identifying and winning the projects that leverage our strengths and offer reasonable returns, and on developing new markets in environmental services and building the financial structure for our business to grow and be successful.

With that, I will now turn the call back to the operator.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Matt Duncan - Stephens Inc.

Matt Duncan - Stephens Inc.

Hey Rod, the first question I’ve got is piling contract at Curby. You said several thousand piles and its sounds like work is just starting. Can you give us some brackets around what the contract value there maybe?

Rod Ruston

No, but I can tell you that the amount of work that’s going to go on for piling, it’s a very, very wet clay site and there’ll be a considerable work liability with that piling going up for a fair time.

Matt Duncan - Stephens Inc.

Let me ask that a little bit differently then, should piling revenue in fiscal ’11 be up from fiscal ’10, given what you’re seeing from that project and the potential for others?

Rod Ruston

It will be in the order of about $10 million over the next seven months of revenue there, and potential for it to grow.

Matt Duncan - Stephens Inc.

When I look at your gross margin, you guys obviously had a much higher gross margin this quarter than what you have expected, than what we had expected. I’m just curious what you now feel like a sustainable gross margin level is for you guys on an annual basis, realizing that the December and March quarters are going to be better than June, September, but this number continues to track higher than expectations, and I’m just wondering where you think it’s settled then?

Rod Ruston

Yes, I think we really need a look at the two combinations of items that drove that in the quarter. One was a very successful construction project; it was well executed, it was on time, it was on schedule, and we made very good money as a result of that. So that certainly helped some of the margin improvement, particularly in the Albian construction mining site.

The other big pickup for us was on the equipment in terms of the utilization. We saw a lot more utilization of our larger fleets, capacity fleet, so that helped to drive that big favorable variance on the equipment side. We have also realized some cost savings that we believe are permanent in nature on the equipment group, and we’re looking at passing some of those cost savings onto our customer.

So we do not expect to see the same kind of gross margins in the coming quarters. We expect it to normalize back to the levels that we’ve talked about before, in sort of that 16%, 17% range.

Matt Duncan - Stephens Inc.

It sounds like, you’ve also found some cost savings and you’re executing well. Is it fair to say that you’re probably trending to the upper end of that rather than the lower end, given the cost savings you have picked up since we’ve originally talked about that 16% to 17% range?

Rod Ruston

Yes, all things being equal, then we would expect to be at that upper range. Keep in mind as well that the mix of work can also play a part in that margin. If we’re doing a lot more work that involves bringing in third party materials and sub contractors, we typically don’t makes the same margin on that type of work. So as project development revenue comes back as well, that’s something else that will play a part in it.

Matt Duncan - Stephens Inc.

Then Rod for the outlook for new construction projects, obviously you referred it to quite a few things that have been announced recently, most of which are with companies that have been customers always in the past. When do you feel like you might be able to actually see some of those projects turn into revenue in a way? I know you guys have won this piling job at Curby, so it’s already starting to on a smaller basis, but are there some bigger jobs out there that you think you guys could win, that can maybe show up in the fiscal ‘11 numbers?

Rod Ruston

Some of the work we expect to be starting in the summer of this year.

Matt Duncan - Stephens Inc.

Then last couple of things here and I’ll jump back in queue. First, just a modeling question; on the equipment that was added in December if it’s under operating leases, Dave can you give us some sense, what that should do to your equipment operating lease expanse on the P&L on a quarterly run rate basis?

David Blackley

We don’t have that number off hand, exactly what the lease and cost associated with that equipment is.

Matt Duncan - Stephens Inc.

Okay, and then the last thing here, just kind of some questions around the balance sheet and it sounds like the potential for a new bond issue. Can you give us a sense of, I guess right now, if I remember correctly, it’s a US $200 million denominated bond, but you know you’re Canadian obligation is 263. How much of that amount do you think you might issue in a new bond? Any sense of what the timing may look like and what the interest rate may look like on that, and then what sort of maturity do you hope to get on that?

David Blackley

Yes Matt, we’re looking at a number of factors right now. We haven’t really settled on any particular strategy as Rod mentioned early. We’re working with our financial advisors to determine what the best strategy is, but certainly with the timing of the spreads over the last six, seven months, with the strong activity in the bond market, that is one option for us.

We’re also looking at substantial cash balance here, and that’s part of what we’re factoring into the equation, what do we want to do at cash? How much do we want to use the pay down bonds? Do we want to refinance with bonds? Do we want to go and use some other mechanism? We certainly have several opportunities opened to us. It’s really just determining what is the right one for us.

Matt Duncan - Stephens Inc.

Then Dave, I would guess you do expect to be a free cash flow generator over the next six months?

David Blackley

Yes, that’s what we’re looking at.

Matt Duncan - Stephens Inc.

Any idea how much free cash, just to help us get an idea of what sort of cash balance you maybe working with at the time when you look at what you do with this bond?

Rod Ruston

You want us to send you our entire business plan and ask for your thoughts... that would be difficult for me to get back to you right now.

David Blackley

Let me just say Matt, the business of in solid shape. We see good opportunities ahead, so the timing for our refinancing is right at the present time. In broad terms, we don’t intend to refinance the lot, so we intend to do some portion of the bonds and take some for another strategy.

Chris Yellowega

Yes, Matt just to clarify one more thing, you said it was $263 million on maturity. If we were to do any refinancing sooner than that, we would have to look at addressing the swap issue. So it’s actually a little bit more than that. I think somewhat closer to $280 million when you factor that in, if we were to do it today.

Operator

Your next question comes from Greg McLeish - GMP Securities.

Greg McLeish - GMP Securities

I was just wondering if you could maybe elaborate a bit more on new project development. As you have indicated, there are a lot of opportunities, and there is also a number of enhancements regarding SAGD. I’m just wondering how you address that on the SAGD side.

Rod Ruston

We certainly say SAGD is being a big area of market for us, and the reason which is heavy construction and mining, so certainly it’s done very well on the mining side over the last six, nine months. The bit that’s gone down actually is the construction side of that business, and we see that in itself ramping backup again. A good example of the type of work that’s available is the number of years to go, about three year to go; we did all the site preparation for CNRL, the Horizon project there. That’s the same sort of size of work that’s out there.

Greg McLeish - GMP Securities

You had a number of contract that were coming up for renewal, can you elaborate on the success of that, or maybe just elaborate new business that you’re winning or just sort to give us an order of magnitude there?

Rod Ruston

I don’t think we had any particular contracts coming up or renewal. The only one that we did renew, that did come up was the one I mentioned in the statement there with Suncor. That involved in us basically rolling over a contract, but providing bigger trucks within that contracts that give them additional capacity. We’ve been also winning a lot of work or undertaking a lot of additional work under our contract on Shells and Albien mines. That’s been a very strong revenue source force for us. That’s about it.

Greg McLeish - GMP Securities

Just finally, you did indicated that there would be some safe service agreements or potentially some safe service work on the horizon project; is that starting to come into fruition or is that already going full bore. The timing issue can give you some of the overburden?

Rod Ruston

Actually on the horizon project, we are seeing work that’s starting to spin off on a day to day activity. So it’s like service work is increasing here with the overburden wrap up.

David Blackley

The other place where we’re back doing work is, we’re back on Syncrude site as well, doing work for them with their overburden removal.

Greg McLeish - GMP Securities

Right. I didn’t want to really touch on that too much, but that’s very positive.

Operator

Your next question comes from Bert Powell - BMO Capital Markets.

Bert Powell - BMO Capital Markets

I think you guys have said your lower equipment cost due to timing of repairs, can you give us a sense of how to think about that? Is there a bump coming in one of these quarters as you play catch-up; I just don’t understand what you mean by that David.

Kevin Mather

There are two things that have driven that as David noted. The first was higher than anticipated equipment utilization. So in the last quarter we’ve really got a lot more hours and we targeted out of our very large equipment, so that drove some of the over recovery. We then realized some of the cost savings associated with improved services level from our vendors, higher labor productivity and retired costs coming back in line.

So we’ve adjusted our pricing of our equipment accordingly, and we do not expect to see a significant over or under recoveries in the future.

Bert Powell - BMO Capital Markets

So if look at this quarter, and given that in the heavy construction business that you had a pretty high percentage of recurring, that the equipment cost at this percentage of sales is a pretty good run rate until we get into more project costs in the mix?

David Blackley

Yes, I think that’s a fair comment.

Bert Powell - BMO Capital Markets

Okay, and then just in terms of the heavy construction business, if my memory serves, there was some large trucks that I think you guys had over at rental; Suncor comes to mind, but I might have that wrong, and I’m just trying to understand how those are flowing through and affecting margins, and are those still deployed, and what’s the timing of those coming out of the fleeter if that’s a near term event?

Chris Yellowega

We do have a number of trucks on rental with Suncor. So they are using those fleets to supplement their own ore fleet, and that’s part of the contract that was renewed, and we actually increased the size of those trucks to help Suncor a little bit further. From that activity, we’re now working with Suncor and other projects, and starting to work on using some of our own operated fleet on things they need done on a day-to-day basis.

Bert Powell - BMO Capital Markets

So what’s the CapEx number that you guys think is reasonable for the total amount, not worrying about what’s included in rental versus cash expenditures for 2011?

David Blackley

I think we’re currently estimated as part of our budget process there, so I mean we don’t have the number finalized at the moment. We’re looking at it right now, and we certainly are very mindful of the importance of generating good cash flow in this coming unit. It’s something that we’re factoring in, but again, we have to balance that against what we need to bring in to meet increase demand.

Bert Powell - BMO Capital Markets

Last question Rod, just in terms of thoughts on timing in succession?

Rod Ruston

Me or the team?

Bert Powell - BMO Capital Markets

No Rod, I was referring specifically you.

Rod Ruston

I’ve recently signed an agreement with the board to extend up to two years.

Operator

Your next question comes from [Theonie Filarinos] - Raymond James.

Theonie Filarinos - Raymond James

Most of my questions are answered. The only one I’m standing with is about your pipeline work. I’m just wondering how far through those two projects you mentioned your view, about halfway through or…?

Rod Ruston

On both of those projects we would be more than half way through. In this month we are cleaning up one, and on the other one, we are probably at about the 60% mark.

Operator

Your next question comes from Bill Highland - Ridgecrest Capital Partners.

Bill Highland - Ridgecrest Capital Partners

I was hoping you could talk a little bit more about the environmental potential. How big has that business been historically if we looked at ’08, ’09, and I’m trying to get an idea, what the kind of work intensity could be going forward as these new rules come into play?

Rod Ruston

The sort of work that we’re talking about for, that we see big potential on, has been for the contract that’s fairly small over the last number of years, because the touch of tailings dams that have been put in place, tailings dams that will last for 20 and 25 years. What the Alberta government has said is that they want the oil sands produces, as to reduce the footprint by starting and completing a damn over about a five year period.

Now in order to do that, its going to require some pretty substantial earthmoving type works to help them drive a material within the counter dams then to move that into places where it can be consolidated with solid material, and to build new and smaller dams for the future.

So we see it as a growing business that’s coming, not one that’s been around a lot in the past. The area that we have done a lot of work in the past has been on the reclamation and for example, if you go up to Fort McMurray, there’s an area up there of Syncrude’s reclamation, which is the only area of Fort McMurray to-date that’s been actually signed off by the Alberta government as being fully reclined and handed back to the government. North American was one of the prime contractors that did the work for the reclamation of that area.

Bill Highland - Ridgecrest Capital Partners

So, I guess this would fall under the mining and construction, correct?

Rod Ruston

Yes.

Bill Highland - Ridgecrest Capital Partners

And it’s been a relatively insignificant part of your business historically, so could require a more meaningful percentage of your equipment, and could be a further growth engine, that’s good to know.

Operator

Your next question comes from Adam France - 1492 Capital Management.

Adam France - 1492 Capital Management

Any issues in getting equipment, any long delays, anything along those lines that could push project out?

Chris Yellowega

In terms of the equipment that we use, equipment deliveries are back to normalized levels again, so equipment deliveries range from pretty close to off the shelf, to about six months delivery for the type of stuff that we get into. So no, there’s nothing that would delay any of our growth opportunities.

Operator

Your next question comes from Kalpesh Patel - Jefferies & Co.

Kalpesh Patel - Jefferies & Co.

I wanted to know what is your relationship with the Husky, and I guess historical and current participation in Sunrise?

Rod Ruston

Our relationship with Husky is that we have done some pipeline work for them in the past. We’ve laid a fairly major pipeline for them about two and a half, maybe three years ago. We also have a good relationship with the executive in Husky. They know us very well, but for previous work done for them at Sunrise, we haven’t done anything.

Kalpesh Patel - Jefferies & Co.

Okay, and I guess the same question for ConocoPhillips and Surmonts?

Chris Yellowega

On ConocoPhillips’s Surmont project, we are in discussions with those folks, as well as participating in bid work on the different types of projects that they’ve done, and are doing what we normally do with developing our client relationship there.

Kalpesh Patel - Jefferies & Co.

So you’re not on the site at all right now?

Chris Yellowega

The site really isn’t doing a lot of development work that’s starting to ramp up. So they are doing bidding and planning work right now.

Kalpesh Patel - Jefferies & Co.

Okay. You mentioned I think in your prepared remarks a second pipeline or second phase of a pipeline contractor for Spectra, is that right?

Chris Yellowega

Yes as part of the [McTavish] projects, we are working on the south loop and there’s a north section to the project, and we are expecting that work to be let in the next number of months and we’re working with the client to try to secure that.

Kalpesh Patel - Jefferies & Co.

So what is I guess the size of that project? So you are saying in the next quarter it’s going to be less?

Chris Yellowega

That actually remains to be same from the client. It is on their plans to be doing that work this year, but we are in discussion with them really to determine the size and the plan going forward.

Kalpesh Patel - Jefferies & Co.

Okay, but you are expecting it within the next few months?

Chris Yellowega

Yes.

Kalpesh Patel - Jefferies & Co.

In terms of your SG&A, I mean you guys have had great SG&A numbers this year. Do you see more improvement in there, or is this kind of the level we can expect going forward?

David Blackley

I think this is more the level that we’re going to try and aim for going forward. We would like to keep our G&A cost in and around about our run rate that you’ve seen for the last few quarters.

Kalpesh Patel - Jefferies & Co.

And one last question, your thoughts on the pressure to move from cost plus pricing to a fixed price contracts?

David Blackley

Certainly the pipeline division is largely working on contracts, and not necessarily fixed price, but certainly unit right contracts. Within the oil sands operations of piling, and the heavy construction, and mining division, the balance of unit price to cost plus is probably pretty much the same now as it what was a year ago.

In actual dirt moving, and that sort of stuff that we do, it’s a very large contract and it will be unit price, but a lot of the work will be cost plus, because the client themselves doesn’t actually know exactly what they want in the roads; if they want built or if they want planed out, etc.

Operator

Your next question comes from Bert Powell - BMO Capital Markets.

Bert Powell - BMO Capital Markets

David just wanted to look at the lease expense again. If I look at your disclosure, it looks like the fourth quarter lease expense will be about $15.3 million. Is that because leases are coming off or you haven’t factored in what’s anticipated? In another words, if I look at the disclosure, can I use my 2011 operating lease expense at $55 million, which would sort of look like $14 million at quarter or is the $16.3 million we’ve got this quarter more indicative on the run rate basis?

David Blackley

I think it will be a little bit higher than that, but I don’t know the exact number off the top of my head, just because we have some of these leases coming and then starting in January.

Bert Powell - BMO Capital Markets

Higher than the $15 million or higher than the $16.3 million?

David Blackley

I think it will be a little bit higher than the $16 million not much, $16 million is probably a reasonable number.

Bert Powell - BMO Capital Markets

Then just lastly on the G&A, I know you focus on the past of how a lot of consultants and whatnot in there. I just wanted to understand the gains that you’ve made. Has that been just having those consultants come out, and this is what’s in the business or is there still that to come and what we’ve seen to-date has really been your savings that you guys have been able to put through the core G&A that’s within your domain?

David Blackley

Yes, what we did actually about a year ago if you recall, it was a combination of things. We did cut back on the consultants, we didn’t need them as much going forward, but we also did a pretty significant review by headcount and we saw several areas where we could look at reducing that headcount. As we move forward, we’re going to keep a strong focus on that and be very mindful of our overhead and think very carefully before we start adding bodies.

We don’t think we need to go and add substantial bodies again going forward. We’ve put a lot of effort over the last couple of years, and in terms of addressing systems and processes, and we think we’re in a good place today to leverage off of that effort that we did two years ago.

Bert Powell - BMO Capital Markets

So there’s no need and better time to have the consultants comeback to finish up what was in the unfinished business?

David Blackley

I mean anything else that we do in terms of further system improvements or process improvements, we would look to address that internally with our own people.

Operator

Your next question comes from Greg McLeish - GMP Securities.

Greg McLeish - GMP Securities

Just wondering if you could help me out with your unallocated equipment cost, and what they might trend to in the fourth quarter?

David Blackley

We expect to keep that $13 million at the end of the year. So we don’t see any improvements or erosions of that $13 million of unallocated equipment cost.

Greg McLeish - GMP Securities

Is there anyway of forecasting that through into 2011 or is that one of those numbers that is sort of …?

David Blackley

It shouldn’t be material in any given year. I think that’s probably the best way to do. We tried to set up our charge-off rates and our budget structure such that we’re recovering our equipment cost that’s very close to it.

Operator

Your next question comes from Tatyana Thibodeau - ClearBridge Advisors.

Tatyana Thibodeau - ClearBridge Advisors

I missed most of the call, so I apologize if you’ve covered this. I just had one quick clarification question on the pipeline side. There’s some mentioning of unfavorable weather conditions affecting your margins in the quarter. Can you just talk about sort of what the impact of that was in the quarter and then how should we think about more normalized margins for those smaller pipeline contracts going forward?

Chris Yellowega

Tatyana, this is Chris Yellowega. I think on those particular comments, we had a project were it was very cold and also we had experienced a substantially warmer trend and we find what that did is it slowed the equipment down when it was warm, and then when it cooled off, it actually slowed down our productivity. So we didn’t have an opportunity to catch up.

So what happens is on this particular contract as we were schedule driven, so we had to increase the resources in order to achieve the schedule, and therefore lowered our margins under the fixed price. It’s not something I would expect to rollover into our other pipe line contract. It was a combination of things on that one.

Project margins and pipeline have been declining through the year in terms of the bid and award margins, and I wouldn’t expect them to exceed low double digits for the foreseeable future.

Tatyana Thibodeau - ClearBridge Advisors

How should we think about the revenue run rate from what you observe right now?

Chris Yellowega

I think we plan on a revenue run rate and pipeline of around $30 million to $40 million. We’ve said that before and I wouldn’t say that we would be substantially different from that on an annualized basis.

Operator

Your final question comes from Todd Garman - Peters & Co.

Todd Garman - Peters & Co.

Just a quick question on the heavy construction and mining segment. You mentioned that one of the projects that you were working on was completed and executed on time. Were there any incentives awarded to the company as a result of that execution and would you therefore expect them not to recur in the coming quarters?

Rod Ruston

Yes, we had actually a couple of project that we bid on either a firm or lump sum price, and we performed substantially better than we expected. We had some weather help in those projects, as well as some great execution. So those we would treat more as a one off occurrence in terms of the real positive impact of margin. I wouldn’t expect that to be a recurrent thing.

Todd Garman - Peters & Co.

Could you try to quantify or estimate what that impact might have been in the quarter?

Rod Ruston

No, I can’t do that.

Operator

Gentlemen, there are no further questions at this time.

Rod Ruston

Thank you very much.

Operator

Thank you. Now this concludes the North American Energy Partners conference call.

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Source: North American Energy Partners Inc. F3Q10 (Qtr End 12/31/09) Earnings Call Transcript
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