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North American Energy Partners Inc. (NYSE:NOA)

F1Q13 Earnings Call

August 9, 2012 9:00 AM ET

Executives

Kevin Rowand – General Manager, Corporate Development and IR

David Blackley – CFO

Martin Ferron – President and CEO

Analysts

Stephen Ragard – Stephens Incorporated

Greg McLeish – GMP Securities

Bert Powell – BMO Capital Markets

A. J. Strasser – Cooper Creek

Theoni Pilarinos – Raymond James

Operator

Good morning, ladies and gentlemen. Welcome to North American Energy Partners’ Fiscal 2013 First Quarter Earnings Call. At this time, all participants are in a listen-only mode. Following management’s prepared remarks, there will be an opportunity for analysts, shareholders and bondholders to ask questions.

The media may monitor this call in listen-only mode. They are free to quote any member of management, but they are asked not to quote remarks from any other participant without that participant’s permission. I advise participants that this call is also being webcasted currently on the company’s website at nacg.ca.

I will now turn the conference over to Kevin Rowand, General Manager, Corporate Development 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 months ended June 30, 2012, which represents the first quarter of our 2013 fiscal year. All amounts are in Canadian dollars.

Participating on the call are Martin Ferron, President and CEO; David Blackley, CFO; Barry Palmer, Vice President, Oil Sands Operations; Bernie Robert, Vice President, Corporate Services, and Harold Gudmundsen, General Manager, Asset Management. David will start off today with a review of our new business segmentation and our first quarter results. Martin will then provide an overview of our recent business improvement initiative and outlook.

Before I turn the call over to David, I would like to remind everyone that statements made during our prepared remarks or in the Q&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 the conclusion, forecast or projection in the forward-looking information.

For more information on these risks, uncertainties and assumptions please refer to our June 30, 2012 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 over to our CFO, David Blackley.

David Blackley

Thank you, Kevin, and good morning, ladies and gentlemen. Thank you for participating in today’s call. As we outlined in our press release, we’ve recently reorganized our business into two segments, from three previously. Our Heavy Construction and Mining statement continues to include mine support services and project development for the oil sands and other resource industry customers.

Our new Commercial and Industrial Construction segment encompasses piling and pipeline operations, as well as structural steel construction, oil and gas tank servicing and screw pile and anchor – screw pile and pipeline anchor system manufacturing. The results representing for the three months ended June 30, 2012 reflect the three organizations as due results from the comparable period last year.

Looking first at consolidated results for (inaudible). We achieved year-over-year gains primarily due to normalized weather and the continued strong performance of our Piling operations.

Consolidated revenues increased $235.9 million in the first quarter of 2012, up from a $194 million during the same period last year and our gross margin increased to 7.7% from 3.4%.

Operating profits also increased to $0.2 million compared to an operating loss of $5.7 million last year. G&A increased by $7.1 million due in part to a one-time charge of $2.5 million related to our business restructuring. Excluding the effects of non-cash item, we recorded a net loss per share of $0.14, this compares to a net loss of $0.26 during the same period last year.

On a segmented basis, results from our heavy construction and mining division were generally flat. Revenues of $165.5 million were up just slightly from $163.4 million last year. We executed a large volume of several construction works during the period including work on Syncrude’s shear key project, increased activity at Suncor Base mine, site development activities at Total’s Joslyn mine and PetroChina’s Dover SAGD facility.

However, this was largely offset by a significant reduction in activity at Shell’s operations. This customer slowed work on a major tailings project and also began to in-source more of its mining services during the quarter.

Profitability from the Heavy Construction and Mining segment was very similar to last year. While we achieved higher margins on overburdened removal work at Canadian Natural under our amended contract, this was offset by a lower volume of civil construction work at Shell, higher material cost from the Syncrude project and continued underutilization of some of our heavy equipment. We ended the quarter with segment profits of $8.6 million and a margin of 5.2%, virtually on a par with last year’s results.

In contrast, our Commercial and Industrial Construction segment posted strong gains during the quarter, with revenue up 130% year-over-year. This primarily reflects a high level of piling activity and a return to normal weather conditions following last year’s extreme weather and fire event.

We also benefited from the structural field construction activity at the Mt. Milligan project in Northern BC. In addition, our Cyntech business achieved strong international sales of screw piles.

Profit from the Commercial and Industrial Construction segment also improved sharply climbing to $10.5 million from $0.2 million last year. Margins meanwhile improved to nearly 15%, from 0.06% last year. These gains reflect the higher work volume and improved margins on most of that activity, particularly in our Piling operations.

Our pipeline operations also fared better as we shifted our focus to lower risk and higher margin pipeline maintenance and integrity work, although these gains were partially offset by lower utilization of some July pipeline construction equipment. Overall, it was a very good quarter for Commercial and Industrial Construction.

Before I turn the call over to Martin, I’ll comment briefly on capital spending and our cash position. Total capital additions for the first quarter amounted to $12.8 million including $7.9 million of sustaining capital. The continued growth in our Commercial and Industrial Construction activity was supported by $4.9 million in capital spend. And as of June 30, 2012 we had approximately $22.7 million of borrowing availability, compared to $70.4 million of borrowing availability and $1.4 million of cash at the beginning of the year.

With the receipt of funds from the Canadian Natural contract resolutions, we removed the remaining $20.7 million of temporary increase to the available revolving credit facility. In early July we also benefited from an $8 million reduction in spend requirements. We anticipate that we will have enough cash from operations to fund our capital expenditures through fiscal 2015.

That summarizes our first quarter results. I will now turn the call over to our CEO, Martin Ferron, to tell you more about our business restructuring and pipeline.

Martin Ferron

Thank you, David, and good morning everyone. It’s a real pleasure to be joining you on my first quarterly conference call. Before starting with North American I was able to study the company for a few weeks from the outside looking in. I also had the opportunity to gain valuable perspectives from members of the Board of Directors and the executive team. As a result, when I arrived in early June, I was able to quickly swing into action in terms of setting out some near-term priorities, as it seemed clear that urgent change was needed.

The priorities we identified are to, one, strengthen our balance sheet and liquidity; two, significantly lower our cost structure; three, improve the risk profile of our business; and four, regain profitability. By tackling these issues, I believe that we can enhance employee moral as part of a wining group again, that is serve our customers and, most importantly, restore Shell the confidence and value.

At the outset, one main uncertainty for me was the potential human bias to swift change, that is the overall culture of the company in general and the brain of the executive team in particular. However, I was extremely pleased to find almost immediately that I had the support of all parts of the organization and we fast became a cohesive team. This allowed us to make some improvement in the first quarter results, but most significantly set us up for a better future performance.

In early June on we took the challenge of not allowing anything within our control to detract from the achievement of our financial goals. Also everyone now fully understands that accountability really matters. Addressing cost, we firstly made a symbolic but also substantive step in deciding to close the executive office in Calgary. This sent a clear message that the executive group meant business in terms of change and would lead the effort from our main operating base in Edmonton.

We have made this move already and are entirely focused on our action plan. We have also targeted a $9 million, $12 million on an annualized basis reduction to our budgeted G&A cost which translates to a 20% cut before any stock-based compensation costs.

In addition, we are aiming for at least a $20 million reduction in capital expense for the rest of the year and we intend to significantly reduce equipment and the utilization cost going forward. We also limited merit salary increases and reduced the amount of our planned retention bonus payouts, thereby saving around $3 million for the year.

By acting fast, we were able to implement the necessary steps to achieve these saving in early July. This resulted in a reduction in our stocking levels of over 60 salaries and 200 hourly personnel.

Remaining on the theme of cost reduction, but also now addressing strengthening of our balance sheet; we stepped up our effort to sell underutilized mine and equipment assets, in order to better size our fleet, much expected medium term demand. During the first quarter we completed $22.2 million of asset sales as part of this initiative, which resulted in an $8.7 million of net proceeds asked about of leases on some of these units. We are repositioning some of our own equipment to lease our rental fleet requirements, and we’re also reducing the size of our light vehicle and service equipment fleet.

We have completed additional asset sales early in the second quarter and target the receipt of at least $15 million of net proceeds from future asset sales for the rest of the year. While the realization of net proceeds, some of these asset sales will help to strengthen our balance sheet position, more specifically our leverage, we’ll also benefit from a reduction in ongoing operating lease costs.

Moving in relation to our balance sheet, we are now much more focused on the reduction of our on build revenue, the resolution of claims and the timely collection of our accounts receivable. Specifically in this regard, I am personally leading the effort to resolve the claims related to recent difficult projects in our pipeline business.

Turning now to address improvement in our risk profile, we evaluated our business mix and concluded that we should concentrate on activities where we best deploy our own assets and personnel.

In this way, we can better control our own profit outcome; therefore, we will not take on future projects where our performance definitely lies largely in the hands of subcontractor third parties. In particular, we will continue the recent decisions to only pursue low risk integrity management work within our Pipeline unit while we assess its market value; also we will take no further part in certain high-risk sectors of our industrial business.

Moving on now, to what we expect more conditions to be light for the rest of the year, we, along with our competitors in the Oil Sands Mining segments are experiencing some near term demand headwinds.

This appears to be caused by our customers being very wary of conditions in the overall market economic environment, which is resulting in increased uncertainty and volatility in the market price for oil. My experience tells me that in times like these, customers will mind entirely the cost, and this is exactly what is happening. We are seeing project delays, budget cuts, in-sourcing initiatives and other supply chain management steps.

None of this is really surprising in the circumstances, but our short-term opportunities may well be impacted. More important though, there is a medium to long-term, as I’m a true disciple of the industry space, that Oil Sands activity will grow considerably in the decades to come.

On that note, I’m encouraged that we recently bid for a decent sized mining support contract which could start up as early as the third quarter. We also expect to take part in the bidding process for an even larger such contract at the end of our fiscal year. Both of these opportunities could represent a good boost to our project portfolio.

In services’ specific projects in our Heavy Construction and Mining segment, the second quarter will see us continue work on Syncrude’s shear key project and begin construction on the new MSE wall of Syncrude Base Mine. At Suncor, work is expected to provide steady volumes through the summer with reclamation projects providing added volumes during the winter months.

Our work on Shell’s atmospheric fine drying phase 3 project comes to a close in the second quarter. Additionally, civil construction activity is expected to ramp down in the second quarter as PetroChina’s Dover SAGD project and work authorizations are delayed for development of Total’s Joslyn mine, while that customer considers amendments to that site engineering plan and budget.

However, new work will start in quarter three, if engineering work is completed and budgets are approved. These, in fact, should be partially offset by continued demand for reclamation and tailing services, as well as continued activity on mine expansion projects and overburden removal at Canadian Natural.

Our outlook for the Commercial and Industrial Construction segment remains very positive with work continuing at the Mt. Milligan project through the end of the calendar year. Piling demand is also forecasted to remain strong through fiscal 2013, supported by strong industry fundamentals and a large project backlog.

Industrial piling work in the North Alberta region continues to drive our Piling business, both at the mine sites and the SAGD sites. We also expect to see high levels of demand continuing from Saskatchewan potash mines and from residential condominium constructions in the Ontario region.

Well that concludes my first quarterly commentaries. I trust that left you with a very clear impression of swift and strategic plans to improvement are well underway. And these will help us perform more effectively in the coming quarters, whatever the demand picture looks like.

My confidence in that closing statement is hopefully demonstrated by my accumulation of 280,000 shares before our trading window closed. With that, I’ll now turn the call back to the operator for Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Matt Duncan of Stephens Incorporated. Please proceed with your question sir.

Stephen Ragard – Stephens Incorporated

Hey this is actually Stephen in for Matt this morning. Thanks for taking my question, guys. First, I was wondering if you could provide an update on your interest coverage ratio covenant, just maybe remind us how much consolidated EBITDA you’re going to need to put up in the 2Q to stay within that covenant?

David Blackley

Yes, certainly, Steve. The number that we’re looking at for an EBITDA for Q2 would be around about $25 million, the rest will remain on site with the interest coverage.

Stephen Ragard – Stephens Incorporated

Okay, and have you begun, maybe to talk about the banks potential options, if you fall short of that or...?

David Blackley

Stephen, what I won’t – we aren’t specifically talking about falling short on that today, but what we are doing is we are monitoring it pretty closely and we’re in regular communications with the bank. As the quarter progresses, if it looks like we have an issue here we’ll be very proactive in that communication process with them very early on and address the issue.

Stephen Ragard – Stephens Incorporated

Okay, sure. My second question, Suncor recently made some comments implying they are not considering moving forward with their investments, Total and Joslyn, Fort Hills and Voyageur; what are you guys hearing on that front? And if they did stop this project, maybe could you give some color on how that would impact you guys?

Martin Ferron

Well, we hear the same comments as you and obviously it’s a cause for some concern. It could be some posturing on their part, it could be real intent. I would say that we’re being cautious right now. We are taking actions to cut our cost structure and to strengthen our balance sheet and the message from Suncor emphasizes the importance of that initiative, I believe.

Stephen Ragard – Stephens Incorporated

Okay. And my last question and I’ll hop back in queue. I know you noted anticipation of strong Commercial and Industrial activity to partially offset if you see any weakness, but how should we think about maybe overall revenues on a sequential basis for the September quarter here? Thanks.

David Blackley

No, I think we would expect to see some more growth in revenue here in Q2 relative to Q1, but we’re certainly not anticipating anything. So it may be flat, or it may be a little bit up. The Q3, Q4 again, we’re not anticipating any significant revenue growth right now. What we will expect to see as we go through each of those quarters is some of the mining work ramps up as we get in the busy season there over the winter in Q3 and Q4, we will see that being offset by declines in the construction part of the business. That’s part of the natural seasonality that impacts both mines.

So overall, we’re not anticipating big increases in revenue in each of the quarters forward, should be fairly flat. Keep in mind that if you compare it to last year, we’re also going to see a big drop off over the pipeline side, too. I think in pipeline we had in the region of about $150 million of revenue and we certainly won’t be getting anywhere close to that this year.

Stephen Ragard – Stephens Incorporated

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Greg McLeish of GMP Securities. Please proceed with your question.

Greg McLeish – GMP Securities

Good morning, guys. Just a question is regarding your future asset sales, I think, is it an additional $15 million that you’re indicating of selling?

David Blackley

No, that will net proceeds, Greg, it will be – we’re looking at net proceeds of around about $15 million.

Greg McLeish – GMP Securities

Okay.

Martin Ferron

At least that.

Greg McLeish – GMP Securities

Net proceeds of $15 million through the balance?

David Blackley

Yes.

Greg McLeish – GMP Securities

What will happen, what are you sort of forecasting your operating lease expense will be through the balance or how should it be trending through the balance of the year?

David Blackley

They will depend a little bit on which assets we’ve done and timing. So that’s a little bit of a tough one to predict, but on expectation is that we would see some modest decreases in our operating lease expense in each quarter. My guess would be somewhere between $1 million, maybe as much as $2 million.

Greg McLeish – GMP Securities

Based on last year, no, not the Q1 because Q1 had that sort of $4 million aberration?

David Blackley

Correct.

Greg McLeish – GMP Securities

Okay.

David Blackley

And, I’m not – when I count that in there, I’m just looking about the regular run rate. Again, it’s a little hard for us to predict exactly what we’re going to bring back in the way of equity value on operating lease equipment. It’s all about the timing and how much we get exactly. That could be a factor in reducing the expense going forward.

Greg McLeish – GMP Securities

And just one final question and I will get back in the queue. How much more right-sizing of the equipment do you think you need to do moving forward after you do the asset sales this year?

Martin Ferron

Greg, I think we want to keep that confidential at this point. I think we’re just indicating the benefit we expect to receive from that. We report it every quarter. But we’re obviously trying to sell assets into a market right now and want to keep the details of that initiative confidential.

Greg McLeish – GMP Securities

Great, I’ll get back in the queue. Thanks, guys.

Operator

Thank you. Our next question comes from the line of Bert Powell of BMO Capital Markets. Please proceed with your question.

Bert Powell – BMO Capital Markets

Thanks. Martin, the contracts, I guess you alluded to two contracts and one seems more imminent for a mining services contract, can you give us more color? Are you talking about a site services agreements or are you talking about you will have large contract that’s dedicated? You will be the dedicated resource, you will get paid under that contract? Can you just give us some clarity on what you mean by a large contracts?

Martin Ferron

Well, they are both term contracts for over burden really.

Bert Powell – BMO Capital Markets

They are, okay.

Martin Ferron

Yes.

Bert Powell – BMO Capital Markets

Okay. And then to the pipeline segment, are out of the weld and big business now effectively? Like...

Martin Ferron

Yes.

Bert Powell – BMO Capital Markets

You are focused just on services and that is a smaller, more profitable business.

Martin Ferron

Yes, entirely right, we are just focused on the low-risk, decent profit service markets, exactly.

Bert Powell – BMO Capital Markets

Okay, so no more laying pipelines for North American at this point?

Martin Ferron

No, in the short term no.

Bert Powell – BMO Capital Markets

Okay that’s perfect, thanks.

Operator

Thank you. (Operator Instructions) We do have a follow up question from the line of Bert Powell of BMO Capital Markets. Please, proceed with your question sir.

Bert Powell – BMO Capital Markets

Man, that’s a fast turnaround. I was just going to – the asset sales that you did this quarter, I’m wondering if you could give us some color in terms of what type of equipment, was that large shovels, trucks, what generally kind of made up that?

Martin Ferron

That was some of our large mining trucks.

Bert Powell – BMO Capital Markets

Okay, and where did those go?

Martin Ferron

Again, I think we want to keep that confidential, I’m afraid. We did have a good stipulation though that the buyer couldn’t deploy that equipment in our market unless he took an equivalent number of units to another spot internationally.

Bert Powell – BMO Capital Markets

Okay. And then, just, I know Martin it’s been fairly a short period of time that you’ve been on the helm here. But I’m just wondering, when you talk to customers, I want to just explore a little bit more this in-sourcing, this has been a bit of a theme for North American, I guess your industry for a while. And I’m just wondering if you could offer some thoughts on that in terms of a trend and what that, what the potential is for that to continue and have an impact on your business further going forward?

Martin Ferron

Yes, I’ve only been with North American seven or eight weeks now, but I’ve seen in-sourcing early in my career, lots of bangs. It’s what I’d call a supply chain initiative when customers are managing to cost, where they try to do things themselves for a while and generally they go back to outsourcing. I can’t say that’s going to occur here, but I think it could easily once the market does pick up. That’s been my experience of the last 30 years in seeing these types of initiatives. I think it’s kind of interesting that maybe Natural had the opportunity to – they in-sourced last year, but they chose to stay with us and I think that was a key decision.

Bert Powell – BMO Capital Markets

Okay, thanks Martin.

Operator

Thank you. We do have a follow-up question from the line of Matt Duncan of Stephens Incorporated. Please proceed with you question sir.

Stephen Ragard – Stephens Incorporated

Hey guys, Stephen here again, just a quick follow up. What level of gross margin do you guys expect to achieve maybe on a quarterly basis following your equipment sales?

David Blackley

I think the margins that we would be looking at here would be probably in the low teens.

Stephen Ragard – Stephens Incorporated

Okay, that’s helpful, thanks, guys.

David Blackley

Okay.

Operator

Thank you. Our next question comes from A. J. Strasser of Cooper Creek. Please proceed with you question sir.

A. J. Strasser – Cooper Creek

Hey guys, good morning. Thanks for taking my question.

Martin Ferron

My pleasure.

A. J. Strasser – Cooper Creek

And Martin it’s great to start seeing your kind of fingerprints on the company already. I guess, my question is a little bit more longer term, but one of the things that’s plagued you guys, specifically last year, was the underutilization charge, as your fleet was just simply, I think, as you’ve said, built for a market that had arrived.

We’ve quantified it at sort of around $60 million in costs or so. Have you kind of looked in terms of under your utilization charges, when you look at this company on a near to longer-term basis, how much of that underutilization charge do you think you can eventually just sort of take down? Maybe if you can just kind of help quantify sort of the excessive costs that have been in the fleet, just so we can understand what you’re thinking this company could look like in six months or a year or so.

Martin Ferron

Yes, in a quarter one we had a significant underutilization charge and since I’ve come in, I have been working closely with the asset management group and addressing improvements to that situation and then part of our cost reductions are being targeted at that area.

I’m pleased that we’ve taken steps almost on a weekly basis now to adjust our cost, and I’d like to think that maybe we can start sending that down to near zero. Obviously, we can’t do that immediately, but certainly over the, past the year I’d like to think that we can get close to that.

A. J. Strasser – Cooper Creek

Okay. And then, just lastly, I think, just been where the stock price is, there’s a lot of sort of skepticism in terms of quality of the fleet. Maybe you could just kind of share us your thoughts, as you go ahead and you sort of prune the company and sell some assets, what does that do for you in terms of your assessment of NOA’s asset fleet? How is that being responded to in the market?

Martin Ferron

I think we’re still left with a very high quality fleet. We’re obviously selling the assets that we believe we’re not going to use for the near to medium term. We’re left with the ones we think we will use over the medium to longer-term. So, I don’t think this affects the quality of our fleet too much and I haven’t heard any negative customer reaction to this move. I think they see it as a natural step to take in the circumstances.

A. J. Strasser – Cooper Creek

Right, well thank you, again, for taking my questions, and congratulations again. It’s great to have you as a co-shareholder.

Martin Ferron

Thank you.

Operator

Thank you. Our next question comes from the line of Theoni Pilarinos of Raymond James. Please proceed with your question.

Theoni Pilarinos – Raymond James

Actually, my question was asked. Thank you.

Operator

Thank you. (Operator Instructions) There are no further questions at this time. I would like to turn the floor back over to management for any concluding remarks.

David Blackley

Okay, well thanks for joining us today. We look forward to talking to you next time around. Thanks.

Operator

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

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