North American Construction Group Ltd. (NYSE:NOA) Q4 2022 Earnings Call Transcript

North American Construction Group Ltd. (NYSE:NOA) Q4 2022 Earnings Call Transcript February 16, 2023

Operator: Good morning, ladies and gentlemen. Welcome to the North American Construction Group Ltd. Fourth Quarter and Year Ended Results Conference Call and Webcast on Thursday, February 16, 2023. At this time, all participants are in a listen-only mode. Following the 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 members of management, but they are asked not to quote remarks from any other participants without the participant’s permission. The company wishes to confirm that today’s comments contain forward-looking information and that actual results could differ materially from a conclusion, forecast or projection contained in that forward-looking information.

Certain material factors or assumptions were applied in drawing conclusions or in making forecasts or predictions that are reflected in the forward-looking information. Additional information about those material factors is contained in the company’s most recent Management’s Discussion 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 Joe Lambert, President and CEO.

Joe Lambert: Thanks, Julie. Good morning, everyone, and thanks for joining our call today. Similar to previous calls, I am going to start with our operational performance before handing it over to Jason for the financial overview and then I will conclude with the operational priorities, bid pipeline, outlook for 2023 and our capital allocation before taking your questions. On slide three, our trailing 12-month total recordable rate of 0.53 represents a significant improvement from the start of the year and the Q4 rate of 0.30 was the best quarter of the year. The 0.53 achieved is slightly above our industry-leading target frequency of 0.5 and we will be focusing our efforts in 2023 on prevention of high potential injury events, implementing our active safety program, auditing critical tasks and further advancing our use of developing technology in areas such as collision avoidance, fatigue management and drone use for remote safety monitoring.

On slide four, we highlight some of the major achievements of 2022. I am not going to go through this list individually, but I would simply summarize that, we resolved our first half issues, executed well on our winter works programs, safely and efficiently closed out the year and are focused on carrying our momentum forward into 2023 and looking to take advantage of the opportunities presented in this continuing strong demand market. Slide five shows the cumulative financial results for the year and I am proud to say all four of the noted metrics of revenue, EBITDA, EPS and free cash flow are company records. As you can see on the following slide six, the trend for continuing improvements is consistent. More than doubling both EBITDA and EPS in just four years is an impressive pace that we are eager to maintain.

The next two slides represent two areas of our business that are key to continuing those positive trends. On slide seven, you will see we achieved our highest Q4 utilization on record after just having posted our highest Q3 on record and the demand for our fleet remains high. The Q4 utilization of 75% was directly correlated to increased maintenance manpower and improved fleet mechanical availability. We expect the high demand to remain throughout 2023 and continuing into 2024 and beyond. We likewise expect our progress on increasing the maintenance labor workforce will directly correlate to continued improvements in fleet utilization. Lastly on this slide, I would just like to point out that, other than the obvious pandemic impacts in 2020, our diversification efforts over the last several years have delivered into expectation and demonstrated higher Q2 and Q3 fleet utilization, as we have moved to smaller underutilized portions of our heavy equipment fleet out of oil sands and into other geographies and commodities where they have achieved more operating hours.

The diversification now built into the business has removed much of the seasonality and cyclicality seen in previous years. Slide eight describes our advances in technology and represents another area of our business that is key to continuing the positive financial trends. I spoke earlier about the technology being used to improve safety and would like to expand here on our telematics system. Our telematics system is now installed on about half of our fleet and it’s on the biggest and heaviest half of our fleet. We will continue adding to the remaining portion of our fleet and might be subsequently looking into our support equipment as well. In 2022, the telematics system directly saved over $2 million of machine components through proactive interventions and saved an additional 1200 hours of maintenance labor.

We expect these costs and labor savings to about double in 2023 with full year monitoring and additional assets brought online. The telematics system also contributes to improved operations through alerts and mapping that identify operator behaviors and provides locations complete with heat maps for alert events and frequency. The telematics program is really we build up from our analyses, the better we will get in improving maintenance and operations efficiency. With that, I will hand over to Jason for the Q4 financials.

Jason Veenstra: Thanks, Joe. This quarter’s financial review begins on slide 10, with a few of our key performance indicators. Combined revenue of $320 million represented the highest level of revenue this company has ever had in a quarter and is a step change for a variety of reasons that we will briefly touch on. This revenue culminated with trailing 12 revenue exceeding $1 billion and conveniently occurred in the last quarter of our fiscal year. The $1.054 billion mark exceeded our previous company record of $1.016 billion but under a much different margin profile. From this gross margin perspective, we realized 17.8% in the quarter, which is more in the range of what we expect and is based on the improved context that Joe touched on and is much discussed throughout this quarter’s materials.

Moving to slide 11. On a combined basis, revenue was 36% ahead of Q4 2022. Revenue generated primarily by our core heavy equipment fleet was up 30% quarter-over-quarter with the drivers of this increase being equitable contributions from adjusted equipment and unit rates as well as improved equipment utilization. In Q4, we had a full quarter of revised equipment and unit rates, which were updated in late Q3 to reflect the inflationary cost pressures experienced in the Fort McMurray region. Equipment operating hours were up over 15% in the quarter and stable operational and maintenance headcount yielded utilization of 75%, which was significantly higher than Q3 2021 utilization of 64%. Vacancy rates related to the Heavy Equipment Technician roles were steady in the quarter and combined with increases in third-party vendors were the primary factors in the overall equipment utilization achieved.

Wholly owned business lines, primarily being DGI Trading and the external sales of equipment — of rebuilt haul trucks, each posted strong revenue in the quarter consistent with Q4 of last year. ML Northern acquired on October 1, 2022, provided a full quarter of operations after a seamless integration. Our share of revenue generated in Q4 by joint ventures and affiliates was $87 million, compared to $54 million in Q4 2021. Nuna Group of Companies had another solid quarter of activity at the gold mine in Northern Ontario and the core businesses — and their core businesses operated at better than historic levels. Of note, though, the primary drivers of the increase in combined revenue included the continued growth of topline revenue from rebuilt haul trucks now owned by our joint venture with Mikisew and the increasingly important impact of the joint ventures dedicated to the Fargo-Moorhead flood diversion project.

We had our first full quarter of construction work at the Fargo project and the ramp-up of activities remains underway with the project on budget and schedule in this very early stage of the project. As mentioned earlier, combined gross profit margin of 17.8% was a quarterly improvement from the 14.7% we posted last quarter Q3 2022 and reflected strong operational performances in the quarter as our primary operations in Fort McMurray, Northern Canada and Northern Ontario experienced predictable and productive cold weather conditions for the majority of the quarter. Our joint ventures continued their strong consistent operating margins and the updated equipment and unit rates were key factors for the Fort McMurray operations returning to historical margin levels.

Operating margins benefited from the ML Northern acquisition from both lower internal costs as well as strong margin from services provided to external customers. The second life rebuild program commissioned and sold another 240-ton haul truck during the quarter to close out what was a very successful 2022. Moving to slide 12. Adjusted EBITDA of $86 million was easily a company record, beating the previous record by over 40% as the step change in revenue translated to a step change in EBITDA on strong margins previously mentioned. Included in EBITDA is direct general and administrative expenses, which were $6.6 million in the quarter, predictably identical to Q3 and equivalent to 2.8% of the strong revenue quarter. As always, we pride ourselves on G&A discipline and Q4 was again no different in that regard.

Going from EBITDA to EBIT, we expense depreciation equivalent to 12.5% of combined revenue, which reflected the depreciation rate of our entire business. When looking at just the wholly owned entities and our — and primarily our heavy equipment, the depreciation percentage for the quarter was 15.5% of revenue and reflected an effective use of our fleet during the quarter, which incurs a higher degree of idle time due to the colder temperature. Adjusted earnings per share for the quarter of $1.10 was $0.51 up from Q4 2021 as the revenue improvements translated all the way down to net income. EPS was driven by $45.7 million of adjusted EBIT, net of interest and taxes. The interest rate for Q4 was 7.1% as we trended up from the Q4 2021 rate of 4.7% from the well-known interest rate increases.

The gross interest expense of $7.8 million should be a high watermark for us as we paid down debt late in Q4 and expect rates to be fairly stable moving forward. Moving to slide 13, I will summarize our cash flow. Net cash provided by operations of $64 million was produced by the business with the difference between this figure and the $86 million of EBITDA being cash interest paid in the quarter and the timing of joint venture cash distributions in relation to the EBITDA they generate. Sustaining maintenance capital of $26 million was dedicated to maintenance of the existing fleet as we invest in the fleet that drives our core business. Working capital changes generated cash in the quarter as expected. For the year and given the fairly straightforward nature of the year from a cash perspective, the use of our $70 million of free cash flow that was generated can be easily broken down into its three categories; $44 million related to shareholder activity, primarily share purchases and dividends; $13 million on growth acquisitions being ML Northern; and $13 million on net debt reduction.

Moving to slide 14. Total liquidity is back above $200 million and reflects the impact of free cash flow generation in the quarter. Net debt levels decreased $52 million just in the quarter as $67 million of free cash flow was primarily dedicated to deleverage with the remainder invested in ML Northern. Net debt leverage is now at 1.5 times and ended the year consistent with expectation. Due to the timing of cash receipts in the last couple of days of 2022, we ended the year with $69 million of cash on hand, which is higher than our targeted balance of between $15 million and $20 million. On a trailing 12-month basis, our senior leverage ratio, as calculated by our credit facility dropped to 1.5 times, but did not benefit from this high cash balance and coincidentally is at the same level as net debt leverage.

I will briefly end on slide 15, which includes ROIC and return on equity. In particular, we are proud of the ROIC metric of 13.0%, which quantitatively showcases our objective to prudently and profitably leverage both our equipment fleet and our expertise. And with those summarized financial comments, I will pass the call back to Joe.

Joe Lambert: Thanks, Jason. Looking at slide 17. This slide summarizes our priorities for 2023. I have previously discussed our leveraging of technology shown in item two, but wanted to highlight the other three areas that will be particularly important to progress in 2023. The first area of focus and core to our culture and values is our ongoing efforts to ensure each and every one of our employees return home safely at the end of every workday. I mentioned earlier how we are using technology to improve safety through implementation of collision avoidance systems, fatigue monitoring and using drones for assessing and monitoring remote work areas. With that said, we are likewise focusing on the workforce. We feel our growing workforce requiring increased new hires and an industry supply low end experience will be best served with an increased focus on further developing our front run supervision and expanding our green hand training programs.

Jumping over item three to item four, we continue to prioritize increasing our skilled trades workforce. NACG has an extensive and comprehensive program to expand both our Acheson and field based maintenance workforce. We have likewise used our procurement team to bring additional vendors from other provinces and countries to support our maintenance needs as the existing vendors and OEMs have struggled to support the increased industry demand. There’s a slide in the appendix on page 31, which we have expanded to show both NACG and vendor maintenance workforce numbers for those interest in seeing how we have built up the skilled trade workforce over time. The ongoing priority will be to continue adding to both internal and vendor capacity until we have maximized our mechanical availability and fleet utilization, and then continuing hiring and training internally to replace higher cost vendors.

As stated previously, we expect our progress on increasing the maintenance labor workforce will directly correlate to continued improvements in fleet utilization and the opportunity to consistently achieve 75% to 85% utilization. Last but not least, item three describes our prioritizing of winning bids and achieving our target of greater than $2 billion in backlog by the end of the year, which is a great transition to our next slide 18. Slide 18 highlights the continuing strong demand and active project tenders. In Q4, we were awarded a couple of projects for our Nuna partnership totaling just over $40 million for work on a gold mine in BC and some roadworks in the Northwest territories. We are likewise starting to see increased bidding activity in oil sands.

Two projects of note in oil sands are first, our expectation that the large regional oil sands five-year scope will be retendered in late Q1 for likely award in Q3. We continue to expect to win our fair share of the large red dot, regional oil sands tender and look forward to seeing the updated tender package and work scopes. Second tender of note in oil sands is an approximate $75 million scope for fueling and servicing oil sands customer’s equipment fleet over the next five years and represents our first major tender of our newly acquired ML Northern Equipment Servicing business working under our Mikisew partnership. We believe we have a good chance of winning this work and continuing to expand our ML Northern business, while simultaneously utilizing our skills internally to lower our equipment servicing costs and improve efficiency.

Last item of note is that we have what we believe are four grade opportunities outside oil sands, which are the four upper left blue dots, which we believe would fit the timing for our fleet transitioning from our Northern Ontario Gold Mine partnership with Nuna. We look forward to having another blue dot win outside oil sands over the next quarter, which will continue our diversification success and potentially offer some upside to our forecasted smaller fleet utilization. On slide 19, our backlog sits at $1.3 billion and we continue to replenish and win our fair share of work across all resource sectors. What I continue to believe is the key takeaway on this slide is that our backlog is roughly proportionate to our diversification target, demonstrating both confidence and sustainability of our diversification efforts.

Lastly, on backlog, we continue to have expectation of exceeding $2 billion before the year is out. On slide 20, we have provided our enhanced outlook for 2023. With our strong Q4 results, progress on priorities and carrying some of that momentum into the New Year, we have been able to modestly increase the midpoint for a couple of our key financial metrics. We have had a great winter work season so far and are definitely looking to continue to build on our success and beat even this enhanced outlook. But it is early days, and our middle two quarters generally carry the highest risk on fleet utilization. I know I will get the question on — excuse me, how our quarters break out in the Q&A, so I will use our EBITDA as an example here. Our EBITDA is roughly equal between the first half and second half of the year, with Q1 being our largest and roughly 30% of annual EBITDA and Q4, usually second largest, but just slightly higher than Q3.

As I stated in my letter to shareholders, capital allocation is always a key priority for NACG and our free cash flow range of $85 million to $105 million provides us with the flexibility to assess all four options of deleverage, share repurchases, dividends and acquisitions. Our first step, which we announced yesterday was to increase our dividend by 25%. Deleverage is the current obvious next focus with our capital — with our cost of capital increasing with interest rate hikes. As I have said many times, our capital allocation decisions are continuously analyzed and we will, of course, redirect cash flow to share purchases or growth opportunities, if they provide superior returns to our shareholders. On slides 21 and 22, we provide a bit of capital allocation in history and trends, which we trust you will agree has been disciplined, shareholder-friendly and prudent.

Over the past few years, we have been fairly consistent with our NCIB programs as the earnings outlooks we have communicated have generally not correlated to the value of our shares. And finally, on slide 23, I’d like to highlight and provide the link for sustainability report, which was also released yesterday. I really like the direction our sustainability work has taken with a focus on tangible measurable progress and look forward to reporting back next year on our continued progress. In closing, I’d just like to thank the great team I have here at NACG for all your efforts and support in helping us achieve these record annual financial results in a challenging economic environment. With that, I will open it up for any questions you may have.

Q&A Session

Operator: Thank you. Your first question comes from Yuri Lynk from Canaccord. Please go ahead.

Yuri Lynk: Good morning, guys. Great quarter.

Joe Lambert: Thanks, Yuri.

Yuri Lynk: Just on the utilization, I think you said, you are targeting 75% to 85%. So should we think about that as the seasonally weaker quarters are at the lower end of that range and quarters like Q4 could be towards that mid-80s level. Is that the way to think about it for this year?

Joe Lambert: It’s certainly getting to that point where we are consistently in that range. I would expect the Q4 and Q1 to be on the higher end and the Q2 and Q3 is on the lower end of that range. And that’s really what we need to demonstrate in this Q2 and Q3 is that we can get into the lower ranges of that.

Yuri Lynk: Okay. And that’s — the main driver there is that small fleet of construction equipment that’s exited the oil sands, is that right? And where have you put that to work, like is it on kind of small- and medium-sized jobs or is it on larger?

Joe Lambert: It’s — I’d split it into a few things, Yuri. It’s — there’s still 100-ton, 150-ton trucks in oil sands that stay very busy during the winter that have not in the past half a dozen years had high utilization during summer civil construction. So during the winter, they are usually very well engaged in reclamation activities, but historically, it slows down in summer. And then in addition to that, our progress on utilization outside of oil sands, which really is — we are forecasting the completion of the Northern Ontario Gold job, and with that, we have got that fleet transitioning. And I’d say, conservatively, we have it coming out of that mine and going into oil sands and having lower utilization, and obviously, a period of non-use while it’s demobing and being transported. So there is upside opportunity on those assets as well.

Yuri Lynk: Okay. Suncor is out there talking about looking to trim their contractor headcount or use of contractors for a variety of reasons. But is that an opportunity for you guys or a threat or how do you think about that?

Joe Lambert: We haven’t seen that coming in the earthworks side. So I guess our impression, Yuri, that it’s mostly happening on plant site side and they are consolidating vendors, which makes a lot of sense. We have got a lot of work consolidated in the earthwork site already. So I don’t think this is an area that they are looking to reduce contractors. And from what we see in the demand and the volume requirement side, we don’t see any reduction in that demand for a long time.

Yuri Lynk: Okay. I will leave it there, guys. Thank you.

Joe Lambert: You bet.

Operator: Your next question comes from Aaron MacNeil from TD Securities. Please go ahead.

Aaron MacNeil: Hey, guys. Thanks for taking my question. Joe

Joe Lambert: Good morning, Aaron.

Aaron MacNeil: Hey. If I compare your Q4 slide deck with the Q3 one, it looks like that large oil sands bid got pushed out a couple of quarters, am I right in interpreting that correctly and how should

Joe Lambert: It — when I would — it was actually — it’s supposed to be put on the commencement dot and we put it on the tender dot in the previous one. So it — these contracts run through the end of 2023. So the dot was always supposed to be on January 1, 2024. So the dots are supposed to be when the work commences. And so it hasn’t — that side of it hasn’t changed. We just made a mistake where we put it in Q3.

Aaron MacNeil: Yeah. No problem.

Joe Lambert: And the tender process has pushed out from last year to this year, but obviously, there’s plenty of time to have it awarded before next year.

Aaron MacNeil: And I guess just as a quick follow-up on that, how much of that work would be like work you currently have versus incremental work?

Joe Lambert: I’d say probably half of it is work we are currently doing. The difference being that, obviously, right now, our backlog reflects one year left of it and this would be five years of — so we are going to peak in every cycle of five years in backlog with those oil sands awards and then they are going to work their way down over the five years and then get awarded again. So we are kind of at the low level of our backlog right now and that awarded that work. And I’d say, probably, half that is what we are currently doing.

Aaron MacNeil: Got it.

Joe Lambert: And the other — but not work that we have five years of scope on work we are doing this year, I’d say. Is that clear, Aaron?

Aaron MacNeil: Yeah. No. That’s perfect. Joe, you mentioned in your prepared remarks that, Q2 and Q3 have the most uncertainty around utilization. You are guiding to a relatively flat year, next year on a year-over-year basis. There’s obviously some puts and takes. So I thought it might be a good opportunity for us to kind of just get a bit more context around the various moving parts, like from what I can think of, I am sure there’s other ones, too, but you have had the negative impact of inflation in 2022 versus 2023. You have got a full year of Fargo-Moorhead in 2023, and then offsetting that, you have got the maybe the negative impact to the Côté Project in 2023. So, I guess, could you frame how material all three of those impacts are and then…

Joe Lambert: I think you have almost finished answering your own question there.

Aaron MacNeil: I just

Joe Lambert: That’s exactly what I would have said is that, where we place that Côté fleet, there’s actually opportunity even on the same site and in the same regions that could have great improvements on utilization from forecast. The Fargo-Moorhead ramp up, but it is lower risk, lower margin work at Fargo, with the big infrastructure work, which I think we have always said. And then there are some areas in projecting the improvements in utilization and projecting the benefits that we are achieving in telematics, where I’d say, we are cautious to project trends that are going very up very quickly without a lot of data points. And we certainly want to get a few more dots on the map or data before we confidently project things higher than where we currently are. So I think those are all opportunities that we will see really out of Q1 and what we see happening in Q2 and get a little closer to it.

Aaron MacNeil: Maybe I will ask the question a bit differently. I am wondering on materiality. Like if you take those three factors and forget everything else, like, net-net, are those

Joe Lambert: They would all be positive.

Aaron MacNeil: Okay. So there’s potential for upside revisions to your guidance to the extent that

Joe Lambert: Yeah. I — yes. And I — what I would say, we are — you have heard me use the term stronger for longer in the commodity marketplace. I have been in mining business for 40 years now. This is the strongest across all commodities from a demand side and one that looks like it’s going to run a long cycle because of the EV metals. Certainly, I have seen — while we are talking about energy, coal, met coal, thermal coal, base metals, precious metals, lithium, graphite, this is generational kind of demand cycle we are seeing in commodities, certainly for my generation anyways, I have never seen it. And I think that’s an overall driver that gives us confidence that demand there, it’s getting the mechanical availability and utilization out of our fleet and executing

Aaron MacNeil: Okay.

Joe Lambert: and that’s what we do.

Aaron MacNeil: Thanks, Joe. I will turn it over.

Joe Lambert: You bet.

Operator: Your next question comes from Jacob Bout from CIBC. Please go ahead.

Rahul Malhotra: Hi. Good morning. This is Rahul on for Jacob.

Joe Lambert: Good morning, Rahul.

Rahul Malhotra: Good morning. So I just had a question on 2023 guidance and the current backlog. So guidance, if we look at the EBITDA guidance, it implies an improvement over 2022, but the backlog levels are lower both quarter-on-quarter, year-on-year. If you just talk about backlog duration and whether you expect to use more from backlog this year compared to last year?

Joe Lambert: No. As I stated a couple of times in the presentation, we expect our backlog to be over $2 billion by the end of the year. It’s just a cyclical nature where we have got a regional contract, which is a line, four main producing sites and they are on a five-year cycle. So you are going to have — you are going to peak every time they are awarded and over the next five years, those are going to draw down. So and I am just talking about half the business that’s in the oil sands right now. So the decline quarter-to-quarter would be expected because these contracts are only awarded every five years. As soon as — we thought it might — it originally came out and looked like it was going to be awarded last year, but because of all the inflationary pressures and because they can, they pushed it off until this year.

And so we expect that to be five years of our — about 75% of our work in oil sands is going to get committed to a five-year contract. And so the quarter-to-quarter decline in backlog from three to four really didn’t matter. That’s — every time after these awards occur, that’s going to happen in oil sands. And we have had significant wins outside even like the big infrastructure project in the states, that’s got a six and a half year operating construction in 29 years of operations and maintenance, that number is just going to draw down over that six and a half years of construction more than anything else. Did that cover off what you are looking for, Rahul?

Rahul Malhotra: Okay. Yeah. Yeah. That’s helpful. Thank you. And maybe just on the Fargo-Moorhead project. So has that project been fully ramped up or would you say there’s still more runway from a quarterly contribution perspective over the next couple of quarters?

Joe Lambert: No. We — it just — we just opened it up in roughly September of last year. We just started earthworks, and the earthworks side of it, we will get pretty close to peak this year. So we will get full year operating. We had roughly a quarter last year. Well, the full year contribution this year. And really this year and next year are getting to where we will peak, peak production, peak workforce on those sites. Generally, it will happen during the summer, but they run all year long. So they have been operating — they are operating today, they were operating last week and they will operate continuously now for the next six years.

Rahul Malhotra: Great. And maybe just last one for me, so when we look at your guidance ranges, I guess, the question is, what determines the low and high end, and does this assume a relatively quick transition of the Côté Gold Mine fleet?

Joe Lambert: We have got a pretty conservative estimate of that fleet coming out of Côté, taking a reasonable amount of time for transportation and then going into a lower utilization aspect. But if we had a very quick transition and got it into a 24×7 high utilization, which is what we would like to do and what So it’s not a huge amount. It’s not going to change that range. But there’s a lot of other contributing factors, predominantly our utilization and whether our fleet mechanical availability. As I have told people before about every point of utilization is worth about $1 million a month in topline. So continuing to add and if you look at last year’s averages versus this year, if we can continually add and get better and get into that range of 75% to 85%, it will have positive impacts going forward.

Rahul Malhotra: Great. Thank you. I will pass it over.

Joe Lambert: Thanks.

Operator: Your next question comes from Tim Monachello from ATB Capital Markets. Please go ahead.

Tim Monachello: Hey. Good morning, guys.

Joe Lambert: Good morning, Tim.

Jason Veenstra: Good morning.

Tim Monachello: Congrats on blowing the roof up on this quarter. It’s been a long time coming.

Joe Lambert: Thanks.

Tim Monachello: I also got to say, you got to be quick on the trigger finger to get a question in this queue. These analysts, I don’t think I could win in a duel.

Joe Lambert: Yeah.

Tim Monachello: For some of these guys work out . Anyways, a lot of my questions have been covered off. One of them, though, the maintenance headcount slide, it’s interesting detail that you provided here between third-party vendors and your NACG headcount. It looks like the gap between that is widening out a little bit. But it seems to be within your historical range, you made some comments in your prepared remarks that you are hoping to ramp both of those two lines higher and then try to close the gap basically and convert or just sort of reduce the amount of third-party vendors. Where would you like to see that ratio of NACG headcount to third-party vendors and what could that mean to your margin profile if you were to close that gap?

Joe Lambert: I don’t know if I have calculated that one, Tim. I could take a stab at it. But we would probably want a good 90% of that workforce to be our own internally. We have always got some around generally you want for any kind of warranty work, as well as some technical support, if you need it. And I’d have to sit down with Jason to calculate that number. But external guys are probably roughly twice as much as internal guys in the expense side. You are carrying obviously, a lot of another company’s cost and overheads in not just the direct labor and they are not doing it for free also. So we have been good. We have dropped them out when we have needed to. Obviously, you will see during the pandemic. Last year, it dropped because they couldn’t give us guys. That’s what that trough is and we had to build up more vendor support just to get to where we needed to. But as we increase our own and approach that high utilization, then we will start pulling vendors out.

Tim Monachello: Okay. Got it. And, obviously, it doesn’t seem like it’s much of an issue anymore having trying to staff. So maybe you can just put in context, like, what does the market look like now for heavy equipment mechanics compared to what it looked like in the middle of 2022?

Joe Lambert: All right.

Tim Monachello: And is there any

Joe Lambert: Yeah.

Tim Monachello: growth that you weren’t able to complete in Q4 just given mechanical equipment availability?

Joe Lambert: We could have done more. I’d say that we weren’t anywhere near the top end of our mechanical availability of our fleet even with that utilization and we had demand that would have kept every piece here running that we could get running and we could put operators. It’s not over, Tim, and this is not going to be an issue that even goes away in years’ time, because this is going to be an ongoing issue of skilled trades in Canada and that’s the way we are looking at this. This isn’t a seasonal. This isn’t a year. This isn’t a cycle. We are changing the way we do this business and looking at how we do our premises, looking into how we bring in vendors, how we bring more equipment down here and do more work in regional shops that we can get more people at, continuing to expand our facilities.

This is going to be something that is a long time, we will be talking about it 10 years from now, because it’s not going to get easier and we definitely want to be on the leading edge of this, because it’s — as you have seen, it drives utilization and utilization is key to our business.

Tim Monachello: Okay. That’s great. One other thing that I wanted to touch on, I think, Yuri asked about it was just around that utilization range that you are alluding to in the 75% to 85% range and thinking that you might be able to get to the bottom end of that range in Q2, and historically, your Q2 has sort of maxed out around the 60% range in terms of 60% to 65% range in terms of utilization. How do you get that extra 10 points of utilization in Q2 in the oil sands?

Joe Lambert: Well, it’s availability of our big truck fleet that we know we have demand on is the biggest driver. That’s the one we can control. And then what we are looking for is some increased demand on the smaller end of the fleet with increased civil construction works over the summer and those are the drivers. So we got to have the demand first and then it’s in our hands to make the equipment available and put operators in the seat. So we have the demand on the big equipment year-round. We are looking to see if there’s increases further in the small stuff or even moving some of that outside of oil sands again to improve utilization and then it’s up to us to execute on the maintenance and the maintenance planning to get mechanical availability over and above what our needs are there.

So it’s — that’s why I said committing to those kind of numbers and projecting it, we got to put a few more runs on the board. You can’t draw a line with a single data point, we need a few. And I am very pleased with how we have progressed and we have exceeded our expectations so far. But there’s a lot of moving parts in this, and Q2 and Q3 will be great tell-tell signs if we can get into that range and even on the low end in those quarters. I feel a lot more confident projecting it year round.

Tim Monachello: Where would utilization be in Q1 so far?

Joe Lambert: We are in the 70s.

Jason Veenstra: Actually, we are in the high 70s.

Joe Lambert: I mean that’s — again you are talking Q1 and that’s a January number. So it’s continuing from where it was in December.

Tim Monachello: Okay. That’s really helpful. And then what would be the utilization that you are assuming for the year in your guidance range?

Joe Lambert: I don’t have that number off hand. I’d have to get back to you, Tim.

Tim Monachello: Okay. No worries there. And then the other question that I had was just around the free cash flow guidance. I noticed that there’s a $25 million deferral. I think that has to do with just sort of distributions from the Fargo-Moorhead project and then it wasn’t added back or it seems sort of flat from — in 2023 from 2022. So I am curious like, if you were to include the cash being held in the Fargo project or any of your JVs is not being distributed, how much free cash flow — what would this free cash flow profile look like for the entire business year-over-year?

Jason Veenstra: I can take that one, Tim. It’s a bit of a loaded question. I don’t know if you are asking to normalize 2022. But, yeah, between $20 million and $25 million is the impact we have seen between earnings and then cash distributed. So whether you want to add that $20 million or $25 million to 2022 or 2023 is up to the reader. I would say for 2023 purposes in our range, as you noted, we left the range the same. We have modestly increased kind of the core business cash generation and then kept the expectation from our JVs the same as we had planned out in October of last year. So we have left it the same. We understand the volatility of JV distributions and we are in the kind of $40 million to $45 million of distributions coming from the JVs. That was our expectation last quarter, continues to be our expectation.

If we are — if the JVs are able to exceed that, we would see upside. But clearly, with the impact we had in 2022, we didn’t want to over promise for 2023. And so $85 million to $105 million is still a very strong cash flow generation and other step change in our capital allocation flexibility, but there clearly is volatility with free cash flow.

Tim Monachello: No. Absolutely. I am just trying to sort of understand better, I guess, the underlying operational free cash generation of the business rather than and I understand — and why you would only talk about the distributions out of the JV, but I think from a — to understand the value proposition here, we need to understand the cash flow — cash generating aspect of those JVs as well, so that’s what I was trying to touch on. Anyway, I will turn it back and thanks very much for the details.

Joe Lambert: Yeah. Thank you.

Operator: Your next question comes from Bryan Fast from Raymond James. Please go ahead.

Bryan Fast: Yeah. Good morning, guys.

Joe Lambert: Good morning, Bryan.

Bryan Fast: Just on the inflation adjustments midway through the year. Is it safe to say that that was fully reflected in Q4 or is there any lag there?

Jason Veenstra: It was fully reflected in Q3 already, Bryan. So, yeah, there’s no lag and no lag or retro in Q4 either, so.

Bryan Fast: Okay. Thanks. And then I appreciate the color on the telematics, but are you able to quantify maybe the returns or payback relative to your investments just on that installation?

Joe Lambert: I’d say it’s already — savings already exceed cost operating even in its first year, last year and we expect that to continue. I think that we would expect it to double this year and we aren’t adding any people or cost. The operating cost per machine hour is less than what we had forecasted and the savings are higher. So and it pays for itself very quickly.

Bryan Fast: Okay. That’s it for me. Appreciate the color.

Jason Veenstra: Thanks, Bryan.

Operator: Your next question comes from Maxim Sytchev from National Bank Financial. Please go ahead.

Maxim Sytchev: Hi. Good morning, gentlemen.

Joe Lambert: Good morning, Max.

Maxim Sytchev: Just a couple of quick ones for me, if I may. Joe, I guess, do you mind providing a bit of color on your initial perception around Fargo, how that’s ramping up sort of any changes? I think you made some comments a number of months ago, like in terms of how inflation could be potentially impacting the economics. Just wondering if you have some refreshed math as, obviously, some of the things have normalized. So, yeah, maybe any color on that, please?

Joe Lambert: Sure. It’s ramping up well. We have been hitting our productivity numbers. We peaked for the year coming up in the summer. But on the earthwork side, which is what’s being executed right now, it’s progressed very well. So equipment and people and everything is working fine. We will start getting into some of the bridge work with our partners. We don’t actually execute that side of it, but our partners will be coming up this summer and commencing that. We did our initial kind of forecast reviews and where we were on inflation and the impacts on our risk assessments and those initial items said that the increases incurred were within our risk matrix, and we are covered off by that and that our project margins and schedule remained intact.

And our next — will probably be towards the end of this year, beginning in next year, where we do kind of the full-on, full-blown forecast of the whole job for the first time after everything has commenced and that will be our first real test of how did the project sit versus how it’s being executed, and hopefully, we have some positive impacts with our — what we see in our earthwork side over the summer and we are able to beat our targets in the big ramp up the year this year. So I guess it’s a stay-tuned kind of a message, but the other side of it is we have gone through and modeled that inflationary pressures in and we haven’t seen a reduction in our expected project margins.

Maxim Sytchev: Okay. Super helpful. Thank you so much. And then last question, pertaining more to capital allocation and some of the earlier comments, Joe, that you made around sort of EV battery metals and how it’s such a robust market. Do you mind maybe, I mean, painting a bit of a picture in terms of how that potentially could fit sort of the preference for M&A or just maybe any color from that perspective? Thanks.

Joe Lambert: There — to put some color on when you look at that bid map and those dots on that map, the blue dots and there’s some significantly large ones. Those are areas of iron ore, copper, nickel, gold and opportunities that we see that have — what we tend to call a high go win percentage that they are going to go forward and that we have a good opportunity to win them. So from a bidding perspective, the work outside of oil sands in the other commodities been as strong as we have seen it. We continue to look at other markets around the world for M&A opportunities and that’s when we will look at — and this fits in just with the overall capital allocation, Max. Obviously, we addressed our dividend. We are looking at the debt because of the high interest rates, but we also see some opportunities in the M&A side.

Obviously, we have had success in vertically integrated bolt-ons like ML Northern and DGI. Those have been great value and we see them continuing to be. So if opportunities come up like that and they are great returns or even the bigger ones do, we are going to pursue them, and we have consistently seen the small ones and we do think there’s some opportunities for some bigger ones that have historically struggled to be accretive. But if — they have to have the returns we are looking for, otherwise, we are going to look at deleveraging, which there’s nothing wrong with that either, right?

Maxim Sytchev: Yeah. No. Absolutely. And maybe– one maybe providing a bit of sort of read-through on how the expectations of sellers changed or maybe not over the last kind of nine months, has it been static or have you seen sort of a reset of expectations on that side as well?

Joe Lambert: Yeah. I don’t know if I have ever seen anything consistent in that regard anyways. I think it’s opportunistic. You find sellers in the right spot at the right time when you are looking at something. So I just think we found great fits and timing with sellers on our DGI and our ML Northern and great fits in those cultures. They have made for extremely smooth integration into our business and those — I wouldn’t call those normal. I think it’s just been a great opportunistic setup for us. But every seller is a little different, and I don’t think there’s a consistent trend there. But when we see opportunities where the integration of the business and the culture and there’s synergy and there’s opportunities to learn from one another and grow off each other, they tend to be the ones that provide the best financial side as well.

So that’s what we look for is things that vertically integrate in our business, have a good return for us, help us lower our costs, while giving us opportunity to expand in external services or other businesses similar to us, we think we can increase our diversification geographically and in commodity and customers and have good accretion numbers. Those are the ones we are looking for.

Maxim Sytchev: Yeah. Makes sense and I appreciate all the comments. Thanks so much.

Joe Lambert: No worry. Thanks, Max.

Jason Veenstra: Thanks, Max.

Operator: This concludes the Q&A section of the call and I will pass the call over to Joe Lambert, President and CEO, for closing remarks.

Joe Lambert: Thanks, Julien, and thanks, everyone. I really appreciate you joining us today and look forward to talking to you again next quarter.

Operator: Ladies and gentlemen, this concludes your conference for today. We thank you for joining and ask that you please disconnect your lines. Thank you.