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Edited Transcript of NOA.TO earnings conference call or presentation 1-May-19 1:00pm GMT

Q1 2019 North American Construction Group Ltd Earnings Call

Acheson May 7, 2019 (Thomson StreetEvents) -- Edited Transcript of North American Construction Group Ltd earnings conference call or presentation Wednesday, May 1, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David Brunetta

North American Construction Group Ltd. - Director of IR and Director of Finance & Information Technology

* Jason William Veenstra

North American Construction Group Ltd. - Executive VP & CFO

* Joseph C. Lambert

North American Construction Group Ltd. - President & COO

* Martin R. Ferron

North American Construction Group Ltd. - Chairman & CEO

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Conference Call Participants

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* Daine Biluk

CIBC Capital Markets, Research Division - Associate

* Devin Schilling

PI Financial Corp., Research Division - Special Situations Analyst

* Maxim Sytchev

National Bank Financial, Inc., Research Division - MD and AEC-Sector Analyst

* Yuri Lynk

Canaccord Genuity Limited, Research Division - Director and Senior Engineering & Construction Equity Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Welcome to the North American Construction Group Earnings Call for the First Quarter ending March 31, 2019. (Operator Instructions) The media may monitor this call in a listen-only mode. They are free to quote any member of management but are asked not to quote remarks from any other participant without that participant's permission.

I would now like to turn the conference over to David Brunetta, Director of Investor Relations.

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David Brunetta, North American Construction Group Ltd. - Director of IR and Director of Finance & Information Technology [2]

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Good morning, Denise, and thank you, everyone, for joining us. Welcome to the North American Construction Group's 2019 First Quarter Conference Call. I would like to remind everyone that today's comments contain forward-looking information. Additionally, our actual results may differ materially from expected results because of various risk factors and assumptions. For more information about our results, please refer to our March 31, 2019 management's discussion and analysis, which is available on SEDAR and EDGAR.

On today's call, Jason Veenstra, Executive Vice President and CFO will begin by reviewing the first quarter results. Martin Ferron, Chairman and CEO, will then provide his comments on our outlook and strategy. Also with us on the call today are Joe Lambert, President and Chief Operating Officer; and Barry Palmer, Senior Vice President of Operations. After management's prepared remarks, there will be a question-and-answer session.

I now turn the call over to Jason.

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Jason William Veenstra, North American Construction Group Ltd. - Executive VP & CFO [3]

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Thanks, David. Good morning, everyone. As mentioned, I'll provide a summarized financial overview of our Q1 results and close with some brief commentary on our new debentures and our current leverage.

Starting with the top line. Revenue for the quarter of $186 million was $72 million above 2018, but could have been noticeably higher had it not been for the abrupt arrival of the 2019 spring break up in the oil sands in mid-March. Year-over-year growth of 63% is largely due to the fleet acquired in Q4 of 2018, which provided new work at the Fort Hills and Aurora mines as well as significant incremental work at the Millennium mine. Organic scope and volume growth was also significant at the Kearl mine as we continue to expand our presence at that mine site.

Our share of revenue from the Nuna Group of Companies was not material for the quarter but did contribute slightly to the year-over-year increase, given this acquisition also occurred in Q4 2018. Steady and consistent increases in our external maintenance services and the Dene North joint venture were offset by the year-over-year decreases from the Highland Valley Copper and Fording River mine in BC.

Moving to the expense side where we always start with capital depreciation, given it's a reflection of the operating hours we put on our heavy equipment and their components. During the quarter, depreciation was $29.3 million or 15.7% of revenue, which is proportionally up from $18.2 million compared to last year as it was the same as a percentage of revenue. This 16% of revenue is higher than our current trend of 14% or less. The higher percentage, when comparing to the trend, reflects the initial impact of initial component depreciation of the new fleet as well as the operational challenges experienced in the 2019 spring breakup. As I'll reference later, we needed to respond quickly from a maintenance perspective this quarter and it impacted depreciation. We expect the 16% incurred in the quarter to be the high watermark for the year and are looking forward to the future run rate coming back to our normal trend line.

Gross profit for the quarter was $29.6 million and a 15.9% margin, up from gross profit of $26.8 million but down from the 23.4% margin last year. The higher gross profit this quarter was, of course, a function of the higher revenue. The lower margin was posted due to the type of the spring breakup that occurred in 2019 when compared to the 2018 breakup in April. This impact was particularly felt in direct equipment costs, given the inefficiencies experienced at the mine site and the suddenly warm conditions.

In addition to this weather-related issue, our results were negatively impacted by 2 assumed legacy contracts at the Fort Hills mine, the larger of which expires in the second quarter and the other in mid-Q3. Excluding this transitional impact, gross profit margin for the quarter would have been approximately 20% or 4 full percentage points higher, which is a more accurate reflection of the operating challenges we faced in Q1.

Below gross profit, general and administrative expense excluding stock-based compensation was $8.8 million or 4.7% of revenue. This percentage level generally reflects our expected run rate, but was negatively impacted by restructuring and other transition-type costs incurred as part of this first full quarter operating expanded fleet as well as the Nuna Group of Companies.

Of specific note in the quarter, the noncash, stock-based compensation expense of $6 million was the most severe we've had on record. The average price of $16 per share at the end of the quarter was a 35% increase in 3 months from the $11.91 average price at the end of the year. The benefit of this share price appreciation was the ability to close the junior convertible debentures at an attractive rate of 5% and a reasonable strike price of $26.25.

Interest expense of $5.5 million for the quarter includes over $800,000 of noncash expense for implied and deferred expenses. The remaining $4.7 million of cash-related expenses relates to the debt financings we've put in place over the past 2 quarters. We remain very happy with the credit facility and capital lease financing rates as we continue to operate at an overall cost of debt under 5%.

Before we look at net income and EPS, I'll touch on the strong gross-adjusted EBITDA of $52.1 million, which exceeded the proportional estimate we provided back in February. EBITDA margin of 28% in the quarter was, as mentioned, heavily impacted by the assumed contracts at Fort Hills. Excluding these contracts, which have now mostly run their course, Q1 margin was over 30%. The full synergies in the oil sands from our expanded fleet remain on schedule for 2019, but are not reflected in this first quarter of operations due to the factors previously mentioned. Putting this in perspective, the trailing 12-month EBITDA of 24% essentially maintains the profitability watermark established last quarter and reflects a year-over-year increase of 2% when comparing to the comparable period.

In an incredibly complex and unique quarter, our operations team did an incredible job maintaining profitable operation while establishing the foundation for the remainder of 2019. Q1 was a transition quarter as we look forward to fully utilizing and optimizing our heavy equipment fleet as well as executing a busy Q2 and Q3 quarters for Nuna.

Regarding net income. We recorded $7.2 million of earnings compared to $11.1 million last year. The $2.8 million improvement in gross profit was more than offset by the $6 million of onetime stock-based compensation and other G&A acquisition-type costs. The increased interest expense was offset by lower deferred taxes and the 2018 sublease loss. The positive net income equals basic earnings of $0.29 per share over the average of 25 million shares. Adjusted EPS was $0.52, which excludes share-based compensation and provides a better reflection of earnings for the quarter.

To close out the financial review, I'll summarize our cash flow for the quarter. As mentioned, we generated $52 million in adjusted EBITDA. As provided in the MD&A, total gross sustaining capital expenditures totaled $55 million in the first 3 months. And when factoring cash interest paid in the quarter of $4.9 million, the business required $5.3 million of cash flow.

Regarding the significant capital investment we made in the quarter. Our routine capital maintenance program is heavily weighted to Q1 and was generally consistent with the Q1 2018 spending of $23 million, which ended up being 40% of the eventual full year figure. That said, the majority of the $30 million spending increase was required to be spent in Q1 on the new fleet to both maximize revenue in the quarter by meeting customer demand as well as the requirement to establish our benchmark maintenance standards and ensure reliable equipment availability moving forward. This free cash flow requirement of $5 million, along with growth spending of $13 million, was funded through a $17 million net increase in lease financing, which was secured at attractive terms and rates.

Growth capital in Q1 includes heavy equipment purchased under a right of first refusal arrangement with an oil sands customer as well as a purchase of strategic mine site facilities. The growth capital was invested in early 2019, with the longer-term outlook in mind and provides further support to achieve the continued growth we've communicated previously. These future profit levels will, in turn, generate the free cash flow needed to fund our stated deleveraging objectives in the medium term and specific $150 million of deleverage by the end of 2021.

To close out, I'll quickly touch on the financial impact of the new debentures. The $55 million 5% debentures achieved our short-term objective of bringing our senior leverage ratio below 2.0. Based on our full year 2019 expectation and the seasonally high March 31 lease balance, our senior leverage ratio is now at 1.8 and poised to decrease as we apply free cash flow to our senior secured debt moving forward.

Lastly, and just for clarity, the 5% debentures are not callable for 7 years until March 20, 2026. From an accounting perspective, we defer the financing fees over these 7 years and therefore, the effective rate on our income statement is 5.6% but the actual cash interest costs, moving forward, remains at 5.0%.

With those financial comments, I'll pass the call to Martin.

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Martin R. Ferron, North American Construction Group Ltd. - Chairman & CEO [4]

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Thanks, Jason, and a very good morning to everyone. Just as I was very pleased with the financial results of Q1 in both 2017 and 2018, I'm delighted with our financial performance in this reporting period. All things considered, to print over $50 million of EBITDA for the quarter was excellent performance and exceeded our expectations.

I've been involved in the reporting of quarterly results of different public companies for over 20 years now. And I can attest that this particular quarter was by far the trickiest one to attempt to predict the outcome of. Recall that we closed 2 acquisitions in late Q4 2018, and we knew that the heavy equipment fleet that came with a second deal would take time and capital to reach our standards of maintenance and operability. Therefore, due to the high volume of oil available, we had to take a larger than usual proportion of gear on rental until we could make headway fix in the Dene-acquired equipments.

Also as Jason mentioned, the weather conditions were especially tough this year with a brutally cold February, followed by an early and abrupt arrival of spring break up in mid-March. The extreme cold of February made it very difficult to catch up on the high volume of in-field repairs and maintenance that faced us. While the early start of spring caused us to curtail some winter earthworks programs and likely reduced our revenue opportunity by around $20 million. Additionally, again, as Jason mentioned, we only achieved breakeven gross profit levels on 2 assumed legacy contracts on our new mine site. This situation was caused by onerous contract terms, including pricing and especially very poor condition of the acquired equipment on the site. Fortunately, these 2 contracts will soon be behind us, with one ending and the other replaced by the new contract we recently announced on better terms.

Taking these matters into a combined account, we estimate that our EBITDA could have been nicely over $60 million, which clearly bodes well for future, in more normal weather conditions, with a fully-maintained equipment fleet and more usual contract circumstances.

Remaining on the topic of our outlook, although Nuna Logistics had an expected quiet Q1, mainly due to the Northern locations they usually work in, Q2 and Q3 are expected to produce normal seasonal contributions.

Nuna has also been very busy on the bidding front, with us participating on a tender with them which could bring in a nice early win to demonstrate value synergies if we're successful.

We are also very active priced in both incremental earthwork and construction work in our core oil sands model on a range of exciting opportunities. This suggests that the next leg of our impressive growth plan will be organic in nature. The trick will be to pass the need for further growth capital with our stated deleveraging targets for 2019 to 2021.

We have not left the high end of our CapEx spending plan of $130 million for 2019 as we intend to spend more than anticipated on the acquired heavy equipment fleets. But more importantly, we have some very stout growth projects that we will address. I'd like to think that we have a decent reputation with capital allocation, and it is our view that the incremental capital spending this year will much better serve our shareholders on the alternative debt reduction in the near term. Our backlog now stands at over $1.5 billion, up from around $0.1 billion at this time last year. It is important to note that we regard this backlog as more of a floor than a ceiling for our growth opportunities over the next few years.

Our customers will still call up plenty of incremental work linked to their mine plans, under the MSAs we have with them just as they did in years before term contracts for earthworks. In some cases, we believe that term work will only amount to around 50% of our activity in earthworks. Next, again, as Jason mentioned, after successful layering and some junior debt into our capital structure on favorable terms, our senior debt to current year EBITDA ratio is well less than 2.0, which has long been my self-imposed objective in a cyclical business.

Our new combined office and maintenance facility here in Acheson is fully up and running, with the latter completely full to the gunwales with internal and external work. We're holding our Open Day here on May 9 and have sent out invitations to all our stakeholders. We look forward to seeing as many of you as possible. I relish the chance to show you around. It's quite a sight to behold. If you cannot make it, please take a look at the shiny, new and fresh investor presentation, which will be posted on our website shortly.

Well, that's it for my short and sweet prepared remarks this time around, except to say that we'll maintain our estimate that the EBITDA we earn in Q1 will likely represent about 30% of the total for 2019. I'm glad that the tough to project Q1 is now in the history books as the outcome has provided me with complete confidence in our future.

With that, I will turn the call back to Denise, the operator, for the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Yuri Lynk with Canaccord.

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Yuri Lynk, Canaccord Genuity Limited, Research Division - Director and Senior Engineering & Construction Equity Analyst [2]

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Good quarter and that spurs a different question on just some clarity on your outlook. You mentioned the quarter was -- could have been better. And I think you're able to catch up on some of that -- some of the work in future quarters. But I think you didn't change the overall percent of increase (inaudible) just could you clarify, are you reading guidance for the full year...

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Martin R. Ferron, North American Construction Group Ltd. - Chairman & CEO [3]

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Yes. You're breaking up a bit, Yuri, but right at the end of my prepared remarks, I said that $52.4 million will be 30%-ish of our EBITDA for the year. So that notches up the estimate, I believe, for the full year.

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Operator [4]

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(Operator Instructions) Your next question comes from Daine Biluk with CIBC World Markets.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [5]

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So I guess to start things off, considering the pretty substantial backlog you guys have built up until now, how do you think about your mix between contracted work and, call it, spot work going forward? I'm just trying to get a sense of what capacity or willingness you have right now to sign additional contracts.

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Martin R. Ferron, North American Construction Group Ltd. - Chairman & CEO [6]

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Yes. Great question. Again, I tried to address part of that in my prepared remarks. It differs by site, but in some situations, the term contract that we have, we think, will only represent about 50% of the work we do on that site over the next few years. You know the customer will still call off spot work just as they did previously, especially for construction activity in summer. So the backlog, as I mentioned, is more of a floor than a ceiling to our expectations.

As far as capacity is concerned, no, we are pretty busy on the sites that we're working on. We have been adding some incremental pieces of equipment to take on more work because it's there. And that's part of the growth capital that we talked about. So as long as customers are willing to give us long-term contracts that provide decent returns, and by decent, I mean very good returns, then I think we'd like to satisfy them and do as much work for them as possible.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [7]

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Got you. Okay. That's very helpful. I guess, maybe, as a follow on to that, for you to sign incremental contracts, would rates have to be better than what the current backlog would be at? Or would -- if they would -- call it spot pricing, would that be enough for you to sign some more longer-term agreements?

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Martin R. Ferron, North American Construction Group Ltd. - Chairman & CEO [8]

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Yes. I think for us, we'd be fine on it. The more work we do, we spread our overhead over it, and we'd make better returns overall.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [9]

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Got you. Perfect. Okay. Can you give a bit of an update on your Highland Valley Copper mine contract? And specifically, any sense or early indications on whether you think the contract will be extended beyond the initial term this summer?

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Martin R. Ferron, North American Construction Group Ltd. - Chairman & CEO [10]

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Joe?

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Joseph C. Lambert, North American Construction Group Ltd. - President & COO [11]

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This is Joe, Daine. It finishes up this year. We've had some initial discussions, but we don't anticipate it's going to progress for the 2-year option period. But that can change. We'll have those discussions over the summer. We've got plans right now to fully integrate that fleet back into our work we're doing right now. It's not a large portion of our fleet.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [12]

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Got you. Okay. Great. Perfect. And then, I guess, maybe just last one for me. With some of the gross spending that you have earmarked for this year, is that largely being directed at fleet expansions? Or would any of that be going to any other line items?

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Martin R. Ferron, North American Construction Group Ltd. - Chairman & CEO [13]

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No, it's just mainly fleet expansions, let's say, to satisfy increased customer demand.

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Operator [14]

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

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Maxim Sytchev, National Bank Financial, Inc., Research Division - MD and AEC-Sector Analyst [15]

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Martin, was wondering if you don't mind maybe commenting on the prospects for the summer construction work for your core clients.

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Martin R. Ferron, North American Construction Group Ltd. - Chairman & CEO [16]

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Yes. I think very promising. Construction has been the slowest part of our work to come back after the 2014 downturn in the oil price. A lot of it was deferred or canceled. So we've been seeing more and more every year of it coming back. This year, we're also seeing very large construction project in terms of the Mildred Lake expansion, project that probably won't impact too much 2019, but certainly gives us a lot of confidence in what can happen in 2020 and beyond as this is a very big construction project, which we hope to participate in. But apart from that, there's plenty of other smaller construction projects, especially at Fort Hills we handle, which we hope to participate in this year whereas we didn't last year.

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Maxim Sytchev, National Bank Financial, Inc., Research Division - MD and AEC-Sector Analyst [17]

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Right. Yes. And I guess in your new presentation, it looks like Construction Services was -- I'm just ballparking like maybe 7% of your EBITDA generation or revenue generation in 2018, so we should expect this to grow obviously in '19, right?

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Martin R. Ferron, North American Construction Group Ltd. - Chairman & CEO [18]

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Yes. For sure. And our -- but even fairly 2020 and beyond, I think.

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Maxim Sytchev, National Bank Financial, Inc., Research Division - MD and AEC-Sector Analyst [19]

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Right. Okay. No, that's very helpful. And then last question on Nuna. Just do you mind maybe expanding a little bit on a going-to-market strategy with this item specifically because I assume you're going to be leveraging their existing relationships with your new fleet capability? So do you mind maybe expanding a little bit on that and the type of opportunities you're bidding on right now?

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Martin R. Ferron, North American Construction Group Ltd. - Chairman & CEO [20]

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Yes. I mentioned one project that we're bidding together. It's for a term contract, 5 years I believe, on a different resource to oil, is what I can say at this point, in a northern location as you would expect. And Nuna, on their own, could only maybe address 60% of our world scope. But bidding it together, we can address 100% because part of it is needing a heavy fleet that we can bring to the table. So I think we put a compelling offer to the customer to do all the work, which I think they prefer one party to do. So hopefully, without lifting too far ahead, I'm hopeful that we can secure that as a first demonstration of revenue synergies that this platform can generate.

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Maxim Sytchev, National Bank Financial, Inc., Research Division - MD and AEC-Sector Analyst [21]

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For sure. And Martin, is there a time frame when you will know on your side if you're successful or not on this endeavor?

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Jason William Veenstra, North American Construction Group Ltd. - Executive VP & CFO [22]

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This quarter.

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Martin R. Ferron, North American Construction Group Ltd. - Chairman & CEO [23]

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This quarter. Q2.

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Maxim Sytchev, National Bank Financial, Inc., Research Division - MD and AEC-Sector Analyst [24]

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Okay. Q2 calendar. Okay. And then sorry, one last question, just from a cash flow perspective, how should we think about the working capital contribution in 2019 because I think, right now, we're modeling a slight drag in this year? How are you guys thinking internally on noncash working capital?

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Jason William Veenstra, North American Construction Group Ltd. - Executive VP & CFO [25]

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Max, Jason here. I would model flat, frankly, for a full year expectation. We collected some receivables late in December of 2018, sort of a little bit ahead of schedule, but we have the ability to do that again in December of this year. So obviously, we had some pretty big swings here at the end of March, but I would expect year-over-year things to be flat.

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Operator [26]

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And our next question comes from Devin Schilling with PI Financial.

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Devin Schilling, PI Financial Corp., Research Division - Special Situations Analyst [27]

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Should we be expecting a full Q2 contribution from Nuna? Or when does this work really expected to ramping up?

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Martin R. Ferron, North American Construction Group Ltd. - Chairman & CEO [28]

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Yes. I think Nuna's work is very seasonal, right, as you perhaps can expect based on where they work. So we're expecting a good contribution in Q2 and an even better one in Q3. That's the way, historically, their EBITDA has been generated. We believe their Q1 contribution this year pretty well matches what it would have been last year, so no real changes there. Everything's on track for them to participate in Q2.

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Devin Schilling, PI Financial Corp., Research Division - Special Situations Analyst [29]

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Okay. No, that's great. I guess moving on, you guys maybe provide a bit of an update of where you guys are at on your progress with the planned maintenance on the acquired fleet and maybe, I guess when we should expect this initiative to be completed.

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Martin R. Ferron, North American Construction Group Ltd. - Chairman & CEO [30]

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Yes. We always thought it was going to take us the full year this year to really get that fleet up and running to our expectations. So we obviously did a fair bit in Q1 as best we could but it's been going now for the balance of the year, ready for Q1 next year. I'm really excited about our opportunity then because, actually, we'll be operational and we'll have less rental gear, and we'll be firing on all cylinders. So balance of year to fix it all, but there's a lot to do, right? So that will be ready by Q1 next year.

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Operator [31]

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

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Martin R. Ferron, North American Construction Group Ltd. - Chairman & CEO [32]

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Well, I appreciate everybody joining us today for Q1. We've got some really exciting times ahead. I'm looking forward to Q2 and beyond, so hope to talk with you again then. Thank you.

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Operator [33]

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Thank you. This concludes the North American Construction Group conference call. You may now disconnect.