North American Construction Group Ltd (NOA) 2012 Q2 法說會逐字稿

Good morning, ladies and gentlemen, welcome to North American Energy Partners fiscal 2012 supporter earnings call. At this time operatives buzz 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 to not -- they are asked not to quote remarks from any other participant without the participant's permission. I advise participants that this call is also being webcast concurrently on the Company's website at NACG.ca.

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

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 September 30, 2011. All amounts are in Canadian dollars.

Participating on the call are Rod Ruston, President and CEO, David Blackley, CFO, Joe Lambert, Vice President of Oil Sands Operations, and Bernie Robert, Vice President Corporate.

Before I turn the call over to Rod, I would like to remind everyone that statements made during our prepared remarks or in the Q&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 fact are considered 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. Business prospects of North American Energy Partners are subject to a number of risks and uncertainties that may cause actual results to differ materially from a conclusion, forecast or projection in the forward-looking information. For more information about these risks, uncertainties and assumptions, please refer to our September 30, 2011 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'll turn the call over to our CEO, Rod Ruston.

Thank you, Kevin. Good morning, ladies and gentlemen, thank you for drawing us today.

As we expected, our work volume [decreased] in the second quarter. In the Heavy Construction and Mining division, we won and began work on several new contracts, including our mining and construction services agreement with Suncor and our heavy construction contract with Syncrude. We also took on increased tailings work for every operating customer in the quarter.

With weather conditions finally stabilizing, our Piling segment also had a busy quarter catching up on its backlog of projects. And in the Pipeline, we got going on two new contracts that have a combined value of CAD92.5 million. Combined, this increase in activity helped offset the impact of the shutdown at Canadian Natural where a major fire at the plant earlier in the year resulted in a suspension of work on our long-term overburdened removal contract.

As a result, our revenues from this one customer were CAD43 million less this quarter than they were for the same period last year. Despite this, revenues across our business increased by CAD11 million year-over-year on a consolidated basis.

Looking at results by segments, Heavy Construction and Mining division minimized the impact of the Canadian Natural shutdown with increased activities at other customers' sites.

At Suncor we increased heavy civil and site development work, took on new reclamation and overburdened activities and provided specialized tailings and environmental services.

At Syncrude we started work on the new shear key foundation for the relocation of the Mildred Lake mine train. We also increased tailings and environmental services to this customer.

Over at Shell's sites we were busy with heavy civil construction work and took on increased tailings-related work including a high volume of summer muskeg removal related to tailings remediation.

We were also busy at the BlackGold SAGD project during the quarter where we have been contracted to provide light construction services. As a result of this new business, second-quarter segment revenue for new -- sorry, for Heavy Construction and Mining was down just CAD12 million compared to last year despite the CAD43 million decline in revenue from Canadian Natural.

Margins, meanwhile, improved to 13.6% of revenue, up from 13% last year. This reflects the reduction in lower margin overburdened removal work from Canadian Natural, partially offset by some continued competitive margin pressure in the market related to equipment oversupply as well as to cost impacts of startup delays on certain projects.

Turning to Piling, this division achieved a $23 million or 85% year-over-year revenue increase for the quarter as weather improved and we were able to make good progress on our backlog of projects. The division also managed to increase its project backlog by 44% to CAD44 million at the end of the second quarter.

We have seen significant improvement in the industrial construction industry and we have levered the growing technical, geographic, and sector diversification of our Piling business to secure and profitably execute on a wide variety of projects.

Just to give you a few examples of the diversity of our Piling operations, up in the oil sands we provided services to Suncor's tailings reduction operations and [thin fine] tails projects using a combination of drills, driven, and screw piles, the latter of which were manufactured by a newly acquired Cyntech business.

We also installed a watertight [sea can] wall at Syncrude's North dam mine tailings project using our Continuous Flight Auger, or CFA, a technology we introduced into Canadian Piling markets in 2005 and which has provided us a significant competitive advantage.

Over in Saskatchewan, we installed foundations for a carbon capture facility at Estevan. This facility, designed to combat greenhouse gases, is the first of its kind in the world and is a partnership between the Government of Canada and SaskPower.

We also executed a large job at Mosaic's K-3 potash plant in Saskatchewan using the largest CFA piles ever installed in Canada being four feet or 1.1 m in diameter.

Our Drillco operations in Ontario also continued to gain steam where we are executing a growing number of shoring for the condo development market. Results also benefit from the addition of Cyntech's screw pile, pipeline, anchor, and tank services offerings which contributed CAD7.7 million in revenue during the quarter.

So as I said we are seeing strong demand across all of our regions and with our diverse range of Piling technologies and significant expertise, we have secured a growing market volume of work in this division.

Margins also strengthened significantly in the quarter climbing to 27.5% from 18% last year. This reflects strong performance on a number of large piling projects as well as the productivity benefits of better weather which meant production schedules could be moved ahead uninterrupted.

Looking at Pipeline. This segment posted revenue of CAD36.5 million, very similar to what we achieved in the same period last year. Revenue in the current period was largely driven by the two new pipeline contracts and the BC and Alberta. Profit margin, meanwhile, increased to 8% from 2% last year, reflecting more favorable terms and improved pricing in those contracts.

So overall, a positive quarter for us and at this point I will call on David Blackley to review our second-quarter consolidated financial results with you in more detail.

Thank you, Rod, and good morning, everyone. I'm going to review consolidated results for the second quarter ended September 30, 2011, as compared to the second quarter ended September 30, 2010.

Revenues for the period were CAD245 million compared to CAD235 million in the second quarter of last year. The increase in revenue primarily reflects increased Piling revenues, partially offset by a reduction in Heavy Construction and Mining revenue related to the Canadian Natural work extension.

Gross margin was 13.6% in the second quarter compared to 12.4% for the same period last year. Increased work volume, more favorable contracts, and strong results from Piling contributed to this improvement. However, as Rod mentioned, we are continuing to feel some pressure on (technical difficulties) capacity on the oil sands market.

We recorded operating income of CAD18 million in the second quarter compared to average income of CAD12 million last year, an increase of [30]%. This reflects the higher revenues in margins during the current period. G&A expense, meanwhile, decreased by CAD1 million due to the impact of lower share price on our stock-based compensation plan.

Backing up the impact of various non-cash items, net income would have been CAD0.22 per share for the most recent quarter compared to CAD0.04 per share last year.

Turning to capital, total additions for the second-quarter amounted to CAD10 million including CAD6 million of sustaining capital and CAD4 million of gross capital additions. Looking at liquidity, there were outstanding borrowings of CAD50 million and issued in undrawn letters of credit of CAD17 million under the revolving facility leaving us with CAD43 million of borrowing availability.

Start up on several new construction projects created a temporary strain on our working capital. We expect this to continue through the third quarter and we will start to see an improvement in the fourth quarter.

To support the higher working capital levels, we negotiated a temporary CAD25 million increase to our revolving credit facility until March 31, 2012.

That summarizes our second-quarter results. I will now turn the call back to Rod to tell you about our outlook.

Thanks, David. Looking ahead, we anticipate that revenues will strengthen somewhat in the third quarter and continue to ramp up in the fourth quarter. In the Heavy Construction and Mining segment, demand is escalating for overburden and muskeg removal work under our new and existing support services agreements. Overburden removal is also targeted to resume at Canadian Natural's Horizon mine in January 2012, but that'll be subject to completion of the current contract negotiations.

As you will recall, we formed a working group at Canadian Natural that was responsible for identifying indices that more closely reflect the inflation conditions that have occurred in the marketplace. This group has submitted the market data and analysis to both companies and the management teams are working to resolve the issue and identify a mutually agreed contractual path forward in time for the targeted restart of the overburden operations in January 2012.

While volumes will be up, margins from this segment could be constrained due to continued equipment oversupply in the market, a situation we believe will be overcome as the market demand rises over the next six to 12 months. We will also be undertaking more equipment maintenance than normal during the third quarter as we prepare for the anticipated surge in the fourth quarter.

Keep in mind that while repairing services demand is expected to be very high, we have experienced client-driven startup delays and slower than expected ramp up on some of the oil sands construction projects. This is being caused by a client focus on substantially completed engineering prior to startup as a recently adopted cost control measure.

The overall outlook for our Piling business remains free promising and we have seen significant growth opportunities in the potash plant expansion in Saskatchewan, tailings management in the oil sands and the power transmission sector in Alberta.

In the near-term, we continue to have a diverse range of projects in our backlog to keep us busy, including additional work at Mosaic's K-3 potash mine, a booster pump house for Shell in the oil sands and foundation work for Enbridge at their tank farm expansion in Edmonton. While a solid backlog of work remains to be executing, the pace of activity is expected to normalize and, as a result, margin performance is expected to come back down to -- down from the 20-acre sand achieved in the second quarter to the 18% to 20% margins we have seen in prior periods.

Piling activity typically slows somewhat during the fourth quarter, due to winter weather conditions but we expect to see the pace pick up again next year as the division is currently bidding on a wide range of projects to start up at that time.

Our Pipeline business, meanwhile, is continuing to execute well on the two new large diameter pipe projects. The timeline on one of these projects has been extended into next spring due to the client-driven startup delays, which is going to increase weather risks and we are working with our customer to address this through the change order process.

From an industry perspective, we have seen a marked improvement in the fundamentals of this business over the last six to nine months as construction demand has increased significantly and smaller operators have exited the market. This has led to both better pricing and a more reasonable balance of risks between the contractor and the owner.

We believe this business climate will continue in the foreseeable future as bidding activity in this segment continues to be strong, including several new opportunities for the upcoming winter season.

Overall, we anticipate continued growth across our business for the balance of fiscal 2012, and based on current bidding activity, we would expect this to carry through into next year. With that, I will turn it back to the operator.

(Operator Instructions). Stephen Volkmann of Jefferies & Company.

Good morning. I'm wondering, you talked a little bit about the competitive dynamics improving but we also seem to have some overcapacity ideas in agreement up there still, so the next few months or couple of quarters. I'm wondering if you just have any further information about maybe what utilization levels are, if you think any of the competitors are adding significantly to their fleets or how we should look at that?

Yes, certainly. But I think we should all recognize this is the first conference we had in the last [two] years. We met Duncan from Stevens, hasn't asked the first question, so congratulations Stephen on getting in first.

Thank you. I was up at 7 AM for this.

In answer to your question, remember last year that [Icon purchased the Cal Harbor fleet]. They spent a fair bit of time doing maintenance on that fleet and we understand most of the work they're wanting to get done has now been done. So they have got a maintained fleet ready to go. But as far as we are aware they don't have a lot of work and we see that fleet as an overhang in the market.

We don't see our competitors or ourselves actually adding significantly to our existing fleet at the present time. But the overhang is coming from that fleet that is still out there.

Okay, great, and so second question is just on the Canadian Natural issue. Are there any signposts in terms of timing that we should be watching for? Are there deadlines or should we be expecting any announcements in the next month or so?

Well, we think even a notice -- back when we were shut down on the site, the letter indicating the requirement to shut down included a sentence that said we -- that they expect to restart and shutdown would be until the 1 or 2 January 2012. So that is what has been our milestone date.

We don't know whether the Canadian -- how well the Canadian Natural plant is going. We haven't heard that it's going badly, but we don't know how far they have ramped it up, so we're not sure of what their demand for oil sands is at the present time. And the -- we also don't know how much stock of overburden remove that they had as far as their overall mine plan goes when they shut it down.

So our target has been and we've worked with Canadian Natural on this to have the issue resolved so that we can get on site and get prepared for a restart on 2 January, but if Canadian Natural want to delay that, then we are fine with that too. So it's 2 of January is the target date, but if it goes through to 2 of February, well, that is fine too. We don't care.

We are not operating our equipment on the site, we have got plenty of work on other sites and the negotiations are proceeding.

And just to be clear, just the process of the negotiation itself just reach a conclusion whenever that happens rather than at some sort of deadline on the calendar?

That's correct. We don't gain any benefit whatsoever by having to achieve an absolute specific target date and settling for less than what we want to settle for. So we are quite open to Canadian Natural signing. It doesn't worry us.

Thank you very much.

Ben Cherniavsky of Raymond James.

Good morning. I'm sorry if I missed it in the notes or your discussion, but could you quantify or can you quantify how much the work in the quarter was tailings-related?

No. We didn't and the answer is no. The reason is that, for example, we said that there is a large increase in the volume of muskeg that's coming and that we've been doing. So, for example, we know that the muskeg removal that we did in the summer for Shell was tailings-related, but it was done not by a tailings group, it was done by a heavy construction group, but it was certainly tailings-related.

We know that the solution that seems to be general solution being come up, that's being developed at the present time is that what the clients will do is they will clear extra muskeg each winter and put it very simply to create a dam for tailings on top of their overburden. They will then use that shallow dam to drive the tailings and in a year's time when they go through that area to overburden removal, they will take that tailings down with them and churn the tailings into the overburden so that it is then deposited forever.

Now that work would be done by our heavy construction group, but you could argue that it is tailings-related. So there's quite substantial additional volumes of muskeg at the present time and in the future overburden, so they are going to be tailings related, and Directive 74-driven, but performed by our Heavy Construction and Mining group.

On the other side there is the technology side. And we've in this last quarter done a lot of work to -- for each of the customers on the technology of recovering tailings from the existing tailings dam and drying those tailings. So for Shell, for example, we introduced the Mudmaster which was a trial piece of equipment that has the ability to dry the tailings to the standard required by Directive 74. At Suncor, we were doing some work on their dam, putting in some pumps and we introduced the skimmers that take the bitumen off the top of the water there. And we ran a couple of skimmers for the entire season as a test program, and we expect we are going to get an order for a significant number of skimmers to be put at Suncor next year.

And at Syncrude, we put our dredge in the water and did some work supplying fines to a test program they've got for centrifugal extraction of fine tails. So it's hard to say because it's literally a truck was doing some work and it was moving muskeg, was that muskeg that was required for overburden removal or was it muskeg that was required for tailings? So we can't, we haven't really split out what was Directive 74-related.

Thanks, that's great color, Rod. As a follow-up question, I wanted to ask you, well, you know better than anyone that you had some supply-chain issues with the Caterpillar dealer there. Has that affected your business at all in the quarter? And have you seen any improvement in parts in the last few weeks?

Yes, it is affecting our business. Availability of parts has been difficult and the time taken for overhaul of equipment has been extended, in some places quite substantially. And in fact, the two parts that issue won the overhaul has been extended, but the second part is there is an uncertainty in the actual timing of the overhauls. It's difficult for Finning to be able to actually say, yes, your truck will be finished on X date.

That is part of the reason for the increased maintenance spend that we see in the forthcoming quarter where, putting our overhaul trucks out to other organizations where we can. Are we seeing it improve slowly? Yes. We are keeping in touch with the Finning management, but what we recently said to the Finning management is we are coming up to our weaker period, which is our biggest truck operation period, and we need some real improvement fast for the supply of parts and the supply of people. So we do see it impacting us for sure.

Thanks very much.

Matt Duncan of Stephens Inc.

Good morning. Congratulations on a great quarter.

Thanks, Matt.

Well, it was a great run up front, Rod, but unfortunately it had to come to an end sometime huh? The first question I've got, look I know you guys don't give guidance and I don't want to ask you to get into the guidance game. But you've given us a lot of commentary around each of your three segments and the outlook there, so maybe help us triangulate those a little bit, in terms of what they might mean sequentially in the December quarter from September.

It sounds like margins are probably pretty flattish. Revenues might be up a little bit but probably not a lot. So net, net are you expecting your earnings performance in the December quarter to approximate what you did in the September quarter?

Yes, it is very similar and you are right, in each of those margins where they are a little bit up, revenues a little bit up. What we're seeing in the business, as I said in the call, is that our clients are being very circumspect on getting things started. They are not rushing, they are taking their time.

I was at a function the other day with Murray Edwards and Murray was introducing, sorry, he was doing a talk. And in that talk a question was asked at the end of it as to whether stage 2 of the CNRL project will go ahead, given the world economy, given views on long-term oil prices, etc. And Murray's answer was yes, definitely. They are going to go ahead, but he's -- the second part of his answer was that what you are going to see and he said from CNRL and he expects from all other producers is that there won't be any more announcements of CAD10 billion or CAD12 billion projects, that everyone will now announce their projects; it will be a CAD1 billion project which will be part of the CAD10 billion or CAD12 billion project, but it will be announced as a CAD1 billion first stage or whatever.

And each stage will be let out for tender and started and be self-contained. So that at the end of that stage they will be able to say, no, costs are running away from us, we are not happy with the direction of things, we are going to stop at this point and we won't do the next piece of this expansion until some later date. So it will be bite-size chunks rather than mega projects and mega announcements.

Now the impact of that for us is that the client is saying to us, yes, we have awarded you the project and we want you to start on 1 November and then 1 November comes around and they are not concerned about saying, look, we put the start date back until the 1 December because we haven't gotten our engineering rights and that sort of thing. So that is what we mean when we say clients initiate a delay in their work.

It is causing us some impact because we gear up and get ready for 1 November and then the things are put off. And so we lose a bit of productivity from some of our equipment and that is where that impact is coming.

So are you guys trying to put anything in your contracts that you are winning to account for these startup delays so that that don't impact your earnings power?

As far as possible, we are. And in some places we can be successful and in other places the size of the contract is such or the value of getting that contract is such that you say to yourself, look, if we are going to have a month delay, we are going to have to wear that month delay. So it's [bid Fort Hills], of course Matt, that depends on the size of the contracts see, and the opportunity for the change.

Sure, and then there's a few large construction projects out there. I know you've talked about the initial contracts that these are coming out smaller, but I guess Total, Joslyn, Suncor, Fort Hills are both expected to go forward. What update can you give us on those? And sort of where you stand with getting work at those two sites?

Total, Joslyn, and Suncor, Fort Hills are expected to go forward.

And you are clearly bidding on those, but nothing yet?

That's right. With -- well the Fort Hills hasn't come out as a bid. Total has come out as a bid, and we have been doing clarifications and that sort of stuff which they do with all the bidders and go through the what do you mean by this and what you mean by that and -- but we still expect some work will be done on the initial work of Total in this winter period coming up and so we would expect that Total will do an award sometime in the next month or so, I would say.

Okay, that's helpful. And then last thing I've got is just to make sure we understand normalized level for Piling correctly. With Cyntech in there now, it's sort of normalized revenue levels at Piling sort of around a CAD40 million number and then I guess the margin for that segment is probably 20% plus or minus?

Yes, that's about right. Basically the reason for the 27% was significant cost savings and productivity improvement in the business over the last three months. And the reason that came about is because we had so much work in that we had a large second quarter anyhow. But then the clients that missed out on getting their work done in the first quarter wanted theirs done in the second quarter as well. So basically you have got a piece of -- in your normal Piling business, you will do a piece of work and then at the end of that day's work you will stand down your machine and because your next piece of work probably won't start for two or three weeks at a different location. And so, you would lose that two or three weeks of equipment utilization.

Basically what we had in the second quarter was the work demand was so high that we didn't have any downtime on our equipment. It moved from one job to the next, and as fast as we could move, it was operating again. That sort of pressure of operation will go away and that's what will just pull the margins back a bit.

Thanks for the answers. Appreciate it. Great quarter.

Patrick [Winton] of Sterne, Agee.

A lot of my questions have been asked, so I guess I just have a --. Maybe you could do a little more detail about the fact that you are seeing capacity but at the same time some of the price inflation is starting to kick in. Maybe the magnitude of that impact and whether it's -- how much of that is in labor and as far as comparing it to the last cycle, going into 2012, how much of that do you expect to be able to pass on to the customers?

We are actually not seeing big price inflation at the present time. And in fact, that is why the customers are being so circumspect about making sure that they don't push schedule over cost. And so, if they find that their prices are being pushed up by competing projects, then one of them will back off the project a little bit is the way we're seeing it.

The only place where we are seeing improved prices is in the -- for us -- is in the Pipeline division. And basically, it's an interesting one because the place where environmental activity, environmentalist activity I believe has had a fairly significant effect. If you look back five or 10 years ago, if one of the large pipeline companies spilled a few gallons of oil in the local river, the locals would have been angry and it probably would have got on the third page of the district paper.

Nowadays if that same thing happens, it resounds around the world. And the result of that is all of the pipeline, the mainline pipeline operators know that they are under the microscope at the present time. And what that means is that their ability to use the smaller, less technically competent pipeline installers has sort of disappeared. They tend to be wanting to look for the pipeline contractor if it's got the quality control systems, has got the price [estimates] for installation and welding and welding control, and the smaller ones have gone out of play. That's reduced the size of the competitor bench at the same time as the size of the market has been increasing.

So that's something that has been driving prices for us there. We haven't seen costs rise substantially there so that's why you can see slightly bit of margins in that business.

That's helpful. And for follow-up, on the Syncrude mine relocations, could you just talk a little bit more about any contracts you expect to be let there and how they will compare in size to the last contract?

This one is the front end of the Mildred Lake mine train relocation. So we expect this to be the primary job for us on that site, but there's probably going to be several smaller polling and small earthworks-related underground utility kind of stuff related with the Mildred Lake one over the next 12 to 18 months.

The big chunk for us will come again being a similar one to what we're doing right now at their Aurora mine site which we expect will probably come out for tender early in the new year for commencement, probably in spring or early summer next year, and be of a similar size and essentially be a mirror image of -- some of the things are different, but a mirror image of what is going on in Mildred Lake will occur at Aurora. It will just occur about a year or so later.

And again this fits in with what Rod was saying about staggering work to make sure that they don't peak all of their jobs and all of their work forces so they can manage costs better.

Bert Powell of BMO Capital Markets.

Thanks. Rod, you indicated there seems to be some timing shift around in the pipeline side of things. Can you give us a sense of what that means for this year and next?

Sorry, some timing shift. I'm not sure what you meant.

I saw in your prepared remarks, you had said there was in terms of the projects you have on the Pipeline side of things, things had shifted around from a timing perspective on sign-ups.

Yes, but really what we were talking about there is we expected to have more revenue from Pipeline in this last quarter. But just with the delays we have seen that revenue being pushed into the third quarter and in the case of the one job that Rod mentioned because of those delays, we know that we'll finish that work up over the winter period.

So spring, the final clean-up reclamation work can only be done in the spring now instead of the original plan being that it would've been done around about this time period.

And then (multiple speakers).

I'm a bit slower at this time of the morning than David.

The client-driven delay in that one, I believe, was an approval that they still required that wasn't in place when the original start date was.

In terms of the margins, I mean this is the first time in a while that we have seen some decent profit out of that as the Pipeline business. And you did mention we are going to get into some weather kind of things. Is 8% the right way to think about that business now, based on how you've recut the contracts or whatever other processes you put in place to mitigate the risk or is this a particularly good quarter just because of good weather or whatnot?

No. This is where you should be looking in the 8% or 10% area now. We have made some significant changes to our Pipeline team. We have also been making significant changes to the contracts. You remember Matt Duncan asked a question earlier, have we been making changes to contracts to better reflect the cost of the client-driven delays and that stuff.

Our contracts in the Pipeline division we've had a lot of success in -- in changing some of the risk profile within the contract resulting in if something happens, we are not the ones that get hit so hard. So yes, more around the 8% or 10% is what we see as an ongoing number here.

And then just back to the maintenance bump for Q3 in terms of your parts availability. Have you made a decision? Are you looking to Finning to say, look, if you can't hit what we need we are running out elsewhere or have you already made the decision to go elsewhere and what would elsewhere really mean?

Yes, we have been going elsewhere already for the last for five months and elsewhere is to basically to the Saskatchewan supplier, where Finning doesn't cover. But surprise surprise, every other man and his dog went the same way.

So now that particular supplier is under stress as well. They are not under stress because of an [ERP] system breakdown, they are under stress just from pure load.

Right, okay. So how frequently are you reaching out to make sure that you've got a good line of sight that you can get the maintenance done in Q3 that you need to get done? Like are you currently right up to date in terms of where things stand or is that something you are (multiple speakers) couple of weeks?

Yes, we talked to Finning day before yesterday and had a long discussion with where they're up to. I met the new CEO and made sure he was aware of where our key points were. That discussion went well and the fact that he understands where our key points are, I don't think he's quite sure what they can do about it other than continue on the path that they are at. The present time he hasn't been there very long.

But they are obviously extremely concerned about where they are at and they are doing their level best to get their business up and running and supplying as they should be.

So this sounds like it is a backlog issue on their part just to churn through what is pent up.

It's a combination of a back -- identifying backlog orders and then being able to actually fill those orders from their parts warehouse.

Carl Giesler from Harbinger Capital Partners.

Good morning. Congratulations. Just a question on your operating lease expense. You have a number -- a good portion of your asset base is under five-year lease, but its 10-year equipment or maybe 10 years plus how should we think about that expense over the next couple of years? And how might that flow through to EBITDA?

If you look at our lease commitments they are pretty substantial to date if we don't take on any new leasing or roll over any of those places when they come due. I think you can look at the quarterly expense dropping in sort of the CAD4 million to CAD5 million a quarter range. So we could see a pretty good fall off in that expense in the coming 12 to 18 months.

But certainly I think this year is really the peak year for us where we are going to end up. I think the way the numbers are tracking right now it's sort of in that CAD75 million to CAD80 million range.

In going forward you would expect at least the scale of your leasing program to at least come down, probably not go away, but come down old it?

Yes, that's only one of the things that we are looking at here is as we start to get back into more positive cash flow.

And just a quick follow-up. How does lease expense impact your unallocated equipment expense? I mean obviously depreciation moves with activity, but that lease expense is pretty constant. So (multiple speakers) -- can you just talk about that and what it might look like over the next couple of quarters?

Yes, so certainly it is much more of a fixed expense. So if we have that equipment underutilized, that would essentially add to the under recovery of our overall equipment costs. But as the utilization ramps up, we clearly get more recovery back from -- it is -- you should really think of it as a fixed expense, unlike our depreciation which is determined based on usage of equipment. So if we don't use it you don't see the depreciation expense.

So if I look at the next December quarter unallocated equipment expense would be somewhat similar to this quarter or how would that move?

Yes, some of it this last quarter it might be a little bit more under recovered just because of the incremental expenses we're looking at.

Jeff Fetterly of CIBC World Markets.

Good morning. I guess, along the same vein as that last question, can you provide a little more color on the lease expense benefit that was in the quarter? And do I interpret those comments earlier as lease expense for this year fiscal year should be in that CAD75 million to CAD80 million range?

Yes. So in terms of the big credit that you saw there in the quarter, it really came from two types of equipment. The one type of equipment was CNRL-related equipment. That was about a CAD4 million credit. It was related to the expense associated with over hours. If you use the leased equipment for more than the minimum hours specified for the lease agreement, it is typically an incremental charge that we have to accrue.

So that would move up and down, depending on where the hours are at. So we saw a big reversal here in the quarter related to the CNRL equipment.

However that CAD4 million didn't flow through to the bottom line. Because if you look at how that job is accounted for, this sort of essentially would just be a flow-through. It is all built into the forecast cost to complete. If you layer on top of that the fact that we are tracking that job at a zero margin, so any increases or decreases in cost would essentially just flow back into a change in the unbilled revenue number. So if you were to compare the unbilled revenue for CNRL at the end of the first quarter to this quarter, you would find that it has actually dropped by about CAD4 million. It was really just a flow-through.

So that was the one component. The other component about CAD2 million was related to a reversal of over hours. We've been looking at some of our lease agreements and we identified a couple of lease agreements there where we had minimum hours that were just way too long, relative to how that equipment has been operating. So we went back and renegotiated the terms on that lease and were able to get some reversal there on the over hours.

So that CAD2 million did actually flow through to our bottom line.

So from a lease expense standpoint, we expect to see a pickup in the remaining two quarters of the year?

Correct.

CAPEX wise, where do you expect to be this year?

We are currently looking at our CAPEX program here to be somewhere in the CAD50 million range. We are clearly monitoring that (technical difficulties).

So we haven't seen any need given the oversupply of equipment in the market, we have been very frugal on what equipment where at in to it, because we don't see a lot of point in us -- even though if we had gotten more equipment we could we were very confident we could grab more work, it would just maintain the pressure on margins when there's plenty of equipment out there at the moment.

Is it safe to say that within the context of your current fleet if you win a Joslyn for the winter, for instance, that you have capacity to handle that?

Yes, absolutely.

And lastly, sorry, Pipeline, even with the delay or deferral of some of that work into the spring, are you still expecting overall pipeline revenue in that CAD80 million to CAD90 million range this year? And what does the backlog opportunity or bidding process look like for next year?

Yes is the answer to the first part of the question, and the second part is that the bidding process for next year in the Pipeline group is strong. We are already bidding work for the next year in that area.

Bidding to grow that business or bidding at a similar pace to this year?

Yes, we want to substantially grow it in size. We can do -- we are sort of a two spread company, and what we've done is we've picked up some work in maintenance of pipelines. And so revenue growth that will occur will be because we've got some recurring revenue type work in that business now of pipeline maintenance for Enbridge and TransCanada. And that will keep us going through the lower construction periods and enable us to keep our workforce and our key management and supervisory workforce which is very important to us for growing that business over the long term, getting more permanent employees rather than the fairly transient employee group that we've had in the past.

Greg McLeish of GMP Securities.

Just wanted to drill down again on that lease expense question. What I was wondering is, you said that you are going to maybe average the CAD75 million to CAD80 million but if you take a look at that, does that mean that it's more like a CAD20 million quarter on an operating lease expense for the balance of the year or is it going to be higher than that? I mean, I'm just wondering if that CAD6 million is included in that when you -- do you have to back that out and then normalize?

Well, again, if that CNRL equipment ramps up and we start to see the increase in the over hours, some of that CAD4 million would revert back, but it would be exactly the same flow-through in terms of the accounting today. So you wouldn't see that fall. If we were to reverse all of that because the hours have gone up, it wouldn't hit the bottom line, it would essentially just be a flow back through in the [unbuild]. Because it really becomes a timing issue.

As I'm trying to think of a number, is it CAD80 million minus the CAD6 million to come out with a normalized for the year?

Yes.

And then just on your working capital just a couple of things there. Your inventory seemed to have really popped up in the quarter. Is there anything in there that's -- what are you ramping up for there?

We have heard rumblings that there is a potential tire shortage coming. So we have been building up our tire inventory just to be ready in case.

And how much of that working capital do you think will reverse into the -- into Q4 and even into Q1? I mean, how much of the line are you going to have to tap? Are you going to have to tap more of the line or are you going to have access availability by the end of the year?

In the short term I think we will have to draw down more into the line. We will still have adequate capacity. In terms of how some of that working capital flows back into our cash, timing is a little bit difficult for us to predict because a lot of it will depend on how quickly the winter work ramps down. So for example, if we find that we get an early spring melt and we essentially shut down by the middle of March, we would start to see more of that cash flow into Q4.

But by the other side, if the work goes into the first part of April, I wouldn't expect to see a big movement in working capital. The cash really starts to come out in Q1.

So it all depends on weather then.

Yes.

Great quarter, thanks.

Eric Pachman of Korsant Partners.

Thanks for taking my question. Joe, I guess question for you. How well -- ? I generally understand there is overcapacity, I'm clear about that, but how well do you think if you are looking just in 4Q, the industry is prepared to handle the level of muskeg removal demand that you are seeing? I guess specifically on the equipment side that you would be using to execute that work?

From what we've seen we believe it will be pretty much fully utilized in that size of fleet across the winter, across the business. So anybody with that size equipment to do muskeg will probably be busy, and it will probably take all of that to get those quantities done.

But we do believe there is some flexibility in the timing of once clients do those things, it just increases costs or it potentially increases cost if you run the risk of going too late in the year and getting spring breakup.

Is there still available rental equipment out there if clients are willing to obviously pay the higher price assuming they are going to be able to push those costs through? Or is the market just potentially with all the demand, could it get essentially tapped out on equipment?

There is usually some rental capacity. I don't know exactly what the rental yards look like right now, but if we needed to get a few trucks tomorrow and we could get the additional cost of the rental paid for, I believe they would be there.

How are those conversations with customers going right now? Are they looking to do that or not willing to pull the trigger yet?

I think it's still -- they still haven't committed on volumes and I don't know if we have a real clear picture of where that capacity is right now. I don't think we'll really know that until mid-December until we are about ready to go to see who is awarded what work and who is holding back.

And on -- what do I think about as far as like if we get an early freeze. I mean, are they going to start to work ASAP or is this generally just going to start in January, December?

It predominantly starts in January. We usually have a small amount that we can get to in December. If we get good freeze down, we can start doing some prep and getting access to areas and freezing down areas in December. A lot of times it's dictated by the client and their budget.

So if their muskeg budget is available in January, then you start in January. We do try to get as much of it prepped in December as we can or if we have access to because it just makes it easier to utilize more of the hard freeze in January for doing the actual extraction and not doing access development and things like that.

Frank Wooten of Point Blank.

Congratulations on a great quarter. I had a quick question with regards to the CAD25 million extension in your credit agreement. In the notes to your [6K], it said that is automatically going to be paid out to any settlement with regards to the CNRL contract. Is there something that they had more details than we are being given on that? Or can you just walk through that with me?

No, they don't -- there wasn't any more detail than we've communicated here. The reason why we put that in is clearly if we get a big settlement here from CNRL, there's no need for us to go paying all the standby pieces associated with that incremental CAD25 million. So the first thing we would do is drop that down. If we don't need it, why have it?

Got it and that is only on the 25, it is not on the previous credit agreement?

Correct.

Thanks.

It appears there are no further questions at this time. I would now like to turn the floor back to management for closing comments.

Thank you very much, everybody, and we will be out on the road going through both the West Coast and East Coast starting next week. And so hopefully we will catch up with some of you. If any of you want us to drop in and see you please make sure you contact me and Investor Relations Executive Kevin Rollins. Thanks for joining us on the call this morning.

This concludes the North American Energy Partners conference call. You may now disconnect your lines at this time and have a wonderful day.