Finning International Inc.

Mauk Breukels - Vice President, Investor Relations and Corporate Affairs Scott Thomson - President and Chief Executive Officer Anna Marks - Senior Vice President, Corporate Controller

Cherilyn Radbourne - TD Securities Jacob Bout - CIBC Yuri Lynk - Canaccord Genuity Benoit Poirier - Desjardins Capital Markets Sara O'Brien - RBC Capital Markets Ben Cherniavsky - Raymond James Ross Gilardi - Bank of America

Thank you, operator, and thanks to everyone for joining us. On the call with me today are Scott Thomson, President and CEO; and Anna Marks, Senior Vice President and Corporate Controller.

Today, Scott will start with his remarks, and then Anna will provide a summary of the financial results for the quarter and the year. Following the remarks by Scott and Anna, we will open up the line to questions.

After the Q&A, Scott will make some concluding comments. An audio file of this conference call will be archived at finning.com.

Before I turn the call over to Scott, I want to remind everyone that some of the statements provided during this call and in the press release is forward-looking. This forward-looking information is subject to risks and uncertainties as discussed in the company's Annual Information Form under Key Business Risks.

Please treat this information with caution, as Finning's actual results could differ materially from current expectations. Our forward-looking disclaimer statement is part of our quarterly releases and filings.

Finning does not accept any obligation to update this information. Scott, over to you.

Good morning, everyone. Today, I will start with comments on 2014, and then turn to our view of 2015 and the actions we are taking to manage through current macroeconomic condition.

We ended the year with good results. To briefly summarize, the key achievements, starting with safety.

Each of our operations demonstrated continuous improvement in their safety performance. On a consolidated basis, our total recordable injury frequency rate, a key indicator of workplace safety, came down 24% and we finished the year at an all-time low.

This is a testament to all of our employees' commitment to safety and a leading indicator of success on our operational excellence agenda. Quarterly earnings per share of $0.62 was a good outcome, given the market environment.

Q4 was our best quarter in 2014 and better than the prior periods. Keep in mind that the quarter included a positive tax adjustment in Argentina, which Anna will explain.

In South America, we maintained strong profitability year-over-year, despite challenging market conditions. In Canada, we continue to demonstrate progress on our operational priorities and significantly improved return on invested capital.

And we generated $385 million of free cash flow in Q4. In all, we leave 2014 having positioned the company well to weather the challenges of 2015 with a relentless focus on cost and capital efficiency.

This focus is key to our operational excellence agenda, and has become even more critical in today's environment. I'll now turn to some detail on each of our operations starting with South America.

As you recall, South America took actions early last year to adjust both the cost structure and invested capital to lower activity levels, and the business has maintained its historic profitability. I am pleased with the solid bottomline performance in South America in light of a significant drop in revenue year-over-year.

The team has done a great job of managing through challenging market conditions and generating strong free cash flow. We believe conditions in South America hit the bottom in Q3 2014, as all lines of business have shown signs of recovery over the last few months.

However, Q1 is always seasonally slow and we expect that will be the case again in 2015. With favorable foreign exchange movements, labor cost reductions and lower energy costs, the Chilean mines continue to be profitable, but we do not expect any new projects in 2015.

However, we do expect a resumption of part sales growth this year, as mining customers have been deferring decisions on component purchases and major repairs for some time. We also anticipate that infrastructure spend by the Chilean government will increase equipment and power system needs in the second half of 2015.

In the U.K. growth in the equipment market has been driven by the residential and commercial construction, quarry, rail and rental sectors.

We continue to see weakness in heavy construction and coal mining. Overall, the market has been expanding, and I am pleased that we have been growing market share in this competitive environment.

Despite softness in some key sector, we've been able to maintain product support levels by increasing equipment rebuild activity. In power systems, there is strong activity in electric power generation and marine.

We recently won some important deals with data center, marine and gas customers. The low oil price is expected to have only a modest impact on our power system business in the U.K.

The UK team has demonstrated good control over invested capital, while achieving 6% growth in annual revenue in British pounds. Invested capital turnover improved year-over -year, and the team was able to maintain the EBIT margin in the 4% to 5% range in a highly competitive market environment.

In Canada, we've executed well on our operational excellence agenda. Canada's EBIT increased from last year, driven by higher volumes and cost savings from supply chain and service profitability initiatives.

Our parts inventory turns were up and invested capital turnover improved considerably. As a result, Canada's return on invested capital rose by 120 basis points.

Turning to the outlook. As you would expect, the lower commodity prices have impacted mining activity across all of our regions.

Persistent weakness in copper and coal prices resulted in consolidated new equipment sales being down a notch in 2014. Now, the sharp decline in the price of oil is affecting our Canadian business.

In the fourth quarter, we saw order intake in Canada dropped by almost 30% from Q3. In addition, our customers have started to reduce their capital expenditure and operating costs.

They are under pressure and are looking to us to support their efforts to improve productivity and reduce cost. Despite this uncertainty, there are still pockets of strength in Western Canada.

Power system is a bright spot, while well servicing activity has been reduced. We are experiencing solid equipment demand in electric power generation and rental.

Our forestry business is growing, as demand for lumbar remain strong and Site C dam and Northern BC will generate activity later this year. I am also very pleased that we have reached a multi-year agreement with Dominion Diamond Ekati Corporation.

This deal continues our longstanding relationship of providing equipment, parts and service to this valued mining customer in the northwest territories. Apart from these pockets of strength, we see some other key differences between the macroeconomic conditions in Canada today versus the last downturn.

In 2008, 2009, activity declined overnight, partly due to lack of access to credit. That is not the case today.

Importantly, we faced this downturn with a much stronger balance sheet, leaner inventory, a smaller rental fleet and no significant capital commitments. And finally, we are supporting a larger active machine population, which provides resilience to our product support business.

Still, we recognize the challenge ahead of us in Canada. We are taking actions to adjust and manage our cost structure to ensure our expenses are aligned with activity levels, similar to our approach in South America last year.

We just made the difficult decision to layoff approximately 500 employees in Canada this quarter. This represents 9% of our Canadian workforce.

In addition, we have frozen salaries for all Canadian salaried employees, have implemented austerity measures and are negotiating with our suppliers. We continue to closely monitor macroeconomic conditions, and we'll take further actions as necessary.

It is important to note that the efforts required to manage in today's low commodity price environment are consistent with the priorities we laid out heading into 2014. We continue to show good progress by growing market share, improving service profitability, optimizing our supply chain and redistributing activities across our branch network.

As we manage through the uncertain economic conditions, it becomes even more critical to successfully deliver on our operational excellence agenda. Looking into Q1, our earnings will reflect severance cost in Canada, challenging foreign exchange dynamics and higher inventory levels.

While we reduced our equipment orders for the factory back in October, the equipment we ordered several quarters ago is arriving now. The good news is that we face today's challenges from a position of financial strength.

Our balance sheet is in the best shape it's ever been and CapEx is well controlled in all our operations. Our business model has the benefit of generating significant free cash flow, particularly in a slowing market.

We generated over $480 million in free cash flow in 2014, and over the last six quarters we've generated in excess of $1 billion. In 2015, we fully expect to continue generating strong free cash flow.

The strength of our balance sheet gives us significant flexibility in an uncertain market. We are actively evaluating available capital allocation opportunities with the intention of making final decisions in the first half of 2015.

I will now turn it over to Anna.

Thanks, Scott, and good morning, everyone. I'll now discuss our fourth quarter and annual results in more detail.

So let's start with Q4. Revenues of $1.8 billion were in line with last year, as higher revenues in Canada and the U.K.

and Ireland offset lower revenues in South America. Product support hit a quarterly record and was up 14%, driven by higher parts sales in all operations.

We saw improved demand for mining parts in Canada and South America and higher power systems part sales in the U.K. Although, new equipment sales were up in Canada and U.K.

and Ireland, it wasn't enough to offset the lower volumes in South America, as a result, consolidated new equipment sales declined by 11%. Our equipment backlog was about $1 billion at the end of December.

In Canada, the order intake slowed in Q4, impacted by the rapid decline in the price of oil. In South America, the order intake stayed at very low levels.

And in the U.K. and Ireland, order activity remained strong.

If we look at gross profit, we continue to execute on our operational priorities and saw an improvement in service profitability in Canada. Despite this improvement and the shift in revenue mix to product support, gross profit was down 5% and gross profit margin of 29.3% was lower than the 30.9% earned last year.

This was mostly due to a number of items that affect our comparison with Q4 of 2013. First, we had a higher proportion of lower margin mining parts in revenue mix in Canada compared to Q4 last year.

Second, the gross profit from rental declined, as rental revenues were down in both Canada and South America year-over-year. And finally, our gross profit in Q4 of last year benefited from some positive adjustments relating to equipment costs as well as certain mining service contracts.

SG&A cost declined by 2.5% on relatively similar revenues, mostly due to lower SG&A in Canada, reflecting successful execution of the service excellence and supply chain improvement initiatives. Moving to EBIT, consolidated EBIT of $142 million in Q4 was slightly lower than prior year.

And EBIT margin was 7.9% compared to 8.1% last year due to the lower gross profit margin, which I have just discussed, partly offset by lower SG&A relative to sales. Now, I'd like to look at EBIT performance by operation.

Canada's EBIT was up by 6%, and while this was not as strong as we expected, the execution of our operational priorities is well-advanced. This is evident in improved gross profit margin from service and lower SG&A, which was down 5% from Q4 of last year, while revenues increased by 8%.

We are pleased with the results from South America, where we were able to maintain a solid EBIT margin of 9.8%, despite a 19% decline in revenues in functional currency. Actions taken in 2014 to manage cost are starting to payoff.

And in the U.K. and Ireland, a $3 million increase in EBIT was largely attributable to the write-off of previously capitalized cost in Q4 of 2013.

Basic EPS was $0.62 in the quarter compared to $0.54 a year ago. We had a $0.05 positive impact on EPS from an inflationary tax adjustment in Argentina, which we qualified for in the fourth quarter.

In addition, a lower than expected actual annual effective tax rate in Argentina had a positive impact of about $0.02 per share this quarter. As you may recall, in Q3, we booked higher provision for income tax in Argentina based on our estimate of the peso devaluation and estimated annual effective tax rate at that time.

In Q4, we adjusted it down, based on the actual peso devaluation, which was lower than expected. As a result of these tax adjustments, our Q4 effective tax rate was only 12% compared to about 25% in 2013.

If we look at the full year, the effective tax rate was 24%, up from roughly 22% in 2013. For 2015, we expect the effective tax rate to be at the low-end of 25% to 27% range.

A few words on invested capital and free cash flow. We are very pleased with our strong balance sheet.

Excluding the impact of foreign exchange, invested capital declined by about $280 million from the end of September, driven mostly by lower inventory levels in all operations. As a result, we saw an improvement in our invested capital turnover and Q4 free cash flow was very strong at $385 million, primarily driven by Canada.

Now, I'll briefly talk about the key highlight for the full year. Annual revenues increased by 2% to $6.9 billion, driven by record product support, which rose by 8%, reflecting higher part sales in Canada.

EBIT of $504 million was 3% below last year due to significantly reduced volumes in South America. Despite challenging market conditions, the South American operations maintained a strong annual EBIT margin.

Excluding the ERP write-off, severance and labor disruption cost, annual EBIT margin would have been 9.8% for the year, which is consistent with historical levels. Canada's EBIT increased by 8%, driven by higher volumes and cost savings from supply chain and service excellence initiative.

SG&A cost increased only marginally, despite an 8% growth in revenues. We continue to successfully execute on our operational excellence agenda and achieved significant improvement in our invested capital turnover, which increased to 2.19x from 2.03x a year ago.

As a result, Canada's return on invested capital rose 120 basis points to 17.1% from 15.9% in 2013. Consolidated return on invested capital was 15.3% compared to 15.7% in 2013, as operational improvements in Canada were offset by significantly reduced business volume in South America.

Basic EPS of $1.85 in 2014 was lower than the $1.95 earned in 2013. If we adjust for the ERP write-off, severance cost and tax-related adjustments in both years, 2014 basic EPS will be comparable to the prior year.

Excluding the impact of foreign exchange, our invested capital decreased by about a $150 million from the 2013 yearend. This was driven by lower new equipment and parts inventory as well as lower rental equipment in South America, as we've adjusted our assets due to a reduction in mining activity.

In addition, we finished the year with lower parts inventory in Canada, driven by supply chain improvements. As a result, we improved our invested capital turnover to 2.10x from 2.04x in the prior year.

And finally, as Scott mentioned, we are very pleased with the strong free cash flow generated this year of $483 million, which allowed us to reduce our net debt to total capitalization or net debt to invested capital ratio to 31.4%. Overall, it was a solid quarter and year, despite many macro challenges.

We made significant progress on our operational excellence agenda, with work still left to be done. Our balance sheet is in the best shape it's been for over 10 years, and we are in a great position to face challenges and capture opportunities.

On this note, I'll turn it back to Mauk for the Q&A.

Operator, that concludes our remarks. Before we go the Q&A, we request everyone on the line, that as a courtesy to your colleagues, you ask no more than two questions, when it is your turn.

Please go to the end of the queue, if you have more questions. Operator, if you could please open up the line.

I wanted to start by asking about your outlook for the product support business in Canada to be stable. Maybe you can just walk me through the puts and takes there, and whether you think you're being potentially cautious in saying that it will be stable because, frankly I am a little surprised that it wouldn't grow based on the expansion of the installed base?

So couple of things. One, I think if you look, historically, you're right.

I mean we haven't had, I think actually, a year in the 10 years where product support on a consolidated basis has not grown. So the history would tell you that it will continue to grow.

If you look at the situation last year, we saw a slight downturn and functional currency or product support. Now, that was mostly on service not on parts.

Parts actually saw a modest increase. So when we look at Canada this year, I think the stable is probably a little conservative.

I think there is some upside to that. But given the environment, I mean it's a difficult environment and there is a lot of conversations going on with customers around margins and we're trying to offset that with more volume, which I think we're being successful in a lot of cases.

But it's a challenging environment. So I suspect that stable is a little bit conservative, but probably appropriate given what we saw in South America last year.

And then just on share buybacks. Why would you not buy back stock with your balance sheet where it is and the share price where it is?

So I mean, obviously, pleased with the strong free cash flow generation, and now this is in excess of $1 billion in six quarters. And I expect 2015 to be free cash flow positive, particularly now in light of the market slow down in Canada.

Q1, as you know, is typically a free cash outflow quarter and we'll make capital allocation decisions when I start to see the Canadian free cash flow generation, which I expect to be in midyear. I am extremely confident, Cherilyn, that by the end of 2015 we'll look back and Finning will allocate at least a portion of its excess capital to repurchasing shares, and particularly if the share price stays at this level.

I had a question on activity levels in Western Canada, in particularly, oil sands for January and February. Have you seen any order cancellations?

And is there any service work here that's been pushed out? Just trying to gauge what January February looks like versus what you saw in the fourth quarter.

It's interesting, because it's mixed. And if you look at our customers, let's start with our customers, I mean, they're obviously reducing capital, right.

You've seen average of 30% reductions in capital expenditures. I think the good news about that is the oil sand customers that are big portion of our customer base, I think continue to run the fleets, and they haven't shutdown, and I don't expect them to shutdown.

That being said, we have seen a reduction in machine deliveries, and we can come back to why I think that's the case. I don't think -- we haven't seen a lot of cancellations, we haven't seen a lot of RPO returns, which is all good news.

And the service base, I mean, there is actually some pretty good activity going on the service base. So it's a mix.

I must say January, February is mixed, but it's hard to look at your customers reducing CapEx by 30% and not think that's going to have an impact on you. And I think, you combine that with the challenging FX dynamics, which ultimately will be a benefit for us, and particularly will be a benefit for us in South America and the U.K., then I think over time it will be a benefit for us in Canada.

But in the first quarter, when you have the Canadian dollar devalue like it did, there's this new equipment dynamic that takes place, and I suspect that we'll see that through the first quarter as well.

Maybe, second question just on the reduction in the workforce in Canada. Where is this primarily happening?

And then how are you thinking about future reductions mean. What do you right size for currently?

I mean, we talked about this for the last 18 months, right. I mean you and I have talked about this Jacob.

I think we've recognized that the SG&A as a percentage of sales is too high in the organization. And I think we've made good progress in 2014 addressing that.

Frankly, it's hard to address that when revenues are growing at 8%, and that's what happened last year in Canada. Despite that if you look at the SG&A line, SG&A line improved pretty dramatically as a percentage of sales.

And I think that's the credit for the Canadian team on managing the cost. But now we have an opportunity with an aftermarket downturn to make some sustainable changes, which will allow us to accelerate these operational excellence agenda and put us in a better place as the cycle upturns.

The mix, I mean there is going to be an impact on salaried and non-salaried hourly employees and we've started that process already. These are obviously difficult decisions.

No one wants to make them. But given the activity levels we need to have a cost structure that's in line with the activity levels and that's what we've done.

The objective here is to -- this is version of 2.0 of what we did in FINSA last year. I mean, looked into the team, the South America team had to make some very difficult decisions.

They did that early in the downturn. They were able to maintain their EBIT margins, their profitability, which we're pleased with, and that will be the objectivity in Canada, as we go through 2015.

Scott, can you talk about pricing in Canada? How the rise in the U.S.

dollar might be impacting or not impacting margins? And has the upheaval in the foreign exchange markets made any of your foreign competitors more competitive in your markets?

So let's actually take this region by region, because I think the Canadian dollar downturn isn't necessarily negative in all of our regions. South America it actually helps.

And it helps from translation perspective, also helps in the U.K. And in Canada, it actually helps from a labor force perspective, from a cost perspective, particularly when over time we price in U.S.

dollars. And I suspect that will be the case over time here.

In the first quarter, I think we are facing some challenging dynamics, because the Canadian dollar has devalued pretty significantly. I think our competitors faced the same issues, but it does create this challenging dynamic between used and new equipment.

And I suspect that that will take a little bit of time to make its way through the system. What I would say is our competitors are in the exact same situation.

I would also say that in the first quarter last year, when we had this downturn or devaluation of the Canadian dollars, we learned a lot. And as a result, we hedged more significantly first quarter this year on new equipment deliveries, on the cat payables, than we did last year, which has offset some of that pressure, but this year we've also had the devaluation combined with the oil price downturn.

So I guess, in summary, I do think it will have an impact in Q1. I don't think its differential from or a difference from what our competitors face.

And I suspect, as we go through the year, this will ultimately be a benefit for us as we're able to incorporate some of that FX into equipment and part sales.

Secondly, just a follow-up on the capital allocation question earlier. What else is on the table in terms of capital allocation priorities?

Can you just rank them here, given where the stock is? And anything else you might be thinking of for use of cash?

So I've been pretty consistent on this. I think there's three options for us: one is internal investments; two is acquisitions; and three is share repurchases.

On the internal investment side, I mean, you can see our capital and rental expenditures through 2014. I mean, we have shrunk that capital expenditure budget pretty significantly and given pretty slow market in both South America and Canada, I don't see a need for significantly more capital expenditure in 2015 relative to 2014.

And in fact, we're actually going through an asset optimization exercise in both areas, and that's having some impact on where we do work. We actually, this quarter, made hard decisions to shutdown a few branches, Hay River and Tumbler Ridge.

We've also moved some power systems businesses, et cetera. That's a long way of saying I don't see a lot of internal needs for capital.

So then that leads you to acquisitions and shareholder repurchases. On the acquisition front, I mean it's an interesting dynamic.

You've got depressed valuations and you've got a business model that generates a lot of free cash flow in a down cycle, so it's something that we have to be aware of. Then on the capital return perspective, the share price in my view is undervalued, relative to the fundamental value.

So as we get through the first part of the year, I think we're going to have to take a very hard look at share repurchases. And as I said to Cherilyn's question, I think we'll sit here at the end of 2015, we'll look back, and we'll have done some activity on the share repurchase front.

The last thing is dividends. And usually dividends is a May decision for us.

And that's typically what we've done historically and we'll do that again in May.

The first question is related to the restructuring. Obviously, you have been very proactive so far, what we should expect in terms of restructuring charges related to the lay off in the quarter?

And also what we could expect going forward?

So you are going to see severance cost in the first quarter. And that's going to be in line with the 500 person reduction.

So I mean that's just going to happen. Last year, we had pretty significant severance charges through the financials as well, given the South America downturn.

I think that South American work force reduction was around 10% too and we had a lot of severance charges. And despite those severance charges, we were actually able to maintain EPS performance.

And I know we've got a look forward here for 2015, but to look back at 2014, and to see flat EPS year-over-year despite a really challenging FINSA South America environment and severance charges, I mean I've been pretty pleased with the performance of the team in 2014, and I'm very confident as we go through the challenges in 2015, we'll execute in a very similar fashion.

And what are the key elements of your monitoring that could lead to further steps or further reduction, Scott?

I mean the objective, Benoit is, as I said, very similar to what was in South America last year, and that's to maintain the profitability or maintain the EBIT margin. And so we think these reductions that we've done now and the austerity measures, it's more than headcount reductions.

There is a lot austerity measures being undertaken. We think those are appropriate to maintain the EBIT margin.

That being said, if things worsened from here, then we'll have to again be proactive and take further action.

And second question very quickly, you made some positive comments for Chile, for the government spending expected in the second half. So just wondering how sizeable is the opportunity and what is secure at this point?

Yes, 2014 was difficult for a couple reasons. One you had the mining downturn, and then you had a new government coming into Chile that wasn't as clear as we would have liked on tax reform, labor reform, educational reform, and the result was that foreign investment essentially dried-up.

And now I think the government has taken very positive steps to clarify the tax regime. They've also seen what the impact on GDP, which has been pretty significant in Chile over the one-year period and announced this infrastructure program, which we feel very positive about.

I don't think you're going to see an impact on that in our results until the backend of 2015, because it takes a little bit of time to flow through the system. But I do feel good about the recent government actions on infrastructure.

I don't want to leave you with the impression that there is a big upside in South America, right now. I mean we've gone through a very difficult downturn.

I think Q3 last year was the trough or the bottom. I do think there will be improvements in product support through the year, and you'll start to see that in Q4 frankly.

So I do think you're going to see modest improvements on the product support side in South America in 2015 relative to 2014. But I do not expect the redemption of significant mining activity in 2015.

I think that we're probably looking at 2016, 2017 for that.

Can you comment a little bit that about the [indiscernible] product support? In the quarter, we saw a mix impacts from more mining parts dragging down gross margin?

Is that expected to continue? And how effective do you think your staff reductions will be to offset that margin pressure?

I mean I think the team is doing a great job. I mean clearly there is margin pressure in product support in Canada.

But I think the team has done a great job in trying to mitigate that through our conversations with customers, trading off some of that margin pressure with volume. And the actions I have seen have been very successful.

And that's a win-win for everyone. I mean that's a win for our customers, because they get a little bit of relief and it's a benefit for us, because we get more volume.

So I suspect that will be successful going through 2015. I mean we do have to take the difficult decisions on cost because of reduced activity.

What we saw in '14 in the quarter on the margin wasn't related to the downturn. I mean this was just more mining mix in the sales mix.

So I wouldn't take 2014 and extrapolate to 2015.

And then maybe just on the insourcing you're seeing that in the oil sands now? And is that like a Q1 phenomenal or is this going on since Q4?

No, it's a little bit in Q4 and I guess it started probably in December, and there is a little bit going on in Q1. And frankly, some of things that we've had do on the hourly employee base.

Some of the actions we've had to take are related to that insourcing. So I think already in Canada we unfortunately had to layoff about 150 hourly employees up in the oil sands, and that was related to the type of insourcing we're talking about.

So you're laying-off techs or tech backup?

That portion was mechanics, but we're looking at the whole cost structure.

And maybe can you just clarify; there was some commentary about accelerating the action program in Canada. Obviously, the headcount reduction is a big step.

But more specifically where can you see real benefits, is it on the fixed asset base or where do you look to make the biggest improvements in 2015?

Yes, so clearly cost is one of it. And again, I want to reinforce, it's much more than just headcount reductions.

I mean there is a big program of austerity measures underway at both Finning International and Finning Canada. But there is also the asset utilization piece there that you talk about.

And I think through '14 we have been very successful in redistributed activities. And we've actually had to make difficult decisions around a few branch closures, as I mentioned here, Hay River and Tumbler Ridge, closed Cat Rental Store.

We've moved the shovels and drills from their location in Fort McMurray into the Mildred Lake that's subleased. We've moved the power systems from Keyano College to Fort McMurray.

We've moved the Prince George rental store into the main branch. And these types of decisions will be faced within 2015 as well.

In the last quarter, Scott, I think you indicated a range of revenue growth for Canada, and I think you said somewhere above zero, but below 8%. Obviously, market conditions have changed quite a bit since then.

Would you have venture to help us get an update on that, what you think this year might look like with all the puts and takes that you know how to consider three or four months later?

Yes, things have changed in three or four months for sure. And I mean, I think we're going to see a decline in revenues in Canada, and it's particularly going to be on the new equipment side.

But just to put that in perspective for everyone, as you think about our gross profit, 70% of our gross profit is product support and only 6% of our consolidated gross profit is Alberta new equipment sales. I mean the great thing about this business model is the product support business.

And when people don't buy new equipment, they have to look into product for a while, but they have to clearly buy parts and service. And that's been the trend of this company over the last 10 years.

And I suspect that will continue this year. I mean, Cherilyn's comment was, are we being too conservative with the stable product support assertion, and we may be, we may not be.

But to answer your question, we are going to see a reduction in new equipment sales in Canada in 2015.

And how do think about SG&A? What's the variable versus the fixed cost structure?

What are the puts and takes from the initiatives you've already put in place, the austerity measures. I mean it sounds like, and I know and we have talked about this offline, you've been very active in this operational excellence agenda, and as you say the austerity decisions and so forth.

I'm a little surprised that that wouldn't have shown up more at this point, but I wonder if you can maybe speak to the timing and then speak to what's the overall trade-off between all the things you can do. And then just the inherent challenge of facing lower volumes, where there is just a certain amount of operating leverage in the business that's going to put pressure on margins.

Because there is a lot of moving parts to consider right now. And I think it just might be helpful to talk a little bit about how you think they might wash out or what your goals are at least, net-net?

So I'll let Anna answer the variable fixed question, but let me just respond to I think a broader question that you're asking. I am actually pretty pleased with what happened in 2014 on the SG&A front.

We saw a pretty significant increase in revenues in Canada and SG&A was down. And actually you can see the fourth quarter, I mean the fourth quarter revenue is up and I think SG&A is down 5% or something.

So some of these improvements you're starting to see come thorough. And I think the ultimate sign of success is return on invested capital, which is what we've been trying to do.

And we've taken the return on invested capital in Canada from 15.5% or 15.6% to 17.1%. I mean that's a pretty significant increase in return on capital in a one-year period.

But now we look forward and we're in a different environment, and that different environment, as you said, is going to see lower new equipment sales and reduction in revenue. Well, the objective here is to maintain the profitability levels, very similar to what we went through South America last year.

And in order to do that, you unfortunately, when you have lower activity levels, you have to make difficult decisions on cost structure. And 500 people is extremely difficult decision, but it's the right decision at this time, given the activity levels to achieve that objective of maintaining profitability, and that's why we've undertaken that decision.

And I think we were quick to do this in South America. I think we are using the same urgency in Canada.

And the objective, I mean you'll see a pretty significant absolute reduction in SG&A in '15 relative to '14. Anna do you have any comments on this?

Yes, just a few comments in terms of SG&A. We did see SG&A go down quite a bit in South America down 12% despite the severance increase in the year.

And so we did do a lot of work there in terms of reducing our cost. With respect to Canada, just in terms of what we saw in '14, we did see our SG&A go down 5% in the quarter, even though revenues went up 8%.

And on an annual basis, SG&A was pretty much flat with revenue increase. So we are seeing a lot of improvements on the operational excellence agenda.

About 20% of our cost, I would say, are variable more or less and the rest are somewhat fixed. So we are trying to get at those fixed cost, and trying to be more efficient with respect to supply chain and service excellence to bring those down.

But we've seen some good work and some improvements already in '14 and we anticipate that to continue into '15.

Could I just follow-up just to make clear, it's maybe just frame expectations clearly Scott. I mean, a couple of years ago, I mean even before your time, but I think after you got there as well and the environment was different, the objective in Canada was to raise profitability levels.

And certainly when you compare Canada to South America, frankly compare yourselves to other cat dealers like Toromont, those levels still seem relatively low. But are you suggesting that in this environment it just becomes more difficult to actually improve the margins and you'll be happy.

If you're facing a significant revenue decline to see the margins for the time being at least, just whole study in Canada, is that how we should be thinking about targets and expectations? Not to put a number on it, but I mean directionally is that what you're aiming for, is that realistic?

Again, I don't want to get into target setting. But I guess what I'd look at for South America last year, you saw difficult decisions, big downturn in the market, and we maintained the EBIT margin and we had a modest reduction in return on capital.

When I actually look back on 2014, I think the team did a great job. I think that should be a checkmark sign of success.

When I look forward in Canada and I see the type of CapEx reductions that our customers are facing and the reduction activity. If we could end the year with the maintenance of the margins, I think that would be again a sign of success.

And that's the only way you do that, as if you take actions pretty quickly, given the cost base. And that's why we've taken the difficult decision we've done on the 500 people and other cost reduction efforts, because it's important to set the ultimate objective.

Just finally with that, would you talk about this including the cost, like the restructuring and severances or you sort of want us to adjust for that when you look at profitability ratios going forward?

No, I mean you can take your own view on it. I mean, I think we've been pretty transparent through 2014 on what severance and what's not severance, and I haven't asked you to adjust anything.

So it will be --

So you think you can maintain profitability, despite those expenses?

Yes. I mean that's the exact way.

I mean that's what we did in South America and that would also be the ultimate objective in Canada.

I just had a couple of questions. First, Scott, can you give a little more color on what you're seeing in construction.

You talked about it a bit in your press release and I think in your opening remarks, you tell that your order intake is weakening in Western Canada is well. Is that more tied to oil and gas related construction or is it general construction activity?

And how do you expect that to unfold as the year progresses?

Sure. So I think you have to separate D.C.

and Alberta for one thing, but I think a lot of -- so that's one aspect of it. Two, I think as the FX work its way through, I think we'll see maybe a different back half of the year versus the first half of the year.

But we are seeing some weakness in order intake and it's in the construction sector as well as the mining sector. And I think it's just a lack of visibility for our customers on what type of activity they're going to have.

So they are holding back in terms of buying new equipment. And then again, there's also this used new equipment dynamic that is exaggerated by the FX movement.

So listen, I think it's going to be challenging 2015 on new equipment, no easy way to say that. I do think the products support business is going to be provide great stability for us.

I do think the cost reductions will help significantly on the margins. And I am convinced that we're going to come out of this with a sustainable business that has accelerated on the operational excellence agenda that we laid out.

And then I just had a question on gas compression as well, because you cited that as a market that's remained relatively stable. Are you actually expecting growth in gas compression in '15?

And how important is that business with respect to products support for you?

I mean it's interesting, gas compression has remained relatively strong, and it's somewhat surprising to me, because I would have thought that that had weakened more than it had, but it hasn't. It's remained relatively strong.

Frankly, I think that over time it will become a bigger portion of our product support opportunity for us, but there has been a lot of sales. Our power systems business was up 35% or something last year.

I mean, it's just a dramatic increase. And typically the product support comes a little bit after the new equipment sales.

So I think over time this will become a bigger component of our product support business, but right now it's not a huge contributor, Ross.

Just for 2015, related to the inventory reduction, you've done a good job this year to lower the overall inventory by $100 million. So I am not looking for any specific numbers, but is it fair to assume that this should be even a better number in 2015, Scott?

Again, I mean, I think the team in Canada, we had a significant increase in sales. And the sales to invested capital ratio improved pretty significantly, so that tells you that we're making progress on the supply chain.

And on the free cash flow, I must say the fourth quarter was, I think Ross asked me last quarter, did I expect fourth quarter to be as strong as fourth quarter last year, and I didn't. I mean I was very pleased with the free cash flow generation in the fourth quarter.

And that's directly related to how we're managing inventory. As we look to 2015, I think Q1 is going to be a little bit of challenging inventory quarter, and the reason I say that is because we stopped ordering to the factory in October, but you've got a few months lead time, so we are going to see some deliveries in Q1.

And it's not going to be a loss, but there is going to be a modest increase in inventory in Q1. With the slowing market, though, I think we're going to see the same dynamics that we did in South America last year, and that's going to mean an inventory destocking.

And ultimately that's going to result in, again, 2015 with positive free cash flow, which will be third year in a row that we've generated pretty significant free cash flow in this business.

And just looking at your CapEx expectation and net rental, as obviously you show some very nice progress in 2014, should we expect those numbers to remain stable in 2015, Scott, or we might even expect further reduction?

So one, there's not a lot of CapEx investment, but I think in 2014, we had great control over capital. So I'm not sure you should expect a significant reduction on capital in '15 relative to '14.

I think we've got that really tightly controlled. As you think about rental, you also saw a pretty modest rental spend in 2014.

And we do think there is a good opportunity in rental. We do think it will be probably one of the first markets to come back in this cycle.

And we are investing capabilities on the rental side. We're spending a lot of time in all three right regions investing in capabilities.

I don't think you'll see a significant impact into our increase in 2015 on a rental fleet, as we build those capabilities, but maybe modest impact. But as we go forward, I would like to invest modestly more in our rental fleet, once we've build those capabilities, because I think it can be a good business for us.

And any update on the CFO search?

No, is the answer, but I think we're making progress, and I am hopeful that we will have some good news relatively soon. I mean we've spend a lot of time on this, and we've interviewed a lot of great candidates.

And as I said, I'm hopeful that we'll make progress on this relative soon.

And last question just for the oil sands project, I don't want to get any specific in the name, but the project have not been cancelled or anything. So I would expect you to be still in a delivery mode 2015, however is it fair to say that the amount to be deliver, that the equipment to be deliver in 2015 will be less than 2014, Scott?

I actually don't have the breakout of oil sand deliveries versus overall deliveries, Benoit. What I'd tell you is the oil sand, you've see a lot of capital reductions from our oil sand customers, but it hasn't been on some of the big projects, which I think is encouraging for us, because that's where we get some equipment deliveries.

That being said, I go back to the comment I made to Ben, I do think we'll see a reduction in new equipment in 2015 relative to 2014.

Great. Thank you.

So as I mentioned last quarter, times of uncertainty underscore the need to focus on what you can control. The course ahead is challenging, particularly in Canada.

We are taking actions now to ensure our cost base is align with activity levels, and we will continue to advance the execution of our operational excellence agenda. Thank you very much for your time today.

I look forward to speaking with you again when we report the next quarter.