Finning International Inc.

Mauk Breukels - VP, IR and Corporate Affairs Scott Thomson - President and CEO Steve Nielsen - CFO Anna Marks - SVP, Corporate Controller

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

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

Following the remarks by Scott and Steve, we will open up the line to questions. 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 are 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 and thank you for joining us on the call today, I would like to start by discussing the steps we’re taking in the context of today’s macro environment. I will also spend time on the resilience of our business model and how we are leveraging it to take advantage of opportunities.

Similar to Q1, both Canada and South America continue to operate in challenging business environments characterized by weak commodity prices. As there is not been any meaningful change in market conditions since the first quarter, persistent volatility and competitive pressures continue to translate to reduce the activity level.

Amidst this economic backdrop, I’m pleased with our team’s continued focus on controlling what we can. During the second quarter, we continued to accelerate our operational excellence agenda with a focus on targeted cost reductions and making sustainable changes to position the Company for success in the long term.

As you know, our cost reductions are squarely aimed at maintaining profitability as measured by EBIT margins on a lower revenue base. At the beginning of the year, we began to step up actions to reduce both our variable and fixed costs.

This quarter, we took additional headcount reductions and continued to optimize the branch network across the business. Due to our disciplined approach to cost management, profitability was up sequentially in all business units in Q2.

In Canada, we saw SG&A costs come down significantly as a percentage of revenue and South America continued to hold margin. While we are focused on cost reductions across the business, we haven’t taken our eye off the ball with regard to our operational priorities.

We’re continuing to make the sustainable changes to the business that are key to substantially improving our operating performance through the business cycle. An example of our progress on this front is the continued increase in customer loyalty scores from last year across all of our regions.

Our business model also gives me great confidence as we work to deliver value over the long term. Two important factors we have in our favor when equipment sales slowdown, our revenue resilience from our product support business plus our ability to generate free cash flow through efficiency gains and inventory reductions.

To that point, our pivot to free cash flow was ahead of schedule for the quarter and we are firmly on track to generate strong free cash flow for the year. We are putting this excess cash to good use to create the best long-term returns for our shareholders.

As we announced last quarter, we acquired CAT dealership in Saskatchewan, announced a dividend increase and launched a share repurchase program. After having launched the share buyback program in May, we began acquiring shares in the second quarter and we will continue to do so in step with free cash flow generation.

This is consistent with our view that share buybacks are an effective use of capital when our share price is undervalued. With that said, we remained committed to disciplined capital allocations and continued to maintain a strong balance sheet.

Further to our announcement last quarter regarding expanding our Canadian operations to Saskatchewan, we successfully closed on the dealership acquisition on July 1. I’m proud of the tremendous team effort which resulted in a smooth transition for our new employees and our customers.

As a result of our strong execution, we are off to a great start and look forward to capitalizing of the opportunities our expanded territory brings. The acquisition is immediately accretive to earnings and will be significantly free cash flow positive beginning in the third quarter.

Overall, I’m pleased with the scope and pace of the actions we are taking to align to reduce the activity levels and drive sustainable operating improvements. We are supported by areas of strength across our territories and a diverse customer base.

And as we move forward, our team will continue to focus on what we can control. We are positing Finning to deliver sustainable value while continuing to capitalize on our strong business model to realize strategic and financial opportunities.

I will now turn it over to Steve, who will provide you with a detailed look at our financial performance.

Thank you Scott and good morning everyone. As Scott mentioned, many of the macro challenges facing our business in the first quarter continued in the second quarter and remain today.

Regardless of these challenges, we drove sequential improvement in EBIT performance in all three regions, continued cost reductions executed on the operational excellence agenda and generated positive free cash flow. Our consolidated revenues of CAD1.7 billion were down 6% from last year, driven mostly by lower new equipment sales.

In Canada, new equipment sales declined by 16% reflecting reduced activity in construction and mining. The weakness in the Chilean mining sector continued to impact South America’s new equipment sales which were down 42% in functional currency.

While we are encouraged by the improvement in construction equipment order in-take in Canada and South America in the second quarter, our backlog remains low by historical standards. Canada’s product support revenue declined by 7% over the second quarter of 2014 driven by lower service revenues as well as lower part sales in construction.

While negative, this is an improving trend from the first quarter on a sequential increase. The oil sands producers and other mining customers continue to postpone non-production related mining activities, park equipment and defer or insource some service work.

As highlighted last quarter, we do not believe these deferrals are sustainable. In South America, product support in functional currency was slightly below the second quarter of 2014 but up 5% on a sequential basis, an encouraging trend, albeit from the seasonally lower first quarter.

Used equipment sales were strong driven by our focus on reducing inventory in Canada and a shift in demand for used machines in Canada as they have been attractively priced compared to new equipment due to the weaker Canadian dollar. The rental market in Western Canada continues to be challenging, we remain disciplined and maintained strict controls on our rental fleet.

Our gross profit margin of 29.1% was slightly below 29.6% in the second quarter of last year. Increased competitive price pressures and our customers’ focus on reducing operating costs particularly in Canada were the primary drivers of lower gross profit margins in most lines of business.

In addition, Canada’s proactive strategy to manage excess inventory has included a significant amount of dealer trade activities which were transacted without the gross profit margin. These pricing and margin pressures were partly mitigated by a favorable shift in revenue mix due to product support.

We have made significant progress on cost reductions and continued to drive cost discipline and operational improvement across all our regions to achieve a sustainably lower cost base. In Canada, SG&A was down 13% year-over-year, while revenue declined by 9%, trading leverage.

Since June of 2014, we reduced our Canadian workforce by about 850 people or 15% and closed 16 facilities. We continue to review our branch network with a view to making sustainable changes that support us for long-term opportunities when demand returns.

Our severance process in Canada were roughly CAD2 million this quarter, consistent with second quarter of last year. In South America, our SG&A in functional currency was comparable to the second quarter of last year and reflected inflationary and statutory salary increases, which offset much of the cost savings from headcount reductions.

As you will recall, we reduced our workforce significantly in 2014 due to the earlier downturn in demand for commodities. We continue to rightsize our South American operations eliminating 85 positions in this recent quarter, which resulted in severance costs of about CAD3 million, similar to the severance costs of the same quarter of last year.

In addition, we closed four branches in South America this year. After adjusting for severance costs, consolidated EBIT was CAD112 million and the EBIT margin was 6.7%.

These results are slightly above the run rate we communicated to you following our first quarter results. Looking at our EBIT results on a sequential basis, excluding severance and branch closure costs, we achieved 19% improvement in EBIT on 9% higher revenues.

Our adjusted second quarter EBIT margin was 6.7%, up from 6.2% in the first quarter. On a regional basis, our EBIT in Canada was down year-over-year despite significantly lower SG&A reflecting the challenging market dynamics that I mentioned earlier.

Excluding severance, Canada’s second quarter EBIT margin was 6.5%. On a sequential basis, EBIT margin improved from 5.8%, driven by our actions to reduce costs.

South America delivered strong EBIT margin of 10.1% excluding severance. Finn’s [ph] consistent performance reflects the resilient product support business and ongoing cost discipline.

In the UK and Ireland, the year-over-year decline in EBIT margin from 5.1% to 4.3% excluding severance was due to inflationary salary increases and FX losses on the translation of euro receivables. On a sequential basis, EBIT margin the UK improved from 3.4%, excluding severance to 4.3% as a result of higher sales activity and the cost savings from ongoing workforce optimization.

Our basic EPS was CAD0.36 for the quarter compared to CAD0.50 a year ago. However, severance costs reduced EPS by approximately CAD0.03 in both years.

We also saw one-time negative impact from the revaluation of deferred tax balances due to an increase in provincial tax rate in Alberta. This reduced our second quarter 2015 earnings per share by about CAD0.01.

But again, this is a one-time effect from the revaluation of the deferred tax balances. We expect this to only be a couple of million dollars increase tax expense per year.

We continue to expect our effective tax rate to be within in 25% to 27% range on an annual basis. Excluding severance and the one-time tax adjustment, our basic EPS was CAD0.40.

While our consolidated invested capital was similar to the first quarter, the invested capital turnover declined to 1.97 times from approximately 2 times at the end of March due to overall revenues and slightly higher average invested capital over the last four quarters. Return on invested capital decreased to 12.9% from 14.1% in the first quarter, principally as a result of lower earnings before interest and taxes.

We generated CAD69 million of free cash flow in the second quarter, reflecting good progress to reduce equipment and parts inventory in Canada, in line with market activity. We expect strong annual free cash flow in 2015 as we continue to sell through excess inventory and tightly controlled costs.

We repurchased roughly 1 million of our shares during the second quarter at an average price of CAD23.85 and expect to continue buying back our shares in separate with free cash flow delivery. Our balance sheet is in excellent shape.

Our net debt to total capital ratio is just over 35%. In addition to completing a strategic acquisition, our strong financial position provides us with great flexibility to return capital to shareholders with a solid dividend yield and share repurchases at a time when market volatility impacts our share price.

On this note, I’ll turn the time back to Mauk.

Operator, that concludes our remarks. Before we go to the Q&A, we request everyone on the line that as a courtesy to your colleagues to 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, can you please open up the line?

Thanks very much and good morning. So, starting on South America, the downturn there has been in place for almost six quarters.

So, I guess I was a bit surprised to see you continue to reduce headcount in Q2. Can you just give a bit of color is to whether that’s related to further deterioration in market conditions or finding ways to do more with less or bit of both?

Hey, Cherilyn, it’s Scott. Yeah, I mean, a couple of things.

So, during the quarter, you have seen the copper price now at CAD2.35 [ph], so it’s at a six year low, multiyear low and I do think there is more cost pressure and more margin pressure from our customers that we need to react to and so, we’re trying to stay on top of that and the 85 positions primarily frankly general management type level, so, not revenue generating more on the overhead side, but we’re going to continue to react. I mean, the team there has done a great job maintaining the profitability.

Margins are actually higher or in line with where we’ve been historically. And I think we’re just going to have to play this quarter-by-quarter.

If we continue to see pressure and low commodity prices and lower activity, then we’re going to have to continue to take action. So, I guess that’s the answer to your question.

I mean, I don’t think -- if you look at product support as an example, we knew new equipment is going to be down significantly, product support is essentially flat year-to-date over the prior year and so, we’ve been kind of trembling along on this bottom here for three or four quarters and I suspect we’re going to stay in this level for the next year at least, given the uncertainty in Chile in particular and also Argentina.

Okay. That’s helpful.

And then in Canada, you mentioned a number of factors that reduced gross margins in the quarter, including a focus on reducing inventory and a pretty sizeable reduction in rental revenues. Can you just give us a sense as to what would be the rank order of those factors?

Sure. Why don’t I start, Steve, then you can add.

So, the rental results I think are pretty consistent with the cyclical nature of what we’re in. I mean, if you look at all of the rental companies that are operating in Western Canada, they’re seeing pretty similar results and that’s customers use rental as peak shaving a lot of times and so, when you see a downtime like this, rental is usually the first thing to go.

So, that’s not unusual. When I think about the gross margin, now I think there are probably four impacts.

One is a little bit more power systems in the mix. So, new equipment sales were down 16%, it’s down 16%.

So, when you actually look at the core market and the mining market, it was down more than that. So, you have a little bit of an offset from power systems equipment, which is at a little bit lower margin, point one.

I think there is a little bit more used equipment year-over-year, which -- and when you compare year-over-year, that was done at lower margin. More focused on generating free cash flow.

I was really pleased with the pivot point in June on free cash flow delivery but as a result, we did some dealer trades at a lower margin type business to get off some of that inventory. And then lastly competitive pressures, I mean it is a competitive market.

I think that explains four reasons why the margin is little bit lower.

Okay, perfect. That’s my two.

Thank you.

Thanks, Cherilyn.

Hi, good morning. So, with the Kramer transitioned into Finning and the 16 branch closers, how happy are you with your footprint in Western Canada right now and what work is left to be done in your mind?

Hey, Jacob. So, as we thought about the branch optimization, we think about it in three phases.

The first phase was what we executed on in the first quarter and part of the way through the second quarter, which was decisions around branches that had little impact on the customer and was the right thing to do from a cost perspective and that resulted in the 16 branch closures and that continued through the second quarter with most recently consolidating the head office space in Edmonton, which was a pretty significant new for our head office and that was done just a couple of ago, completed a couple of weeks ago. The second phase is the oil sands and that’s in process and that’s all about consolidating activity around Fort McKay.

And we started that process, that will continue through the third quarter but essentially it’s shrinking the footprint in Mildred Lake, making sure we continue to take care of the customer there but non-centered activities will move out of Mildred Lake and move to Fort McKay. We’ll also move mining activity out of the other branches, where some mining activity had gone on like COE and town shop in Fort McMurray and consolidate that in Fort McKay and that is underway.

I think that will probably a third and fourth quarter activity but it’s well underway right now. I think the good news about that too is having the Fort McMurray town shop focusing on our core customers, non-mining oil sands customers I think would be a good benefit in this environment.

And then the third phase, which we’re working on right now is, the optimization of that Southern Corridor and the Alberta Saskatchewan backbone and that’s a work in process. Expect that we’ll come to some conclusions on that over the last two quarters of the year.

Okay, that’s very helpful. And then maybe just as my second question, what is your exposure to agriculture right now with that Kramer acquisition and how big of a drag was that on the second quarter?

So, second, Kramer didn’t close until July 1. So, Kramer is not incorporated in these results at all and I think that will be a help for us as we go to the back half of the year, because it is accretive and will generate free cash.

And then second, on your ag question, Saskatchewan obviously have a lot of ag exposure and we haven’t -- the Kramer business had not been as focused on ag over the last couple of years as I think we need to be and so, I think there is an opportunity for us there on ag to actually add to our performance as opposed to take away from our performance.

All right, thank you.

Thanks, Jacob.

Hey, good morning, Scott.

Hey, Yuri.

Just two quick ones from me. I’m not sure if there is, are there further headcount reductions planned right now for Canada at present?

No. I think the question is always dependent on the macro, but I think the team has done an incredible job to be very decisive and get this behind us.

850 people out of the business since last year and 13% SG&A reduction. We think we got the right level of people given the activity we see.

I don’t think you can ever say never because it obviously depends on the macro. So, right now, we’re going to move forward on this basis.

So, it sounds like activity is -- it sounded like in your prepared remarks that that mining activity in Canada has stabilized somewhat sequentially, but was that right in picking up that perhaps the construction markets are a little bit weaker incrementally?

I think that’s fair. I think if you look at the product support business down 7% from the second quarter relative to down 14% in the first quarter, so that’s a good trend.

And it was up Q2 over Q1 and actually the mining piece of that from a part perspective was actually stronger than we expected. We saw a little bit more weakness in the core side than we expected.

So I think that’s a fair observation from you.

Okay. And last one from me.

Obviously one of your competitors had a pretty large sale of autonomous trucks in the quarter. Your client is obviously looking to reduce cost and view those as a way to do it.

Where does Finning or Cat stand with this technology and how do you view your competitiveness in the market there?

Sure. So why don’t I actually broaden that question, so just few comments on Fort Hills.

So first on the ultra part, Suncor is one of the major that has run a mixed fleet in the offense historically and two, the environments we are in is an extremely competitive environment right now and that’s not a surprise to anyone. Three, I am confident as is Cat that we have a leading solution in autonomous and the customer responses have been positive.

We have a good relationship with Suncor. I am obviously disappointed that we didn’t win the ultra part business.

But I am also confident that there will be significant opportunities for us, for Finning particularly on the auxiliary equipment side. As it relates to autonomy, I feel good about the Cat autonomy solution that customer response has been positive, our customers down to Australia where Cat is running an autonomous fleet and so I feel good on that regard.

Thanks, Scott.

Good morning, guys.

Hey, Ben.

Good morning, Ben.

I am going to return to a theme that’s sort of been out there for a while just on the inventories. These numbers don’t reflect any acquired inventories from Kramer, is that correct?

Correct.

So if I look back, if I compare their levels to where they have been in the past, they are more or less unchanged. In fact I think in terms of a turnover, they were lower than -- turnover was lower since 2Q13 and just going through your MD&A I recognized there are a lot of moving parts to this, I guess given that the somewhat surprising slowdown in the parts business, your turnover is going to be a bit lower there.

You mentioned that you stocked up from some deliveries into the back half of the year in the UK and then of course as you mentioned earlier in the year, you received deliveries from orders placed in the fall of last year before the reality of the oil collapse sort of set in. So can you just maybe clarify a little bit how you are feeling about your inventory levels and turnover in light of all the different moving parts?

I mean clearly there must be still some more work to do here with free cash flow being down year-over-year. I imagine that’s a part of it as well.

You are still having a lever to pull there and what’s preventing you from pulling that harder at this point?

Thanks, Ben. Complicated question, because you’ve got three different regions, so let me take a shot at it and Steve, if I don’t get it fully – correct me if I am wrong, but let’s focus on Canada first.

We came into first quarter with excess inventory on the equipment side and that was to be expected given the magnitude of the downturn. If you now go into the second quarter, look at where our free cash flow generation came from.

It came from Canada and that tepid point in June was pretty significant and I suspect now we are past the free cash flow consumption stage in Canada and into the free cash flow generation stage and in fact in July we are going to see the same thing. So that’s good news.

If you compare equipment year-over-year in Canada, it’s up about CAD60 million. So to go through the type of dislocation we did and only have CAD60 million higher inventory, I think a huge credit to that Canadian team.

And on the part side, the turns have increased significantly year-over-year through this downturn and we actually had less parts inventory in Canada than we did at this time last year. And our customer loyalty is up significantly and our service rates are up significantly.

So the supply chain improvements in Canada have been pretty significant and in fact are the driver of the free cash flow in the quarter. If you compare that, though, to last year at this time, where our free cash flow generation was higher, we had the benefit last year of the destocking in South America, which we don’t have this year.

And in fact when you look underneath the numbers and you see our equipment inventory and parts inventory in South America, it’s a little higher than I would like to see it in the second quarter and the team was expecting a rebound that didn’t come to Cherilyn’s first question. And so Chile has been a little bit slower than we thought and as a result we have a little bit more parts inventory and equipment inventory than I would have liked.

And then on the UK we’ve had too much inventory. I mean we’ve stocked up for the selling season, that will all burn off through the back half of the year, but in this quarter we have a little bit too much inventory in the UK.

So I guess summary, I feel really good about what’s going on in Canada to get off of this excess inventory position and increase the parts turn, but you are right, there is more work to do and I think you will see that in the third and fourth quarter with stronger free cash flow generation.

I mean, when you mention the big destocking you did in South America this time last year, I suppose it begs a question and in some respects because you’ve just answered it why that hasn’t happened or when it’s going to happen in Canada, because it seems to me that that’s what still needs to be done. I mean I recognize that you’ve been hit really hard with the downturn and as you say, some credit is due to managing that.

But you must still be sitting on machines that are moving and like that’s where the back half of the year, the free cash flow must be coming from Canada destocking.

I totally agree with that and more work to do and we still have that inventory in Canada, so you are going to see destocking in the back half of the year, you are also going to see the contribution of Kramer which will add to free cash. So I think that your observations are correct.

I think the one thing when you compare South America and having a strong second quarter relative to Canada where we had what I view of the strong second quarter, but not as high free cash flows in the last quarter. So the downturn in Chile started a quarter earlier.

So when you look back to kind of the I guess we are now back to 2014, it is kind of the November, December timeline where things started to really decline in Chile, so that second quarter you did see the destocking and through the remainder of the year I think you are going to see that in Canada here in the third and fourth quarters.

So what I was going to add is the thing to keep in mind is, we really weren’t significantly overstocked in equipment in Canada before the short downturn. So the increase in stock in Canada came really in the first and second quarter.

We were still receiving the equipment that we had purchased in before the downturn in the second quarter. So we do have excess stock still to sell through in Canada and it’s in motion.

We’ve made good progress in the first and second quarter. So we did receive more of the committed purchases in the second quarter.

So we would expect to sell off on a consolidated basis nearly a CAD0.25 billion in inventory in the back half of the year. That would include, as Scott mentioned, we are in what I would call the seasonal inventory in the UK driven by basic construction equipment.

And but we also have seen the order intake, so as Scott said, we fully expect that to sell through in the normal course of business in the UK. When we think about Kramer specifically, we have used the Kramer inventory even before the transaction closed, knowing what the inventory was to make sure we weren’t buying equipment where there were gaps in the equipment inventories in Canada to meet customer orders.

So I am not sure what the ongoing run rate should be for Kramer, but in total we’ve been working out as blended inventory for the past few months and we include that in looking at the total sale down of Canadian inventories.

Okay. If I can count that as one question on inventories, could I ask you just quickly to maybe breakdown the SG&A in Canada specifically like the SG&A to sales ratio, I am most interested in how you are managing that down or if you’ve managed to down – if you strip out the severance cost, that seem to be a big opportunity to get costs under control.

Yeah, as I mentioned, our revenues went down 9%, our SG&A went down 14%.

That’s in Canada?

Yes, in Canada just for revenue. So we’ve got significant leverage created by that, so I don’t know what more specific you like.

I think once we get –

The nature, let me ask maybe the nature of those reductions in SG&A. That’s mostly admin cost and reflection of the lay-offs and downsizing, that’s not a – what profile of that is technicians that you may have let go or hasn’t there been any?

So you’re right, Ben, most of that is people, and that’s a big part of the process. So when you think year-to-date, we had a headcount reduction of about 750 people year-over-year, about 850 people in Canada.

We have been pretty sensitive to think about revenue generators versus non-revenue generators, so a lot that has been what I would call, non-technicians, but frankly given the all-time decline, there has been a lot of -- and this is particular oil sands related, but there has been significant reduction on the technician side as well. The way I think about it is about half and half.

That’s helpful, thanks a lot guys.

And in addition, Ben, so when we shared with you last quarter, we thought the run rate would be between right around $15 million on an annual basis for the labor reductions. Canada is also through the operational excellence activities, reduced discretionary costs significantly another $50 million this year, which I would say most of which is sustainable.

Right. Yeah, I guess – I mean, I am just trying, it’s very difficult at this stage to discern how your productivity initiatives are advancing when the market is contracting as much as it is, and you’re adjusting your cost base to lower revenues, but you also want to be able to do more revenues with the same or less cost?

And I think even though as Scott said, we are estimating say maybe half was variable cost. As revenues come back because of the gains in our operational efficiency, particularly in service, we won’t expect all of the variable to come back pro rata with revenue increases, although it largely would, but it would not come back one-for-one through the reductions, because of the improvements in our actual operations.

Thanks.

Thanks, Ben.

Yeah, good morning gentlemen. Just to come back on the second question about your optimization phases or the three phases, could you maybe quantify what could be the saving expected from those initiatives and whether the target is to maintain a 6.5% EBIT margin in Canada at least for the second half.

Yeah, so I can’t give you a target on the facility optimization, but what I do feel pretty comfortable about is you saw sequential EBIT margin improvement, Q1 to Q2 and I think you’ll see that again in Q3 and Q4. Some of that is because of the cost reductions that are behind us and some of that is product mix shift.

So I feel pretty comfortable about that, Benoît.

And Benoît, I would guide you to say that remember that in the first quarter most of the reductions came out late in the quarter, the second quarter that came out early that’s when we talked about the improvement in EBIT, we should have a full quarter of benefit in the third quarter and of course again in the fourth quarter. So it will be the average for the ramp of the reductions, but that by itself will create a meaningful improvement in the quarter-to-quarter EBIT margin.

Okay.

What’s provided [ph] around that is that’s all dependent on the macro, the macro that we saw in the second quarter.

Okay. And back in June, Scott, you were kind of down 1,500 people since mid-2013, you had been closing 20 facilities year-to-date on a consolidated basis.

So are those number unchanged or has it been increasing since back in June?

I think if you look at since the peak in Chile, so when the downturn started, I think that 1,500 number is about right. I think what you’re now seeing – and the facility numbers that I think we referred to was primarily Canada.

You have seen some facility optimization now in South America in the last quarter and you’re going to see some facility optimization in the UK going forward. And I think given some of the weakness in the UK business from a profitability perspective, there is also going to be some cost reduction initiatives in the UK as we look to the back half of the year.

So I think it’s pretty much in line with what we told you in June, Benoît and I gave you a little bit more color here, but pretty much in line with what we told you June.

Okay. And just to come back on the inventory reduction, I just want to clarify that you’re expecting about 250 million improvement in the second half, so you must be assuming that the inventory turn to improve sharply from 2.3 to close to 2.7 at year-end, am I right?

I don’t want to give inventory turn projection. What we do feel comfortable is that there will be inventory destocking in Canada in the back half of the year.

And as I think about our free cash flow profile over the last I guess now 2.5 years, CAD400 million in 2014 – sorry, CAD400 million in 2013, CAD450 [ph] million in 2015, that went up to 2015, that kind of feels like in that CAD400 million range. I don’t want to get – that might be a little higher or little low, but it feels like that.

And you know what, if I look back at the end of the year and I say, generated that kind of free cash flow, paid out CAD100 million through dividend, did a strategic acquisition in the range of 240 and a CAD100 million in share repurchases, that feels like a pretty good proposition for shareholders as I am sitting here at the back half of 2015, and that’s how I get to think about it.

Benoît, I would just add and clarify from my remarks that I would say, if you’re looking at inventory specifically in cash flow, you looking at a range, I mean, looking at somewhere between – over 200 million or 200 million to 250 million. But the difficulty with just specifying it specific term versus the one you can do the math on is subject to revenues and mix.

When we start looking at the turn then we got what would be the shift and the mix between the various types of inventory parts equipment as well as the topline.

Okay. That’s very, very good color.

And a quick one just for the margins in the UK, it’s been down and you mentioned about the salary increase, so could you provide more color about the magnitude and it will impact also I would expect -- this will impact the margins going forward as well.

Yeah, let me link back to what Scott said. So there hasn’t been as much cost reduction in the UK today, because of the focus on the bigger changes since -- and in Canada.

But we do expect further cost reductions in the UK. The salary increases were more statutory, mandatory, inflationary based, and so we would expect that not to offset future headcount reductions, the annual type adjustment, so we would expect to see benefit from further cost reductions in the UK as Scott mentioned and improvement on the EBIT margin.

Okay. Thanks very much for the time.

Thanks, Benoît.

Hi, good morning. Scott, can you comment on the focus on free cash flow and reducing inventory.

But at a time when I guess a lot of the inventory arrived at a higher FX rate, I am just wondering how you reconcile free cash flow with margin expectation for the Canadian operations going forward?

Yeah, that’s a good point Sara and I think typically in a normal growth market, a weakening of the Canadian dollar would provide a meaningful benefit to our results. In the current Canadian environment, declining business activity, there is offsetting margin pressure on new products and equipment, so as I look at the second quarter results, I don’t think we have exited from that.

And so I think we need to be pretty thoughtful about inventory destocking and how you do that. And we did some dealer trades this year for example, this quarter that will add a lower margin, you looked at used equipment, year-over-year that was done at a lower margin.

But as you think about the inventory position we’re in, we have excess inventory but it’s not big mining equipment, it’s normal core of business, and that’s why I think you need to be pretty thoughtful about this trade-off between free cash flow generation and margin, and we are thoughtful about that and would be thoughtful in the third and fourth quarter.

So, with that you still expect an improvement sequentially into Q3 and Q4, is that on the gross margin improvement or more on SG&A savings?

I think, more on the SG&A, right, so you have a lower SG&A, I think you’re going to have a different mix and more product support, so I suspect you will see sequential EBIT margin improvement.

Okay. I wanted to ask about foreign exchange hedging as well, just given the impact on the UK on receivable translation, just wondered what are you hedging right now and is there room for I guess more optimization on that front going forward?

Anna Marks is here with us and he is closer to the FX. We are generally hedging more on the Co-Chairman side, that’s where you saw the adjustment on the receivables.

So we tend to hedge more on the procurement activity.

We will hedge where it makes sense and we are currently looking at this to see if there is more opportunity, Sara. We do hedge balance sheet exposures as much as possible.

There was a euro receivable in the UK that we are looking at currently right now to hedge, but we do look at our purchases in the future and try to hedge as much as possible and fix the price.

Okay. And just I guess just a little surprising that the receivables wouldn’t be hedged at the same time?

It’s something we’re looking at, Sara. We don't hedge 100%, but it’s something that we do as much as we can.

Okay. That’s it from me.

Thanks.

Thanks. Scott, I'm just wondering if you can give us a little bit more color or insights in terms of what’s specifically going on, on the parts side versus the service side in the parts and service business.

I know service profitability is high in your list of priorities and also wondering how that is impacting your ability to service -- better profitability out of the service side of the business.

Yeah. Sure, look, I guess a couple of comments.

One of the service profitability side, I think good progress, I think if you look at and I think I said this last quarter and in the operational review last week and this was confirmed, if you look at the non-oil sands part of the business, great progress on service profitability and I think all the branches have done a very good job in improving the way we service our customers on the loyalty site and also profitability side. So I’ve been pleased that.

I think the oil sands is more challenging in this environment and when you see this big downturn. You get asset utilization issues and labor productivity issues and that's why unfortunately, we had to make the difficult decision on technicians to help on the labor productivity side and one of the reasons that we’re optimizing all around the Fort McKay facility.

And so that will help, but the oil sands is the major challenge in this type of environment. As we look at the second quarter and look at the product support business, I guess the pleasing thing to me in the second quarter was that although product support was now 7% year-over-year, the parts, we started to see a little bit of recovery on the parts side and so that was pleasing to me, because I think the first quarter was, I was a little surprised at the reduction, the 14% reduction which was kind of parts and service equally.

We continued to see weakness on the service side in the second quarter in the oil sands as some of our major customers are in-sourced and I think what they’re trying to do there is they look, as you would, in their situation, you look at the contract workforce before you look at your own workforce and I think that dynamic went on a little bit and that means we need to be very agile and responsive in terms of how we manage our cost base. So hopefully that gives you some color, Bert.

Yeah. It does.

Thanks for that. And just on the used, what was the source for the used in Canada in the quarter.

Was this RPOs that people didn't convert on and rental? I’d just be curious as to what gave you the supply of used and any color Scott that you can provide in terms of excess supply and pricing on the used in Western Canada, that would be interesting?

Sorry, the last question, Bert. I got the used question.

What was the second question?

Sorry, I’ll move my mic a little closer, just in terms of pricing in Canada.

Okay. Well, so we saw big increase in used.

Some of that was the trade-ins, some RPO returns, not rental, I mean this was kind of mostly trade-ins. We saw a decrease in the margins year-over-year on the used, which was pretty significant and I think that’s indicative of the environment we’re in.

The pricing environment is challenged right now, it is a very competitive environment. I was pleased with our response in 2Q from a participation rate and a market share rate and an order intake rate and those were all the pleasing things.

But the margin and I talked about the four reasons why the margin was a little bit lower. It was challenged and the ability to pass on FX was also challenged.

So, competitive environment, but I'm pretty pleased with the participation and the order intake.

Sorry just to add, so far, the shift in mix and demand of used though is the weakened Canadian dollar did create price favorability on used equipment against new?

Okay. But there was no -- you weren't using auctions to get off of used equipment more so than any others?

No.

No. Okay.

That’s perfect. Thank you.

Thanks, Bert.

Hey, good morning, everybody. Scott, you get a lot of questions on de-stocking, I guess I got a couple more.

I was just curious, can you give a little more color on really how you’re destocking, I mean, we're talking about this I feel like as if it’s an automatic that you can de-stock in the second half of the year, but what do you do, I mean do you cut price, do you send stuff back to cat, or you go in more to auction, I mean, how do you have any visibility in this environment that you can de-stock over to -- where you need to be over a reasonable time period without the demand environment cooperating?

I think that's a good point. It all depends on the macro.

So make no mistake, this is dependent on the macro. If you look at the new equipment sales, they’re down 16% in Canada, a little bit more in core, I think core was down 30% and these are not exact numbers, core is down about 30% and mining was down about 25%.

I was encouraged by a little bit of an uptake in order intake, and so that's good. And frankly we haven’t supported it from the factory since November and so that continues.

So this is not driven by sending things to auction. There is a little bit of dealer trades and there is a little bit of competitive tension around gaining sales.

But so long as the environment doesn’t completely melt down from a new equipment side, you’re going to generate cash. And whether it happens in the third quarter or the fourth quarter or the first quarter next year, given this is inventory that is not stuck, it’s not big mining trucks that people require our new Greenfield investments.

These are dozers and excavators that have a pretty regular turn rate. I feel comfortable that these will ultimately be sold out over the next year.

And I told you what I think on free cash flow, I may be off a little bit, but I do feel comfortable that the Q3 and Q4 are going to be free cash flow positive years and pretty significant quarters pretty significantly.

It would be probably be a better terminology for us if we use sell through versus destocking. Destocking sounds like we're liquidating or fire selling or selling it to unusual discounts to move it.

We’re fortunate in this business that the value of the equipment has a long shelf life and as Scott said, most of the excess inventory in Canada is general construction equipment. So we may be off on timing a bit, but we would expect it to sell through and so it's more a matter of not ordering and not ordering as with more of a forward-looking line, as we manage and sell through what we have.

It’s not a forced reduction and so we have the strength of a balance sheet and the strength of a product to manage this wisely. And in an environment where the holding costs, interest costs are very low.

So some unique characteristics for this business, but -- so we probably should use sell through instead of destocking. I hope that helps.

Yeah. Thanks, guys.

That’s helpful. And then on the Canada product support, down 7%, what’s your overall expectation for the year now, given what you’ve experienced in the first half and should we be expecting to see down, mid to high single digits for the next 6 to 12 months?

Well, we won’t try and give the specific number trend or prediction on the number, but the general trend as you know, we don’t think it’s sustainable for the continued deferral maintenance and even though they may continue to shift some service in house, the parts is where we make the most profit, it’s the best margin. So it’s a matter of timing of when the product support returns, but we do expect it to continue to improve.

Thanks very much.

Thanks, Ross.

Well, thank you very much, operator and thank you everyone for listening. We look forward to speaking with you again next quarter.

Bye for now.