Finning International Inc.

Thank you, operator. Good morning, everyone and welcome to Finning's third quarter earnings call.

Joining us today are Scott Thomson, President and CEO; and Greg Palaschuk, EVP and CFO. Following our remarks today, we will open up the line to questions.

This call is being webcast on finning.com. We've also provided a set of slides that we will reference during our prepared remarks.

These slides are posted on the Events and Presentation' page of our Investor Relations' section of our website. An audio file of this call and the presentation will be archived on our website as well.

Before I turn it over to Scott, I want to remind everyone that some of the statements provided during this call are forward-looking. Please refer to Slide 12 and 13 are important disclosures about forward-looking information, as well as non-GAAP financial measures.

Please note that forward-looking information is subject to risks, uncertainties and other factors as discussed in our Annual Information Form under key business risks and in our MD&A under Risk Factors and Management and Forward-Looking Information disclaimer. Please treat this information with caution as Finning's actual results could differ materially from current expectations.

Scott, over to you.

Thank you, Amanda and good morning, everyone. On today's call, I'm going to comment on our Q3 results, provide an update on how we are executing our strategy and outline our objectives going forward.

I'm on Slide 2. I'm pleased with our results this quarter.

We continue to maintain an excellent safety record, and our customer loyalty scores improved by 16% year-over-year. This performance speaks to the engagement of our people and the trust customers put in our business during these uncertain times.

I want to thank our employees for their adaptability, perseverance and unwavering commitment to supporting each other and our customers, often under trying circumstances. Our revenue was down 21% year-over-year.

Customer activity remains significantly below 2019 levels in most of our end markets, mainly as a result of pandemic related impacts and a lower price of oil. When we compared to Q2, we saw modest improvements in market activity, particularly in product support and rental, as customers resumed work and put their equipment back in service.

Our net revenue was up 8% sequentially from the second quarter, driven by recovery in the UK and Ireland and slowly improving market conditions in Canada and South America. The timing of economic recovery in each of our regions has been correlated with improvements in COVID infection rates.

The execution of global cost initiatives is on track, which is evident in significant SG&A reduction. A lower cost basis driving improved profitability in a recovery.

Significantly higher EBITDA compared to Q2 and reduced finance costs raised our EPS to $0.54. I will now turn to Slide 3, which summarizes our strategic journey.

Improving return on invested capital in all of our regions remains our key focus area in the upcoming recovery phase. There are three components to that.

First, accelerating product support revenue through strengthening relationships with customers and leveraging technology. Second, improving competitiveness of our business with a laser focus on driving down our cost base.

And third, consistently delivering solid free cash flow, which allows us to return capital to shareholders and invest in opportunities that improve the earnings capacity of our business against the backdrop of cyclical end markets. Our teams have done a good job of balancing these priorities by staying focused on controlling what we can in a difficult and uncertain environment.

On the cost side, we've accelerated our strategic plans to drive employee and facility productivity improvements. In South America, our previous investment in technology has enabled us to reduce the cost to serve, address labor inflation and improve operational execution going forward.

In Canada, we have taken significant cost actions to address oil price dislocation and move customer work to locations with lower operating costs. In the UK and Ireland, we are tightly managing costs through the recovery period, while building the right technology skill sets to support us in capturing future market opportunities.

Our latest actions complement the extensive work we have done over the last few years to lower our cost to serve. I'm confident that we have successfully positioned the company for year-over-year earnings growth in Q4, even in a revenue environment that is expected to be lower than 2019.

From a capital management perspective, our results highlight the structural improvements that have been made in our inventory management practices since the last market dislocation in 2015-16. Connected assets allow us to monitor machine utilization trends as a leading indicator of customer activity.

We have also embedded stronger operational discipline around inventory ordering. Significant free cash flow generation this year is a direct result of strong management of working capital and reflects the strength of our business model.

We are pleased to see an increasing level of technology adoption from customers, which is helping our business maintain effective operations as well as increasing the rate of return on investments we have made in recent years. In addition to enabling more robust inventory management, machine connectivity provides us with a solid foundation to grow product support market share and non-mining sectors.

Our ecommerce journey from 10% of non-service parts online in 2016 to 45% in 2020 continues today as we are supporting customers and converting to our online platform. We will remain in omni-channel business with parts ordering available physical branch locations and through our call centers.

Our performance solutions which are value-added technology and productivity services for customers to improve their performance are critical and positioning us to capture new equipment and product support opportunities such as HS2. Integrated knowledge centers supporting our mining customers in Chile and Canada are great examples of how these solutions are strengthening our customer relationships.

We're seeing an accelerated adoption of autonomy by our mining customers, including a wide scale deployment of autonomy in South America at Teck's QB2 site. In Western Canada, only 6% of the Caterpillar ultra-class truck fleet is autonomous, which presents significant potential for future autonomy conversions.

Finally, strong EBITDA to free cash flow conversion has allowed us to reduce our leverage and finance costs and improve our financial position. Before turning it over to Greg for the regional analysis, I will highlight the key drivers of our Q3 consolidated results which are shown on Slide 4 and 5.

While all regions experienced a decline in new equipment sales from Q3 2019, nearly three quarters of the $254 million reduction within Canada, mostly due to challenging market conditions in Alberta. Product support revenue is more resilient as the year-over-year decline slowed considerably compared to the last quarter.

The $110 million reduction from Q3 2019 was split equally between Canada and South America. If we compare our total revenue to Q2, the increase of $108 million was mostly driven by a strong recovery in the UK and Ireland.

While we saw a notable improvement in product support and rental activity in Canada, market conditions remain challenging and the pace of recovery in most sectors in Western Canada is slow. South America was the last of our regions to be impacted by the first wave of COVID, with the peak of infections occurring that started Q3.

As a result, Q3 was a soft quarter from a revenue perspective. While we are seeing an improvement in quoting activity in the construction sector, where our order intake was up from Q2, customers' capital budgets remain constrained, and this is reflected in our backlog.

However, we have seen a notable increase and resumption of requests for proposal activities from mining customers in both Canada and South America. Turning to Slide 5, I'm pleased with our EBITDA performance in Q3.

Successful execution of class actions and a higher proportion of product support in the revenue mix allowed us to improve profitability despite a significant reduction in volume from last year. Our SG&A costs decreased by 13% from Q3 2019 to $290 million.

Some of these costs will come back if market activity fully recovers, but will be in lower cost locations. Our goal is to reduce SG&A as a percentage of revenue to about 17% when the market returns to mid-cycle activity levels.

In 2019, when our revenue was about $7.3 billion, we finished the year at 19% SG&A. I will now pass it over to Greg.

Thank you, Scott. I'm going to provide more details on our Q3 financial results by regions, discuss our strong balance sheet and then summarize our expectations and objectives looking forward.

But before I start, I'd like to extend my gratitude to the full global Finning team for their absolute commitment to not only navigating a challenging business environment, but executing very well. And using this time period to build a more efficient business with a higher earnings capacity when the market recovers to mid-cycle levels.

Starting with Canada on Slide 6, net revenue decreased by 26% from last year, with lower revenue across all sectors and lines of business, reflecting challenging market conditions related to COVID-19 and lower price of oil. Net revenue increased to modest 3% sequentially from Q2, driven by product support, used and rental.

New equipment sales were down 51% as customers restricted their capital spending and implemented cost containment measures. By contrast, Q3 2019 benefited from deliveries of large lower margin mining packages.

Product support revenue declined by 11% from Q3 2019 that increased 4% compared to Q2 2020. Oil sand producer truck utilization returned to pre-COVID levels at the end of September, correlated with the overall production recovery profile.

Recall that in Q2, production was reduced by about 700,000 barrels per day, leading to about 30% of truck's being parked. Some operational challenges at customer sites did differ the ramp up of trucks going back in-service by about a month.

We expect component exchange work to pick up in Q4 and into 2021, driven by an increase in oil production and associated machine hours. In addition, we have started to see mining contractor fleets go back to work, particularly at Suncor Fort Hills, which is bringing in back online the second train that had been suspended in April 2020.

In construction sectors, equipment utilization hours have increased, driving increased demand for parts and service compared to Q2 2020. Recovery in rental occurred during the quarter where Q3 is the typical peak season.

Light rental activity drove strong demand for heavy rentals, landscaping and small contractors improved demand for light rentals. While activity levels are solid, winter season typically sees lower physical and financial utilization in rental.

We continue to see strong momentum from our 4Refuel business with EBITDA up 13% year-over-year and cumulative free cash flow since acquisition of $41 million. The bulk of our cost actions announced last quarter in Canada have been executed.

And SG&A was down 9% or $43 million year-over-year and 4% or $16 million sequentially. We achieved significantly improved margin performance compared to Q2.

Adjusted EBIT as a percentage of net revenue was 8.1% in Q3. We adjusted our results in Canadian operations for $35 million Canadian Emergency Wage Subsidy in the third quarter, which is included in other income.

We continue to drive productivity gains and reduced cost to serve by increasing efficiencies in our back-office functions, optimizing customer's service work across our hub and spoke, rebuild, repair and respond or RRR network and leveraging our improved omni-channel toolkit. As reduced our cost to serve in Canada, we expect to see sustainable improvements in productivity per employee and per square foot.

Our medium-term opportunities in Canada are driven by product support growth from a large and ageing money equipment population, market share gains and product support in the construction sector. We're also encouraged by large infrastructure projects in Alberta, BC and Saskatchewan associated with infrastructure stimulus spending, which has been announced by provincial and federal governments that will offset uncertainty for private sector spending.

Overall, we expect to see improved profitability in Canada in 2021, even in a modest revenue recovery environment. Moving to South America, and I'm on Slide 7.

In functional currency, revenue decreased by 18% from Q3 2019, primarily as a result of COVID-19 impacts, and was up 6% sequentially for Q2. New equipment sales were down 29%, lower mining deliveries in Chile and reduced construction activity in Argentina were the main drivers.

Product support revenue declined by 16%, impacted by lower demand from Chilean mining customers. The pandemic hit a peak in Q3 in copper production and the country decreased by about 6% year-over-year in July and August.

Operating restrictions and Chilean mine led to a deferral of component of exchange and major maintenance work. Compared to Q2, product support revenue was relatively flat.

As conditions gradually normalize and operating restrictions are removed, customers are beginning to catch up on component exchange and major maintenance works in Q4. We expect mining product support revenue to approach pre-COVID levels as we exit 2020.

SG&A declined 21% year-over-year and 6% sequentially, as we saw significantly improved performance in Chile in Q3 from leveraging systems' benefits and cost actions taken over the last 12 months as well as a lower peso. Q3 EBIT as a percentage of net revenue increased to 8.2% compared to adjusted EBIT as a percentage of net revenue of 7.8% in Q3 2019.

Argentina was profitable in Q3 supported by significant cost actions we have taken. Despite some uncertainty in both Chile and Argentina, we're well positioned to drive higher year-over-year profitability in South America in Q4 and into 2021.

Driven by improved execution and a $3 copper price supporting increased quoting activity and product support revenue the outlook in Chile is positive. Turning to UK and Ireland, I'm on Slide 8.

In functional currency, revenue decreased by 15% from Q3 2019, primarily due to an 18% decline in new equipment sales. However, compared to Q2 2020, revenue was up 46%, driven by a recovery in construction activity, following the easing of lockdown measures and the resumption of large power system project deliveries.

Machine utilization hours and product support run rates were approaching pre-pandemic levels by the end of Q3. We saw a notable improvement in profitability in the UK from Q2, reflecting product support recovery and a lower cost base.

Q3 2020 EBIT as a percentage of net revenue was 4.1%. We continue to utilize the furlough program in Q3, about 20% of our employees were on furlough during the quarter, down from 55% at the high point in Q2.

We have a robust cost management program in place to control costs through the recovery. At the same time, we are building the right skill set, particularly in technology to position us for our future opportunities such as HS2.

Although a second wave of COVID is impacting economic activity in the UK, and the UK government has just announced a four-week lockdown, we do not expect the same extent of lockdown measures to be implemented in the sectors we serve as we're in the second quarter. We have a large backlog of high-quality Power Systems project that we're delivering right now and we'll continue to deliver in 2021.

Importantly, while there have been some delays in the construction work is now expected to ramp up slower than initially planned, the HS2 projects will drive improved activities in general construction equipment markets in 2021. We are very well positioned to capture new equipment product support opportunities related to earthmoving work for HS2.

I will now turn to Slide 9 to discuss our strong balance sheet. Our resilient countercyclical business model and improved working capital management drove continued strong EBITDA to free cash flow conversion.

Quarterly free cash flow was $316 million. This allowed us to further reduce our leverage and financing costs.

As of September 30th, our net debt to adjusted EBITDA ratio was 1.7, down from 2.5 this time last year. Our financing costs decreased by 16% from Q3 of last year.

We have made great progress monetizing our surplus, parts and equipment inventory in South America and I now view this exercise is largely complete. In Canada, our inventory is in a very healthy position and has benefited from proactive management.

Q4 is normally our strongest free cash flow quarter. However, we expect this year to be a bit of a different shape.

While we continue to expect positive free cash flow in Q4, we're planning for revenue recovery and have started to purchase inventory. All of that considered, we're tracking to approximately 100% for EBITDA to free cash flow conversion this year.

Our balance sheet is in great shape. We continue to effectively manage our capital and rental expenditures.

We're seeing an increase in customer demand for RPOs, rental equipment with a purchase option. As the majority of our RPOs convert to purchases, we don't consider them in addition to our rental fleet.

Excluding our net investment in RPOs, net CapEx and rental fleet expenditures were $77 million year-to-date, down 56% from the same period in 2019. We expect to finish the year within our stated range of $90 million to $140 million CapEx.

From a capital allocation perspective, our go-forward top use of capital is high returning, short payback organic growth which consists of inventory purchases to support the market recovery, selected investments in our Canadian network transformation and higher rate of return IT projects. Our next priority is to maintain our dividend which our Board of Directors approved yesterday, followed by opportunistic share repurchases, then further net debt repayment and lastly, acquisition opportunities.

Slide 10 summarizes our expectations and objectives going forward. Despite the numerous challenges we have faced this year, our teams have stayed focused on what we can control, namely, improving execution in South America, reducing the cost base in Canada, positioning for significant opportunities in the UK and generating strong free cash flow to lower financing costs.

As we look ahead, we expect modest market recovery to continue in Q4 and 2021. Most commodity prices have recovered to constructive levels.

Large and ageing mining population in our territories will continue to drive demand for parts and service and we also expect some pent-up demand for mining products support following COVID related deferrals. We are capturing product support market share and construction sectors through strengthening relationships with customers and leveraging technology.

And finally, we remain optimistic about a number of significant mining and infrastructure projects that underpinned our revenue outlook for 2021. Still given the economic uncertainty, we expect 2021 revenue to be below 2019.

As Scott mentioned, the execution of our global cost initiatives are on track. We expect to realize more than $100 million of annual SG&A savings from our 2020 cost program.

We estimated about a third of our workforce will return when the market activity fully recovers. These will be mostly revenue-generating employees in lower cost locations.

The work continues to lower our cost to serve with a focus on leveraging back-office efficiency and global procurement functions. Our goal is to reduce SG&A as a percentage of net revenue to about 17% when the market recovers to a mid-cycle level.

Our cost program executed in 2020 will get us more than halfway towards this goal. It will take an organization-wide continued relentless focus on driving continuous cost efficiency in a recovering market to achieve this goal.

Our overall outlook for the balance of 2020 and 2021 remains positive, we expect to generate higher earnings on a modestly lower revenue base in Q4, compared to Q4 of 2019. Operator, I'll now turn the call back to you for questions.

Yes, good morning.

Good morning, Scott.

I was wondering if you can provide a little more detail on the revenue outlook for next year. Is it fair to say that we should expect, you know, growth in the UK and South America but it's a little more uncertain in terms of what we're going to see in Canada?

Hey, it's Greg. I'll, you know, I'll take that one.

For 2021, you know, we continue to be positive about that outlook. You know it's certainly relative to this year, which Q2 was particularly challenged from a revenue perspective.

You know, we do see the potential for growth, we see, you know, oil in the 40s, copper in the 3s. And when that happens, we think we'll see some of the catch up in product support that we highlighted you know just a minute ago.

And we do see solid infrastructure, fiscal stimulus dollars, and we see that more than offsetting some of the private sector uncertainty. So I'd say we're generally optimistic, and we think we'll see your revenue grow to some degree.

And we'll just continue to keep costs top of mind as we do that.

Where would you say that you -

One thing to add on that, Yuri it's Scott. I mean, I think you're - the way you're thinking about is probably correct, right.

If you look at the UK, you've got HS2 underpinning some pretty significant growth in 2021. And then in South America, you've got QB2, and frankly, you know, a full year of no social unrest and no SAP problems.

So that results in revenue growth, and I think the Canada looks as a little more uncertain and challenging. So it's a good methodology for you to think about the business.

Okay. Last one for me, just, you know, how do you feel given all the changes you've made in the business about your ability to drive positive free cash flow in 2021?

Yeah, I mean, cost and capital focus is top of mind at all times. As we highlighted, we will be looking to make some inventory purchases.

We've done a really good job of managing that proactively through this period. And as we see some recovery, we want to make sure we're also positioned for that.

That said, I think we're well positioned to continue to improve inventory turns, invested capital turns. We do see some fundamental efficiency that we've created over the years and we think, you know, well executed and through that recovery, we can still generate solid free cash flow even in the recovering market.

Good to hear. I'll turn it over and thanks.

Thanks very much and good morning.

Good morning.

So the comment that you saw an increase in mining RFPs late in the quarter was quite interesting. I was just hoping you could give us a bit of perspective as to whether those would be opportunities for delivery in 2021 or beyond 2021 and how that looked by end market?

Yeah. Thanks, Cherilyn.

You know, I think it's both, there's a mix of kind of near-term opportunities, particularly in Chile and the Canada are kind of more medium-term. So I'd say there was a balance of interests, a, for some shorter-term items in 2021 and some of that extend into the medium-term and are kind of the resumption of conversations we had last year and you know part and parcel of technology and those are kind of more medium-term opportunities.

Okay, that's helpful. Maybe just sticking with Chile for a second.

Obviously, there's a lot of union negotiations on the mining side in Q4, how are you thinking about active and possible labor disruption as it relates to your business in Q4?

Cherilyn it's Scott, I'll take that one. So I guess that a couple of things from a union perspective, not only in Chile, but across the company, I think we've been pretty successful in working through this difficult time with our employees.

So we successfully signed an agreement, which I think was a win-win with our BC union and that was announced last week. And then in Chile, we successfully signed an agreement, I think about three weeks ago to one of our large unions.

So you know, kind of high level that's all good. I think as you look forward there is some labor disruption in Chile, as you saw, I think you know, Escondida, which avoided the strike, which was good, because Escondida typically set kind of the framework for Chile.

And now Kendall area with Lundin, there's a month disruption there. So, you know, I think, you know, despite the $3 copper, there's still some uncertainty in Chile around, you know, social unrest, et cetera, which we need to be aware of, I mean, overall positive, but, you know, there's going to be some road bumps that we're going to have to navigate through.

In terms of our own union position in Chile, I think we're in pretty good shape for the next year. You know, where I think we have a union negotiation in 2021 late in the year, but we're pretty good right now.

Thank you. That's my two.

Hi, good morning. So nice improvement in EBITDA margins in the quarter.

A comment on the sustainability of this margin improvement in a post-COVID world. I know you talked about the $100 million of cost savings.

It sounds like roughly two-thirds of those are permanent. Is that how we should be thinking about EBITDA margins as well?

Yeah, you know, it was a solid margin or a solid quarter from a margin perspective, it did have a very few low margin mining deliveries, particularly compared to last Q3. But overall, we feel really good about the quality of our inventory, we really feel like we've had the right inventory for the right market which has helped on the margin side.

And then, you know, while we're working with on procurement initiatives on that help on SG&A, for a non-cap suppliers, there's also a lot of work we've done on the procurement side, which also helps with margins. And also just given you know where the markets at, we've got really a solid execution, but with less overtime and less subcontractors.

So those all helped within the quarter. I do think, you know, as we ramp into the mid-cycle market, you know, those are sustainable, you know some of the mining deals will come back, you know, going forward relative to this quarter.

But the other pieces I think are sustainable and we're going to keep pushing on.

And in 4Refuel, you know, what was the contribution and how much of this whole margins as well?

Yeah, so 4Refuel did a great job, grew EBITDA 13% year-over-year, continue to run a very solid operation and generating cash. So they had a very strong quarter, it helped margins in Canada, it's only a certain percentage of Canada so it can only move the needle so much, but solid performance and very solid margins.

Second question here just it seems that the comment about improving customer loyalty. How are you measuring this and, you know, a bit of a, you know, with you with the staff cuts and whatnot going on, you know, what's really driving this?

Is this just, you know, leveraging your technology capabilities or how should we think about that?

Great, thanks, Jacob this is Scott. So we use a third-party provider to do our net promoter score.

So this is something we've implemented across the company probably five or six years ago. And it's been extremely effective as one of the key KPIs that we track regularly.

You know, as you think about the improvement, this has been a kind of a consistent five-year improvement across that all regions, we had a little bit of a blip with the SAP implementation in South America in 2019. But it's, you know, I'm pleased to say that we're now back to pre-SAP levels on NPS.

And so what's driving that? I mean, I think at the core, it's the culture of the employee base.

I mean, this employee base goes above and beyond the service customers. I mean, we've done that for 85 years and when our customers need us, and this pandemic, the customers needed us, our employees, you know, get after it.

And you know, I couldn't be more proud of our employees through this period. I think technology has helped too, you know, I think the fact that we've been able to deliver parts uninterrupted, we've been able to, through both online channels and in branch channels.

And the fact that we've been able to have great insights into customers' machines through connected data, I think that's helped as well. So I think that you can't point to one thing, but this is a trend that, you know, we've seen continued over a five-year period, and where all the management team really proud of it.

All right, thank you very much.

Hey, good morning, Scott. Good morning, Greg.

Good morning.

Following on the constructive comments on mining, I mean, specifically in Chile, how do your discussions with your customers today compare with those of 2018 and 2019? You know, specifically as it relates to capital deployment around brown and greenfield operations?

I guess definitely to just on South American margins? I mean how should we think about that 8.2% in 3Q, you know, and should we consider any further operational improvements or operating leverage gains?

Or is it really just a matter of mix going forward?

Yeah, so I'll take that, you know, on the customer side, you know, we have, as mentioned, we saw an increase in RFP and quoting activity on the mining side, both from producers as well as contractors. And you know, they're, despite the challenges of COVID, they're in a pretty solid shape, you know, copper over $3 and the peso being at a fairly low level, their cash margins are in good shape.

And we are seeing more discussions about projects that have been contemplated for a while moving forward, whether it'd be debottlenecking, brownfield or expansion or some smaller greenfield. So there's quite a spectrum of the conversations going on.

And then you know the breadth is kind of growing, which is, which is encouraging. And we just see customers, you know, willing to step up and order equipment, first with the contractors and more RFPs with the producers.

So something we'll watch closely, but has been you know stepped up and certainly in terms of tone and encouragement. From the South American margin perspective, we do think of a solid performance.

You know, we don't think we're done yet in terms of cost efficiencies that we can drive. And, you know, I mean, just excited to see what we can do.

And we keep costs under control, and we'll recover some of these volumes.

And I just think the only thing I'll add on the South American piece is, as you look at the cost performance and the capital performance, you know, the reduction in SG&A and the $150 million you know monetization of that inventory, I think the performance has been outstanding, and that 8.2% margins that essentially weighed down significantly by Argentina and Bolivia. So when you actually break out the Chilean margins, you're looking at, you know, 9 plus in an environment where product support's down 16%.

And you're in a pandemic. I mean, Juan Pablo and the team just deserve a ton of credit for what they've done here for the last year.

That's great color and agreed. Just maybe turning it over to Canada.

I mean, last quarter, I think you talked about alternatively reducing costs in Canada by $15 million to $20 million toward not for Qs, I think so you were effectively pointing to structural margin somewhere in between the adjusted and the unadjusted number. Should we use similar dynamic here in 3Q?

I mean, if that's the case, how should we think about margins going forward, especially product support set to recover quarter-on-quarter?

Yeah, I think it's the same thing in South America. I mean, we're going to focus on what we can control and we're going to keep working on the costs, not only on the reductions we've done, but you know, finding the next frontier and working through that.

And then as volumes recover, you know, we hope that that's additive. You know so that's what we're focused on the pace of recovery.

We'll have to wait and see, but I think if we can continue to control the costs side and work on capturing our share of the recovery. And then some, I think we'll be in good shape.

Okay, great quarters, guys. Thanks.

Thank you.

Hey, Guys. Good morning.

Good morning, Ross.

That was a really interesting comment on the Chilean margin, being 9 plus in this environment, I'm just wondering how you're thinking about it? And South America, do you feel like you can - for the whole region, I mean can you scrape your way back to a 9% to 10% margin in a $2 billion revenue environment?

Or you think you really have to get back to $2.5 billion to sustain that level of profitability?

Hey, Ross it's Scott. And listen, I think you had a question in the last call that was a good question, right.

I mean, we have been frustrated with you know the profitability of that business for the last couple of years and some self-inflicted wounds around technology, which are aimed at improving structurally the performance of that business, and we're starting to see it, you know, you're starting to see the cost come out of the business, you're starting to see the improved turns. And if you look at inventory, our new equipment revenues down something like 30, you know, 25%, 30%, and our turns are up, right.

I mean, so that speaks to some of the benefits we're getting from this system and discipline on the working capital performance. And we've got Argentina and Bolivia, which, yeah, Argentina made a profit.

But you know, very small and Bolivia actually was a drag, given the whole country was shut down. Now, fortunately, Argentina is now $100 million business and 16-year low and Bolivia is a relatively small business too.

I have no doubt when you see the revenue improve in South America, you're going to see margin expansion. And I'm just excited to see it, because I think we've been waiting a couple of years to do it.

The team's really on it. We've got the technology in place, we've got a copper price of $3, we've got now quoting, we've got QB2 behind us.

And so long as the country can navigate, you know, some of the uncertainty associated with the plebiscite associated with the election, I think it's going to be an exciting two years in Chile.

That's great. I guess I get to the million-dollar question on you know, what are mid-cycle margins for Finning if we were to stay in sort of a $6 billion, you know, revenue environment for few years instead of a $7 billion environment?

I mean, if you look at your business over the last 10 years, that's kind of been the range we've been talking about. I mean, it looks like you're going to do somewhere around 5.5% EBIT margin this year for the company, you did 7.5% in 2012 to 2014.

So we stay at $6 billion or so just given the, you know, the, some of the headwinds in Canada, to get to a sort of like the midpoint of that range? Or can you actually grind into the higher end of the range, given all the, you know, initiatives you've undertaken the last five or six years?

Yeah, I think listen, I don't want to - I want to avoid giving a projection. That being said, you know, there's a couple of things that I feel pretty good about, I mean, I feel good about increased profitability in South America for the reasons that I talked about.

And I feel good even in Canada with a challenging end market that you're going to see improved profitability relative to this year. And so you know, where that ultimately gets to, I think depends a little bit on the revenue for sure.

But I continue to see improvements on the profitability side, relative to where we are today. On the working capital side, because you know, we think about this return on capital, not just profitability, you know, I think the last three or four quarters that we've generated, now $600 million, this year, $300 million so last three quarters has been $900 million.

I mean, it's a big amount of free cash flow. And I think we're coming up against $3 billion in free cash flow generated in the last seven years.

And that includes one or two years where we didn't do as good job as we could have. And so as I look forward here with increasing turns and better performance on the supply chain, I think the combination of improving profitability, increasing invested capital turn leads to you know, very good return on capital improvements.

What is normalized EBITDA to free cash conversion do you think? I mean, 100% this year, you're going to generate a ton of cash, you destocked a lot of inventory now it's going to start to go the other way a bit, but you have just a range in mind through this cycle that we can think about, because it's been very tricky to model free cash flow for Finning and that you know, in a downturn versus an upturn from year-to-year, I got to take this some type of range we can work with some bottom years?

Yeah, I mean, from a mid-cycle perspective you'd like to generate you know roughly 50%. You know, in years where the markets slightly down we've got the countercyclical piece that's got us to a 100% this year, you know, that's, you know, that's not a level that's going to be sustained.

And you know, it's a pandemic year and a recovery year, maybe it's slightly less than 50%. But I'd say mid-cycle 50%.

And if you continue to make structural working capital improvements, you can push above that.

Thanks, guys.

Thanks, Ross.

All right, thanks. So I just wanted to follow-up on you know, one of your earlier answers.

But, you know, at the Investor Day a couple of years ago, I think you were targeting, you know, return on invested capital of around 20% for the Canadian and South American business. So, you know do you feel - do you still feel that this is a reasonable target?

And if so, you know, how dependent is that path to get there, you know, within your control versus, you know, outside of your control?

Yep. Thanks, Devon.

I mean, those targets certainly didn't include the pandemic. And we're navigating that and using this time to, you know, help create a business with a higher earnings capacity.

And I think we've done a good job of the early stages of that. You know, I think those targets are still, you know, goals that we should set our sights on, and we want to work towards them.

And as Scott highlighted, you know we continue to improve our margins, and we're going to continue to be relentless about working capital. And when you improve both at the same time, and it goes well, for Relic, you know, particularly when we look at the target of 17% SG&A, that certainly is a very helpful variable in that equation.

And if we can step back on that type of path.

Yeah, I guess I would add just one other thing too, is, you know, we're in this pandemic, so we sometimes forget, but you look back to 2019 and the end markets weren't great. You know it was a difficult end market situation.

We had record revenue, record EBIT, record profitability, and ROIC in the kind of 15% to 16% range -

For Canada.

For Canada. And so since then, we've now done the - just what we did in the second quarter, which is a $100 million which we think most of its structural and sustainable.

And Greg highlighted, we're continuing with the laser focus to continue that path on the cost reductions. So we're not taking our eyes off of those targets that we set in the Investor Day, albeit there's been a delay given the pandemic and given the situation we find ourselves in right now.

Okay, that's helpful. Can you give us a sense to the implications to Finning from Cat's acquisition of where's oil and gas division?

Just do you expect that you'll need to contribute anything to the acquisition costs? You know, whether it's like assuming inventory, you know, buying some locations or, you know, anything, I guess, what are those returns to Finning?

You know, that's something where that transaction hasn't closed yet. And there's still a shareholder vote.

So we will just - we'll hold comment on that. But in general, we do expect that there'll be some complementary things we can work on together at a minimum.

Fair enough, I'll turn it over. Thank you.

Thanks. Good morning, everyone.

Just regarding your commentary on the competitive pricing environment in Canada, in your view, what is it going to take for that pricing environment to improve?

You know, so it - I mean, it is a challenging environment for, you know, particularly our customers in oil and gas. And, you know, we got on the cost actions early, you know, in April, we worked with our customers in partnership to take out those costs earlier.

And so, you know, I think that's a dynamic where we will see pressure from customers, because ultimately, they're in a challenging position. We think we've done a good job of working proactively with some, certainly, you know, higher commodity prices and some higher activity levels would help on the pricing dynamic.

But, you know, we control what we can, make sure we've got the right inventory at the right time, which is always helpful, and we think we've done a good job of this year. And then at the end of the day, you know, pricing is related to value add, and we're looking for avenues to add as much value as possible.

You know showing up and doing a solid safe job in a pandemic adds a lot of value. Having technology tools that our customers adopt like myfinning.com that's pretty sticky and helpful, really helps in working with customers to adopt things like autonomy really helped.

So we're doing a balancing act of working on our cost base and adding value. And we think customers are appreciating that.

But from a macro perspective, you need increased activity in the economic growth, infrastructure spend, higher commodity prices and when that tightens up, you know, that's when I think that you know, prices tighten up to.

Okay. Thanks, Greg.

And then maybe to switch into the UK. Are the new lockdown measures, how are they impacting operations there?

And maybe what are you doing or seeing that is making you better prepared compared to the first wave?

Yeah, it's something we're on every day to make sure that we're managing best we can. And even through the first wave our operations didn't close in the UK or Ireland.

So it's something we've been navigating for quite a while. And construction sites were the things that did close in March and April.

And it looks like it'll be a very high priority for governments to keep those open and working. And so it's kind of business as usual.

Certainly, we've got all of the PPE shift separation and all the sorts of activities that we've done the whole way through, but in terms - it is fairly business as usual for us and, you know, it's something that we'll have to continue to keep navigating.

Thanks. That's it from me.

Thanks, Bryan.

This concludes our call. Thank you all and have a safe day.