Wajax Corporation

Mark Foote - President and Chief Executive Officer John Hamilton - Senior Vice President and Chief Financial Officer Brian Dyck - Senior Vice President, Equipment Richard Plain - Senior Vice President, Power Systems Steven Deck - Senior Vice President, Industrial Components

Benoit Poirier - Desjardins Capital Sara O'Brien - RBC Michael Tupholme - TD Securities Bert Powell - BMO Ben Cherniavsky - Raymond James

Thank you. I'll make some opening remarks, and turn the call over to John for detailed results on the second quarter.

As we expected, second quarter earnings showed improvement compared to the first quarter of this year. The Equipment and Power Systems segments each posted improved earnings compared to the previous year, despite a $0.5 million charge taken in the Equipment segment related to the downsizing of branch operations, primarily due to a slowdown in British Columbia coal mining activity.

In the Industrial Component segment, trends continue to improve from the first quarter. We're pleased with the 42% increase in backlog over the first quarter, and in particular with the increased orders for oil sands related mining shovels.

During the quarter, we transferred accountability for the oil sands based rotating products group from the Equipment segment to the Industrial Components segment. The change will allow for a stronger foundation for operations in the oil sands by exploiting the engineering and repair services capabilities in Industrial Components, and it provides us a platform for future expansion into other Canadian mining markets.

Rotating products first half performance was weak on a year-over-year basis, due to certain maintenance contracts not repeating this year. And we expect improvements in the trends of this group as the year progresses, and we continue to be very confident in this growth opportunity.

We also announced plans to restructure and simplify the sales force in Industrial Components, which is expected to result in improved sales team effectiveness, increased engineering and repair services capabilities and lower costs, including improved cost leverage as the business grows. We're very committed to growth in the Industrial Components segment, with particular emphasis on the addition of products and value-added services in support of our oil sands mining and oil and gas customers.

While the changes we have announced, we have lowered our costs. Our primary focus in making the changes was to realign the resources in the business to areas of growth and profitability.

As we disclose the specific numbers on the restructuring provision are expect to charge in the third quarter between $3 million and $3.6 million, and savings estimated from the restructuring is $5 million annually and we expect $2 million for the balance of this year. Heading into the third quarter, the outlook for end-markets and results for the full year, excluding the expected restructuring provision, remain substantially unchanged from our view at the end of the first quarter.

While we continue to expect 2014 to be a challenging year, we're beginning to see encouraging signs of increased capital spending from our oil and gas customers and we're pleased with our oil sands activity. Our increased backlog and the restructuring in Industrial Components segment has given us added confidence, as we continue to make investments in our strategic growth initiatives.

As a result, we have maintained our monthly dividend at $0.20 per share, keeping to our guideline of paying out at least 75% of current year expected net earnings. John?

Thanks Mark. Second quarter 2014 consolidated revenue was $374.4 million.

That was up 3% from last year. Consolidated net earnings of $12.3 million or $0.73 per share, were down from the $13.5 million or $0.81 per share recorded last year.

Earnings before finance costs and income taxes were almost equivalent to last year. However, an increase in finance costs and a slightly higher tax rate accounted for the vast majority of the net earnings decline.

Consolidated backlog of $224.5 million at the end of June was up $66.7 million or 42% from March 31, on increases in all three segments. In particular, an increase of $62.6 million in the Equipment segment includes $53.1 million related to two multi-unit orders for mining shovels.

Turning to the individual segments and starting with Equipment. Total revenue was down slightly to $188.2 million for the quarter.

Equipment sales decreased $5.3 million and Equipment sales in forestry and crane utility increased, however they were more than offset by decreases in mining, construction and material handling. The Canadian market for material handling equipment was down almost 8% and sales for JCB construction equipment were lower than the previous year.

Parts and service volumes were up 7% to $69.9 million on higher mining and forestry sector sales. And quarterly segment earnings increased 4% to $13.6 million as a result of the favorable sales mix, despite absorbing a $500,000 worth of cost related to the restructuring of the two BC mining branches that Mark alluded to.

Turning to Power Systems. Revenue increased 18% to $82 million.

Equipment revenue increased $10.6 million on higher power generation and off-highway oil and gas sector-related sales. Parts and service sales increased $1.9 million, primarily on higher sales in the on-highway sector.

Segment earnings of $4.2 million increased $900,000 or 27%, which was attributable to the increase in sales. And in Industrial Components, revenue of $105.2 million was up 1% compared to $104.5 million for the year posted last year.

Bearing and power transmission part sales were up 1%. Fluid power and process equipment sales, including rotating products group, were also up 1%.

Earnings of $4.6 million were down $1.1 million year-over-year. Higher gross profit margins were more than offset by a $1.8 million increase in SG&A cost.

The increased costs were primarily attributable to additional personnel costs, including wage and benefit. Headcount was actually lower than last year.

Turning to the balance sheet. We finished the quarter with funded net debt of $218.2 million and that was roughly flat to the previous year.

And the corporation also declared dividends of $0.20 per share for August, September and October. So now, we'll open up the call to questions.

First question, if we come back on the pre-tax cost saving of about $5 million, you mentioned that it will be about $2 million this year. But when we imply it from a margin standpoint, it seems to be almost 1.3% impact annually.

So can we expect to see 5% to 6% and in which timeframe?

Well, again, we're not going to get in specific predictions with regard to the EBIT margin. But you could take the savings and add that to the profitability in your model to come up with the appropriate margin percentage.

And just, while looking at your inventory was up almost $10 million this year. You mentioned that it was primarily related to power generation projects.

However, looking at the nice contracts you signed up on the Equipment side, what should we expect on the inventory front in the next couple of quarters?

You shouldn't see a dramatic increase in the inventory, based on the increases in backlog that we received. Some of that product will be delivered in 2014.

But I believe, we already have some of the product inventory. Is that correct, Brian?

Yes.

And the larger portion would be the amount that we delivered in 2016, and obviously that wouldn't be in 2014.

So the bulk of the deliveries are more geared towards 2016, right?

The bigger percentage of deliveries, yes, would be 2016.

And just looking at the new accretive that this will be. Could you mention what is the kind of the interest rate savings on the annualized basis, John?

There is no real interest rate savings, because it would run off the current pricing grid that we have. So it's not really a savings in interest rate, it just gives us some additional flexibility and some additional room in terms of some of the covenants that we have.

And with respect to Q3, could you mention whether you intent to be able to match last year performance in terms of EPS?

We didn't mention that. No.

Can you comment a little bit on Power Systems? I know historically you've said some times those sales could be lumpy.

It was at any particular order delivery or is that continued outlook for improved sales going forward?

Sara, its Richard Plain here. We've seen some improvements in just general oil and gas business as well as a number of sort of small to medium size power gen projects in various parts of the country, so both of those sectors have shown some improvement for us.

So that's continuing into the back half of the year?

We're expecting to continue to have some positive outlook in both of those.

And wondered if in Industrial Components you can comment on, why employee cost were up? Are these kind of retention incentives or is there anything else going on there?

Actually as I mentioned in Industrial Components, our headcount was actually down, but the wage cost were up for a couple of reasons. One, on a comparative basis, the second quarter this year versus the second quarter of last year, on a year-over-year comparison that would have actually been two wage increases included in there, because the wage increase that we would have had in 2013, we delayed it until the second quarter of last year.

Accompanying that, we've had some increases in our benefit cost. Our benefit cost, were essentially self ensured as most companies like us are on a benefit cost and the true up occurs in the second quarter.

So in Industrial Components, they would have had moneys coming back from the premiums that they would have put in last year. This is year there was a net cost.

So there was a delta there.

And wondered just in terms of leverage level, John, 1.5x to 2x being your sweet spot, where you'd like to get to. Is there an opportunity to get there in 2014?

And in the same kind of context, what is your free cash flow outlook? I just wonder if there is any particular use of working capital that might be seen in the back half of the year.

I guess we would hope that our leverage position would improve, as we get to the end of this year. And on a free cash flow basis, again a lot of it depends on how we make with the mining equipment in terms of those sales.

But our current expectation from the standpoint that where we would finish up with our working capital position as well as our EBITDA is that we would see some improvement towards the end of the year. It may not get us back into what you call it, the sweet spot, in terms of our range, but again the range that we had given, we had also indicated that there were times such as this that we're quite willing to be outside of that range.

And just in terms of your covenants at 3.25x, are you confident that you won't bump up against that, because of working capital changes, and that might not jeopardize your dividend payment ability?

Well, I can't give any guarantees, but certainly the expectation that we would have for the rest of this year is that we wouldn't come anywhere near that.

I wanted to ask about the Industrial Components area. I guess just in general, you can talk about what you're seeing within that area?

And sort of as a related question, I was a little surprised that, given the fact that that area now contains rotating products, we didn't see a little bit stronger growth. So in putting those two questions together, if you can just kind of talk about what you're seeing in the rotating products piece?

As far as the revenue as a position in Industrial Components grew, their backlog is growing and it continues to grow in that market. And as John said at the beginning, pretty much all line of businesses are up slightly in that market.

Our oil and gas market segment is up over last year as well as our aggregate in forestry. So we're noticing a bit of a pick in there.

As far as the rotating business goes, coming in, the reason why the revenue was not up, as mentioned before in the first quarter, revenue in rotating was down significantly due to some projects that we did last year that didn't repeat this year.

And then did the comps get a little bit easier then, as we look forward in, as far as rotating goes?

Yes.

And then maybe a question for Mark. Just strategically, the reorganization you are doing in that area, Industrial Components, there is mention of that setting you up, as far as of future possible expansion into Canadian mining markets or other mining markets.

Is that something we should think about as a potential near-term opportunity or is that just you sort of highlighting that as a possibility, but it's further out?

Yes. I guess it depends what the plans near term are.

I think the focus right now is to use the infrastructure that exists in Steve's group to help the guys in rotating in the oil sands. And Steve runs 14 service centers inside of Industrial Components, which are located pretty much in the major Canadian mining markets.

So moving some of the rotating capabilities to those locations, we think is a pretty solid opportunity. I don't think we see anything fundamental this year, but it's certainly not something we consider kind of long-term.

So let's say, it's more of a mid-term opportunity I think.

And then, I just wanted to touch on Power Systems. I mean, I think you in some ways just addressed this, but just to be clear, when I look at the performance of the Power Systems segment in the quarter, and just trying to focusing on specifically the off-highway oil and gas customer demand, I mean it sounds like you're more upbeat about that area as we look forward, but I thought I saw a comment as it relates to backlog saying that the order activity was actually down in the second quarter compared to Q1 there.

So just trying to reconcile that?

I guess, we've seen an ongoing improvement over the last year, both in Q1 and coming into Q2. So overall, I would say, for the full year, I am optimistic that we're going to still see some continued demand in oil and gas, quarter-to-quarter volume-wise we're up about 25%.

So that's how we'd comment on that right now.

That 25%, that's Q2 versus Q2 of last year or that's --

Yes. That's quarter-to-quarter, year-over-year.

Mike, I wouldn't read too much into the comment with regard to the backlog that it did decrease in the quarter somewhat because of the oil and gas business. Again, we still are kind of more positive on the oil and gas business than what we have been.

So I wouldn't read too much into that.

Just in terms of the restructuring, is all of that done at this point, like you've made all the moves that you wanted to make or is that something that happens as we go through the quarter?

Bert, its Steve Deck. No, we are not finished yet.

We'll have more to report at the end of the third quarter.

So the comments with respect to the $2 million savings for this year, is really a much more of a fourth quarter comment?

No. Bert, its Mark.

I think it's safe to say, we expect Steve to finish the activities on the restructuring by the end of the third quarter. And the resulting savings of $2 million would kind of flow in through the third and fourth quarters.

That may not be exactly proportionate, but it does start in the third quarter.

So it has started already. Brian, just wanted to talk a little bit about the equipment side.

One of the things that we have heard from your peers so far has been competition and that impact on margin for new equipment sales. Can you give us your view from the Wajax perspective on what's going on in the market from a competitive perspective?

I think, Bert, the first quarter was probably a little more difficult than the second quarter. Although, whenever the markets are flat like they are now, it gets competitive, but honestly in the second quarter our Equipment margins were pretty good.

Brian, is that simply because you're choosing your spots or has demand picked up and some of the access inventory is starting to get absorbed into the system, and there's just not the pressure there. I'm just trying to figure out whether it's your decision or its market driving that?

We might have been in a bit better inventory position in the construction equipment game. And I think that's more or so what you're talking about.

So we weren't in the position of wanting to really liquidate it. And I think the deals that we got into, we're able to get some reasonable margin out of it.

And quite frankly, in Eastern Canada we have increased our share significantly. So I'm going to say, in the first quarter it was very interesting, a little different in the second quarter.

So looking forward here, the expectation is to continue, Q2 is much more representative of how you would view the rest of the year?

I think so. Yes.

And then just on EPG, you continue to make investments there, I think more in the rental fleet. Can you just talk to us a little bit about what your CapEx plans are for that and how utilization rates are coming along on that front?

I'll deal with the CapEx plans and Richard can deal with the utilization. CapEx, as you may recall, we have said that over the course of the last couple years, including this year, we have spend at least $6 million on a rental fleet for the EPG business.

We'll probably up that a little bit this year. But it will certainly be well under $10 million.

And utilization-wise, what John alluded to in terms of the CapEx spend, we haven't seen a lot of that equipment hit the ground yet. So we're still waiting for certain volume models to hit the ground, so that we can get that out working.

But so far, we've been with the remaining fleet that we've had out in the market, we're pleased with our utilizations there, that they are meeting our current expectations.

I am just wondering how your outlook does not changed substantially in light of the backlog increase you've got, and what you're seeing in end-markets like oil and gas and oil sands? Is it that this is all, basically as you anticipated earlier in the year or has something got better and something got worse?

Are you just being conservative? I am just trying to reconcile a few things that happened there in the quarter?

Ben, its Mark. I think if you take it apart a little bit and start with mining the oil sands, I think Brian's business took a bit of a hit with respect to the branch closures.

And he managed to recover some of that with the shovel orders that are due later this year. So there's a bit of an offset there.

I think in Richard's business, while we've seen some increase, and in Steve's, in the oil and gas business, and there have been nice healthy increases in the second quarter, they are up a bit from the first. We are still a bit skeptical about how fundamental those increases are going to affect, how we think about our outlook for the balance of the year given some of the other influences in the business.

So I would say, it's safe to say, that we definitely have some positives in the second quarter, but they helped us to offset some negatives. And as such, we remain substantially unchanged from where we were at the end of the first.

And John, I wonder if you broke out the equipment inventory in the mobile machinery group from Power Systems. How would that look quarter-to-quarter and year-over-year?

How would it look? Well, I guess Power Systems would have increased somewhat because of the Power Gen.

And Equipment, I think it would have increased marginally, if anything, but nothing significantly.

So Equipment is kind of flat?

Yes. Let's say it's flat.

And I think we had mentioned in our MD&A that Power Systems was up mainly because of the Power Gen stuff.

And you're comfortable with flat for the mobile machinery or is that just a [Multiple Speakers].

Well, I guess, as we have always said over the course of the last couple of quarters, we're certainly hoping that we would be able to liquidate some of the mining equipment inventory that we have. Over the course of the first six months, I think we did managed to get to move a couple of smaller pieces, but it remains to be seen if we can move some more of that towards the end of the year.

And I know, we talked about this offline a fair bit, Mark, but maybe just raising them on a public forum, how do you guys plan to reconcile your current balance sheet, with sort of outlook you have in terms of near-term demand drivers and where we are in the cycle, substantially not changed. With some of the growth opportunities you might seen, for example, in rotating parts, and if you have any free cash flow in the back half of the year into next year, is it all going to go to debt reduction or is there a way you can reduce debt and fund growth at the same time assuming the current market conditions prevail?

Well, that's a good question. I think suffice it to say that over the balance of this year our focus is on managing the leverage and the growth kind of with the balance, given that we don't expect the market conditions to get fundamentally better.

So the amount of free cash flow that we could use, we would use for growth specifically would be low, I think in the near-term. I think it perhaps is a different story as we look out beyond the end of this year based on some factors that we're working on from a strategy standpoint, which may change that complexion I think as we get into 2015.

But over the near-term, we are balancing the leverage we currently have with what we consider to be less imperfect market conditions to just to make sure that we're in balance by the end of this year.

Well, thanks very much for joining us today. And we look forward to speaking to you at the end of the third quarter.