Wajax Corporation

Mark Foote - President and CEO John Hamilton - SVP, Finance and CFO Brian Dyck - SVP, Wajax Equipment Steve Deck - SVP, Wajax Industrial Components Michael Gross - SVP, Wajax Power Systems

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

Thank you operator, I will make some opening comments and then I’ll turn the call over to John for some details on the first quarter. While Western Canada market conditions continue to be challenging, the first quarter segment earnings for Equipment and the Industrial Components group met our expectations.

Our results in the Power Systems business were disappointing as the continuation of lower earnings in Western Canada related to the energy sector were not offset by anticipated improvements in power generation and operations in Central Canada. The reorganization we announced last quarter is proceeding on schedule and we expect to realize savings in 2016 of between $6 million and $7 million with the full $15 million in estimated cost savings to be realized in 2017.

In addition, the Power System segment has substantially completed the execution of its restructuring plan announced in the second quarter of last year with actual cost savings meeting our expectations. Consistent with the last quarter, our outlook for 2016 is that market conditions will remain very challenging; we continue to expect that earnings will be under significant pressure due to difficult market conditions in Western Canada and reductions in resource customer capital and operating expenditures.

Excluding the impact of this quarter's $12.5 million restructuring costs, we expect lower year-over-year earnings in the first-half of 2016. During the second half of the year excluding the impact of $41.2 million in goodwill and intangible asset impairments recorded in 2015, earnings are expected to improve versus the first-half of the year driven by customer equipment deliveries and cost reductions.

We expect to deliver four large mining shovels in 2016 to customers in mining and oil sands market for a combine sales value of more than $65 million. And two of those shovels are expected to deliver in the second quarter and two of the shovels are expected to deliver in the fourth quarter.

These two of the four shovels just mentioned, the orders for them were received in the first quarter contributing significantly to consolidated backlog being up 22% from the start of the year. Backlogs in Power Systems and Industrial Components were also up in the quarter and contributed to the consolidated increase.

On April 20, 2016, we closed the acquisition of the assets of Montréal-based Wilson Machine Company. The Wilson is an North American leader in the manufacturing, repair precision rotating machinery and gearbox with annual sales of approximately $6 million and its major customers in Eastern Canada align well with our existing customer base.

Wilson service offerings are an ideal fit for our 4 points of gross strategy and we believe we can leverage the corporation's sales force and larger geographic footprint significantly drove the business. With respect to the dividend, the current amount of $0.25 a share was established in March 2015 at the level that is believed to be sustainable to our expectations of a negative cycles, we reaffirm that dividend for the second quarter this morning and will continue to consider the amount of dividend quarterly taking into account the corporation's forecast of earnings, leverage and other investment opportunities.

While conditions do remain challenging, we are very confident in the enhanced earnings potential from the execution of our strategy and by a reorganized company. John?

Thanks Mark, our first quarter 2016 consolidated revenue was $285 million that was down 10% from last year. Revenue declined in all three segments and was adversely affected by reduced activity in Western Canada as a result of the energy sector downturn.

My comments on net earnings will be on adjusted net earnings which exclude $12.5 million of restructuring costs, our consolidated adjustment net loss of $600,000 or $0.03 a share compared to an adjusted net earnings of $5.7 million or $0.34 per share recorded last year. The decline in year-over-your earnings was attributable to the reduction in volumes partially offset by lower finance cost.

Consolidated backlog of $205.8 million at the end of March increased $36.6 million or 22% compared to December. Returning to the individual segments and starting with Equipment.

Total revenue of $128 million in the quarter was down 12% compared to last year. Equipment sales decreased $15 million as a result of reduced equipment sales in most categories, primarily in Western Canada.

Parts and service volumes were down $2.6 million to $54.4 million compared to last year on lower oil sands volume. Quarterly segment earnings of $6.7 million were almost flat to last year as the negative effect of the lower volume was offset by improved equipment margins and lower selling and administrative costs.

Revenue decreased 16% to $62.9 million, equipment revenue decreased $3.6 million on lower off highway sales to oil and gas customers, sorry I’m on Power Systems now, I’ll just start again. Revenue decreased 16% to $62.9 million, equipment revenue decreased $3.6 million on lower off highway sales to oil and gas and power generation customers in Western Canada.

These declines were partially offset by improved Power Generation revenues in the Central and Eastern Canada. Parts and Service sales decreased $8.1 million attributable to lower sales to customers in Western Canada.

Segment earnings decreased $6 million to a loss position compared to the previous year on lower volumes and margins. And then in Industrial Components, revenue of $95.1 million was down 3% compared to $97.9 million posted last year.

Bearings and power transmission parts revenue decreased $1.7 million compared to last year, and fluid power and process equipment sales were down $1.1 million. Weak sectors were oil and gas, and oil sands with positive sectors being forestry, utility and transportation.

Earnings decreased $2.1 million to $1.3 million. Lower sales and margins were only partially offset by $400,000 decrease in selling and administrative expenses.

The lower margins included $900,000 of increased inventory obsolescence charges compared to last year. We finished the quarter with funded debt of $158.2 million, $9.2 million increase compared to December.

Today the corporation declared a $0.25 per share dividend for the second quarter of 2016 payable on July 5, 2016. So operator, I’ll now open up the call to questions.

Can you comment on the Power Systems, I was just a little perplexed at the negative EBIT margins given we’ve seen similar sales level like in Q3 2015. Can you just comment on the difference between the gross margin impact that impacted the quarter and the SG&A and maybe how we should think about SG&A going forward given there is already reference to $7.5 million in savings in SG&A?

The $7.4 million of savings was not all SG&A, in fact almost $5 million of that would be in cost of sales line. The remainder would be in the SG&A, you're not seeing the net benefit of that because there were some offsets to the let’s call it $500,000 that would have been saved in SG&A as a result of the restructuring.

The offsets would be with regard to costs for the CRM system that we are putting in as well as incentive cost that we wouldn’t had last year.

So what savings in the gross margin line because that reduced facilities depreciate, I am just trying to figure out how you sort of think about that?

The savings people that will do it primarily be technicians, but as well as people in the service departments, because there is overhead in the service department in our cost of sales line. So you don’t see it come through because of the volume decline, and because most of these savings are in Western Canada, the volume decline far outweighed the cost that we were able to take out.

Okay. And into Q2 now, I mean, what’s the expectation with - first of all, I guess there is reorganizations going on, there was the power systems, which is complete, is that accurate to say?

It’s substantially complete.

And then there is the corporate reorganization, I am just trying to sort of gauge how we figure that out in terms of the impact - in the current environment, would you expect to see a benefit from SG&A savings, is that all SG&A related and what exact expenses are you pulling out?

The savings, and again this is a rough estimate, approximately 60% we would believe of the overall savings that we are talking about and the corporate overall restructuring would be related to SG&A. The remainder is in the cost of sales line.

Again, this was - it’s a little bit different in terms of its overhead that’s being taken out, so it doesn’t really - it’s not really reflected on any meaningful amount of technicians. It’s all overhead people.

Regarding the power systems group, of the total savings that we are talking about, which is approximately $15 million, almost half of it will be coming from power systems.

Okay. And that - when would you expect to see the benefits, is that - in this current environment, can we see the benefits of that in the margin?

Yes, we will see the benefits of that. We saw a very small amount in Q1, because we just started this at the end of Q1, so as the quarters go on in 2016, we will see an increase in benefit, not only in power systems, but in all three of the business and in the full benefit in 2017.

Okay. And then just turning to industrial components, there was comment about competitive pressures in Western Canada, can you comment about sort of the margin improvement expectations in that business?

It seems like it’s - both power systems and industrial components have been struggling on and off for a couple of years now. Just wondering how you think about that business in the current environment.

Is there light at the end of the tunnel in terms of seeing more normalized margin going forward or are we stuck in kind of a difficult situation for at least the foreseeable future?

Hi, Sara, it’s Steve Deck here. We continue to experience margin pressures in Western Canada, especially in our Nisku facility and our Calgary facility.

Don’t know if I have a crystal ball to know whether that’s going to improve right now. Right now, we are sitting in a market environment that’s not good that we hope is going to improve, but there are no signs right now.

Okay. And Mark, maybe just in light of that, I wonder if historically going back several years, Wajax considered pairing out of the segment of industrial components, is there any thought that’s being given at management or Board level to reorganizing the company into core equipment and power group and looking at what other alternatives and options are out there for industrial components?

Sara, there is no consideration like that all. Two reasons, one is with the reorganization we are going through now, the kind of current concept for the segments really doesn’t exist past that end of that change.

So infrastructures between the company - the companies from office sort of speak in the back offices for the three businesses essentially get merged into common support groups. And we use the resources across a variety of parts of the company to push the categories that we are in today.

Having said that, even if we weren’t doing any of that, the importance of industrial components for the company’s overall strategy as far as filling out of broader needs - broader range of needs to its largest customers. It’s a pretty integral part of what we are about.

So there is no consideration right now for changing any of that thing.

Okay. And then just lastly on the dividend, the funded debt to EBITDA covenant looks like there is no issue right now, but going forward, if there is a working capital usage, I just wonder, are you concerned that that convent may limit the ability to pay a dividend going forward?

We don’t - as we forecasted the business for the balance of the year, hence the affirmation of the dividend in the second quarter and we continue to think it’s sustainable through what we expect the down cycle to look like. In the event that there was a working capital or capital investment requirement that was in the best interest of the company for its growth, then we would reconsider the dividend, but as we sit here today, the way we look at leverage, the way we look at the company’s expected earnings, et cetera we felt comfortable with the dividend being declared for the second quarter.

Okay. That’s it for me.

Thanks.

Good afternoon, guys. I just want to make sure I am thinking of this correctly.

So when bridging 2015 and 2017 SG&A, there is the reduction - $15 million reduction, which most of it is SG&A and the $2.5 million from the power systems? Is there a separate component as well that’s volume related.

I just want to make sure that just jumping to expectations in ‘17 here that obviously thinking cost wise, I am thinking of this business correctly.

Yes, the $2.5 million from power systems would be cost related - or not be volume related rather and the $15 million is essentially not volume related. Now, obviously there is the step-function on any reasonable volume increase then we think we can hold those cost reductions.

But if our sales would have grown significantly, then we would obviously have to look at that.

Okay, thanks. And just on FX in the quarter, there is a big move this quarter.

Was there any impact to your margins as it relates to FX?

Not significantly.

Okay. That’s it for me.

Thanks guys.

Good afternoon, Mark. Good afternoon, John.

Just to come back on power system, I was just wondering if you could provide more color on how we should expect the margin to recover in the coming quarters, especially from the minus 4.1 we saw in Q1?

I guess, clearly our objective is to run the business profitably. Our expectations for the first quarter were not last year’s level of earnings, so they were considerably less than that, but as John pointed out and I think we said earlier that we did come in short of our own expectations.

So our objective is to run the business profitably. I think there is three things we focus on right now, one is to start with what John said earlier, there is fairly good piece of the cost reductions from the corporation reorganization will flow into power system segment earnings more so in the second half of the year than is heard so far.

So that’s one thing. I think we have enjoyed some success in Central and Eastern Canada with some nice increases in sales, but we believe as the second quarter kind of unfolds there would be some improvement in margin percentages driven by businesses outside of Western Canada.

And third and finally, obviously it’s still a big focus on Western Canada, while the volumes are obviously quite low, the first quarter trend is roughly equivalent to the fourth, so down roughly about 50% in the West. We still do have sales opportunities in the West and we still do have efficiency opportunities that we are chasing both in the shop and other areas.

So I think our focus really is to run the business on a profitable basis despite what the revenue hit has been at Western Canada and we’ve got a number of initiatives underway to do that. I think to tell you what you should expect from an EBIT margin perspective, I think that would be a bit difficult for us to do given the moving parts that are in front of us at the moment, but rest assured that our expectation is to make the business profitable.

I understand. Should we expect the EBIT margin to turn positive or probably still less in Q2?

I don’t want to forecast, I think we are really just focused on improving the performance of the business and the marginal forward does - has effect [indiscernible] effective at doing that or not.

Okay. And on the mobile equipment side, you will be delivering about four big shovels this year just to - I was wondering if you could provide more color on how this will unfold on the backlog?

It seems that you have two shovels right now and just wondering if there's any implication on the inventory and where the other two should be delivered.

Benoit, it’s Brian. We have a two shovels coming out in Q2 and one of those shovels was in our inventory, so roughly around $10 million or $11 million in Q2 and then the last two will be coming out in Q4 and they would be roughly about a little bit more dollar volume in the Q2 business.

Okay. That’s very good color.

And just in terms of the $15 million saving, it seems that the timing has been pushed out slightly toward 2017. I was wondering if there's any implication or why this has been pushed out a little bit from 2016 to 2017.

Yeah, I think maybe you misinterpreted something. Actually we’ve accelerated the savings.

So if you look at where we were -

Sorry, John. Yeah, exactly.

Okay. And on Power System and also on the Marine Power System, it seems that you have some opportunities on the Marine front.

Could you please give us an update that it seems that you were well positioned on a few opportunities?

Yeah, it’s Michael Gross. On the Marine side we are pretty well positioned and you have seen that we were successful in securing the SAR, the search and rescue vessels and we are currently just holding on the next portion of the NSPS, National Shipbuilding Procurement Strategy which is the joint support ships and there is more to come.

Okay. Thank you.

Great, thanks. I just want to make sure on the Power Systems that that is right.

So if revenues in the business where they are today $3 million to $15 million savings, the business on a run rate basis is down to lose or an operating level is going to be down $10 million a year, half the savings of the $15 million are going to come back. So if revenues don't improve, the business then would lose $3 million.

So any move to profitability or breakeven is dependent on volume or have you got some one-time items in that $2.6 million that don't come into subsequent quarters?

Bert, some of the improvement is going to come from margins and I don’t think there is - we can’t point to anyone specific thing in terms of a onetime items, but there are a bunch of things that were negatively affecting the margins, that some of the things that Mark had mentioned as well. There are some contract rollovers that we recently had that we've been able to improve the margins.

There is a bunch of small things that we can do including upgrading our efficiencies in the service area. So it's not just volume, there are some margins issues.

So if I look at this quarter, so then the answer is various mix in there as well as, it’s negative impacting the power business?

I wouldn’t suggest it’s a negative mix, but I am just meaning that there were margin pressures essentially in all lines whether it's equipment sales, parts and service sales. So on a go-forward basis we have an opportunity to improve in all three areas.

Okay. Any sense of magnitude if you just kept things everything else equal this quarter, if you just factored in the new contract rollovers or whatever you have been able to do on the parts and service, what would the minus $2.6 million have been ceteris paribus?

I don't have those numbers in front of me. I think, Bert, the way the message I guess we want to leave you is that over the course of this year, our goal is to return this business to profitability and it will be a combination of SG&A and overhead in the service area, cost reductions, some margin improvement and some volume improvements.

I don’t think we're trying to hide behind a lot of numbers on this one. I think the reality is the volumes in Western Canada for Power Systems have declined to the point where the cost structure is not affordable and hence a lot of the work that’s been done and the reorganization has taken those costs, so I think the margin pressure in Western Canada has also been significant.

And we do - there are some tactical improvement opportunities in the West from a gross margin standpoint that do really probably more to service than they do to equipment sales that we think will be slightly accretive to the gross margin in Power Systems. The bigger opportunity I think is in Central and Eastern Canada where we do have margin improvement opportunities and those we're taking now as we speak.

And we also have some opportunities in the shops, but we do have some product margin and parts margin opportunities that are available to us, but weren’t executed - were executed towards the end of the first quarter, actually into early the second. So we're very focused on improving the gross margin in Power Systems both in Western Canada and the balance of the country and taking the cost out without necessarily taking it out to the extent where we hurt the balance of the organization with kind of our overall reorganization plans.

But I don't think it's - I am not sure if we are really prepared to tell you what the extent of margin improvement opportunities would be, but I think it will take us a better work to ensure that they are coming through.

Yeah. I appreciate that, Mark.

We're just coming from minus to positive just trying to figure out how linear that tracks up. That’s all from our perspective.

We have to come up with something in starting from minus up, that’s going to have a number of different trajectories. I just want to see if we can get any color on what's the right way to think about the cadence of that coming in over the course of the year, but if you’re not there yet, then what is it?

And Brian, just on these - the large shovels going in, and it actually kind of impressed me you guys were able to hold the margins in the mobile equipment group this quarter, how does those large sales impact the operating margins in the mobile equipment group, like my expectation would be that those would probably be given competitive landscape will probably be fairly low margin out of the gate.

I think your expectations are probably right on, it’s a pretty competitive environments and in the mining business right now and the sales margins on those shovels was pretty competitive.

And the last question for me, Brian, have you seen any - is there anything, any green shoot or anything that you're looking at and talking to your guys that we're seeing for a turn in parts and service. Are people frustrated at kind of fumbling on or trying to do that themselves supply that service themselves, is there anything that you're kind of seeing that would tell you that there is a turn happening in the parts and service side of the business?

We have some - a couple of reasonable outstanding quotes in the mining business for some planned maintenance that I would say was deferred over the last couple years that we're hoping to have come through. I think a bit of a pickup for us and we deliver large mining shovels, there is a nice work order attached to them, to put them together where we're looking for that in Q2, but I’m going to say, in Western Canada, we're still seeing a bit of softness, especially in the construction business.

I think duty utilization, that's still hurting our parts and service business a bit there, but I think, overall, when we look at Q2, I think we're getting close to the bottom there.

Thanks. Just wanted to circle back on the shovels to be clear, it's two shovels in Q4 or pardon me, 2 shovels in Q2 and 2 shovels in Q4, is that the combined value of the orders that will be delivered in Q2 is about 20 million to 22 million.

Is that right?

Orders of magnitude. Yeah.

Okay. And 64 million for the year, so the delta there all comes in Q4?

Maybe a little bit more in Q2. Yeah.

It’s a little bit skewed to the Q4 deliveries, because of the 4 shovels, there's one that's a little bit smaller than the other three and that smaller one will be delivered in Q2 with one of the larger one.

Okay. And as I understand, 2 of these shovel orders you already had and 2 were new, but I may have misinterpreted this or mis-recalled this, but I had some notes that suggested you actually had more than 2 shovel orders prior to this quarter on the books for delivery this year.

Is that incorrect or did something fall away?

I think, it’s Mark speaking. We disclosed that we had 4 shovels.

We disclosed we had 3 and then we disclosed we had 4. The different point in time in the first quarter.

I think the earlier comment was that there were 2 additional shovels that were ordered in the first quarter that contributed to backlog.

I see, okay. So we’d already heard about at least one of those or maybe both, but they were actually added to backlog in the quarter?

Yeah. Mike, if you go back to when we initially disclosed the 2 shovels that we're delivering, 2 of the larger shovels, we disclosed, I guess, it was about a year-and-a-half ago the original disclosure of this.

There was a bigger package and some of that stuff was delivered in 2015.

Okay, perfect. And then in the MD&A, there were some discussion about increased SG&A expenses related to the deployment of the computer systems.

Can you tell us how much of that would have been in the quarter and how do we think about that going forward in terms of the rest of the year and if applicable into ‘17?

It was 400,000 to 500,000 in the quarter. There will be some costs that will carry on, but some of it will disappear.

So a portion of it will carry on.

Okay. And how long does that carry on?

Well, part of it will carry on indefinitely because it would be the subscription. The other thing you should know as part of the net cost savings that I've been talking about with regard to - and what we've disclosed in the MD&A, the 6 million to 7 million for 2015, as part of the restructuring, that's a net amount.

There will be some costs in there that you'll see later on this year for consolidation of the Equipment and Power Systems, computer systems, you will see that, but the 6 million to 7 million we gave to the people is a net amount.

Okay, perfect. And then John, last quarter, you guided to an expectation of changes in non-cash working capital for full year 2016 being a source of cash of between $30 million and $35 million.

Are you still comfortable with those numbers?

Well, I think we said we were going to be positive in terms of our cash. We still believe we’ll be positive, but I'm not suggesting that we’re going to commit to those kind of numbers.

Okay. Did I mis-recall that or is that, I thought you gave those specific numbers last quarter on the call?

Like I was wondering have they come down there?

I can’t remember, I’ll go back and analyze the recording.

Okay. That’s fair enough.

And then just lastly, Mark, with respect to the guidance, it reads very similar to me to the way you presented it last quarter, but I’m just a little bit curious about the guidance for the second half. There is reference to, if you exclude the goodwill charge that you incurred toward the end of last year, but as I understand, is the guidance you’re giving for half 2 is that half 2 ‘16 will be better than the first half or are you giving year-over-year guidance for the second half.

We’re giving it compared to the first half.

It’s okay guys. My questions have been asked.

Okay. Well, it’s Mark speaking.

Thanks very much for joining us on the second - sorry, the first quarter conference call and we look forward to speaking to you again at the end of the second quarter.