Wajax Corporation

Mark Foote - President and Chief Executive Officer John Hamilton - Senior Vice President, Finance and Chief Financial Officer

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

Thanks very much. I’ll make a few introductory calls and then turn the call over to John for some color on the third quarter.

Opening remarks, as expected, third quarter net earnings improved compared to the second quarter and included a $1 million in insurance proceeds related to the Fort McMurray wildfires. We’re particularly pleased by the improvement in our Power Systems segment, where our cost reduction and margin improvement initiatives began to pay off despite continuing challenges in the Western Canada market.

Consolidated net earnings were up slightly compared to the previous year as savings from our restructuring activities were more fully realized. This net earnings improvement was achieved despite lower revenue and a $2.8 million gain on the monetization of mining trucks that was recorded in third quarter of last year.

The reorganization we announced in March of 2016 is proceeding on schedule and we are on track for completion by the end of 2016. We now expect approximately $8 million of savings in 2016, with the full $15 million in estimated cost savings expected to be realized in next year.

Consistent with the last two quarters, our outlook for the remainder of 2016 is that market conditions will remain challenging, particularly in western Canada. However, we expect fourth quarter earnings will continue to benefit from the earnings improvement initiatives implemented in the Power Systems and from the completion of our reorganization.

John?

Thanks, Mark. So third quarter 2016 consolidated revenue came in at $286.6 million, that was down 1% from last year.

Equipment segment revenue increased 7% on the strength of higher mining equipment and parts and service sales, whereas revenue in Power Systems and Industrial Components segments declined 16% and 3%, respectively. This was as a result of reduced activity in the Western Canada energy sector.

Our consolidated earnings for the second quarter were $7.6 million, or $0.38 per share, and that compares to $7.5 million, or $0.38 per share in 2015. The year-over-year increase in Equipment segment earnings was offset by reductions in Power Systems and Industrial Components.

It should be noted that net earnings in the third quarter included approximately $3 million of cost savings attributable to our restructuring efforts, as well, we had $ 1 million of pre-tax proceeds from the Fort McMurray fire insurance claim. In addition, 2015 net earnings include the $2.8 million gain from the monetization of mining trucks that were in inventory.

Consolidated backlog of $142.1 million at the end of September decreased $23.1 million compared to June. While the backlog in the Power Systems segment increased in the quarter, the consolidated decline was primarily related to the delivery of a large mining shovel in the Equipment segment.

So turning to the individual segments and starting with Equipment. Total revenue of $138.9 million in the quarter was up 7% compared to last year.

Equipment sales increased $8.6 million mainly as a result of the delivery of the large mining shovel in the oil sands. Parts and service volumes increased 2% to $56.8 million compared to last year, mainly as a result of higher mining sector volumes.

Quarterly segment earnings of $10.7 million, or 200,000 ahead of last year, as higher volumes and lower selling and administrative costs, we – sorry, we experienced higher volumes and lower selling administrative costs. 700,000 of the Fort McMurray fire insurance claim proceeds that accrual went to reduce selling and admin costs.

You should also be noted that the last year’s earnings included $2.8 million gain on the monetization of mining trucks that was in the Equipment segment, obviously. Turning to Power Systems.

Revenue decreased $16 million to $55.5 million. The Equipment revenue decreased $4.2 million on lower offhighway power generation sales to customers in Western Canada.

Parts and service sales decreased $6.2 million attributable to lower sales to the – to on and offhighway customers in Western Canada and lower volumes to offhighway customers in Central and Eastern Canada. Segment earnings decreased $200,000 to $900,000 compared to the previous year.

As lower revenue and margins were only partially offset by $2.4 million of lower selling and admin costs. Turning to Industrial Components.

Revenue of $93.3 million was down 3% compared to $96.6 million posted last year. Bearings and power transmission parts revenue decreased $800,000 compared to last year, and fluid power and process equipment sales decreased $2.5 million due to reduced activity in the Western Canada energy sector.

Earnings decreased $300,000 to $4.4 million. The earnings effect of lower sales was mostly offset by $700,000 decrease in selling and administrative expenses.

We finished the quarter with funded net debt of $147.9 million, that was down $10.7 million compared to June. And today, the corporation declared $0.25 per share dividend in the fourth quarter of 2016, payable on January 4, 2017.

So, operator, we’ll now open up the call to questions.

Hi, good afternoon, guys. Good job in the quarter.

Hey, Michael, thank you.

So I’ll start on Power Systems, lots of pressure on that business. So you certainly made some difficult decisions there.

That division is now profitable again, any sense of the potential margin runaway, absence of a margin – of a market recovery?

It’s mark. The – I think the margins we saw in third quarter – our focus right now is to keep that business profitable.

I think that in absence of any significant change in the market, I think, our expectations remain pretty realistic. Our focus right now is on continue to make sure that the gross profit margins continue to improve albeit less significantly probably going forward than the – we managed to do in the third quarter and continuing to focus on expenses in that business, particularly in the service departments, where the volumes are fairly low mostly in Western Canada.

I think the – as John has pointed out previously, the majority of our overall company restructuring cost savings effect is felt in Power Systems. And so we’re assuming that cost structure stays pretty competitive going forward.

But in absence of a significant improvement in the market, we’re – our expectations are pretty conservative that kind of low single-digit EBIT margins probably what we’re looking at until we can see some kind of market-based recovery.

Okay, thanks for that, Mark. Turning to the Equipment side of the business, could you comment on what you’re seeing, or hearing from your mining customer right now?

You’ve had the two large Hitachi orders, one in Q3 and one presumably in Q4. But you’ve also seen an increase in parts and service this quarter.

So we’re looking beyond 2016, how should we think of, or maybe your thoughts on new equipment or aftermarket spend from those potential customers?

Yes, it’s fair to say that we saw – there’s a point there in the MD&A, we saw an increase in mining parts business in the third quarter that there’s a – there’s an improvement, at least, with respect to our fleet of equipment, some improvement in the utilization of that equipment. So we’ve seen some increase parts and service in some under carriage and repower work, which won’t necessarily repeat, because that’s a periodic maintenance work that the customer will do once every X number of hours.

So that won’t necessarily repeat. And I think we’re staying for the balance of this year.

We’re thinking that the kinds of trends we’re seeing in mining parts and service, we believe we can maintain for the balance of this year. Looking into 2017, I think that’s a bit more of a difficult story for us right now that the visibility customers are going to give us on their maintenance requirements, is going to be lower than it is over the short-term.

As you know, we won’t repeat the major shovel sales we did this year. So really our focus on the whole good side is to push a real hard on the available mining deals that are out there.

We’re pleased with the coating activity in the non-oil sands mining space, and we see some signs of life in that. But it’s a bit premature for us to say, whether we should be bullish on kind of whole good sales going into 2017.

Okay. Mark, could you comment on which sectors or which metals you’re seeing some of that positive reaction outside the – your oil sands?

Look, there’s a bit of met coal activity in British Columbia. So you can see just from the public information that the Walter Energy mine hopefully that sees some operating time sometime in 2017, we’re not sure about that, but hopefully it does.

And we had a fairly good sized fleet there that we had idle, I think, it was second quarter 2014, John? And we’re seeing some activity in new plant in Eastern Canada.

We expect mining bids that are available, that’s on the equipment side. There’s some additional activity on the power generation side.

So that hopefully, that helps you a lot.

Yes, that’s helpful. Maybe I’ll just sneak one in – just on inventories that’s come down in the last recent quarters.

But could you comment on more provide a sense of if there’s any aged or excess inventory that potentially could be being sold at a discount and maybe when that clears up, or – for Wajax, or even for the industry?

Are you talking about maybe whole goods inventory or parts?

I mean, I can ask on both. But it probably be more pertaining to new equipment?

Okay. Yes, We do still have some excess or call say it excess new equipment inventory.

We still have some mining equipment in inventory. I wouldn’t say that we’d be selling those products at a discount, but certainly the competitiveness of deals is pretty tough out there.

So I’m not anticipating on a whole goods side that we would have any issues with regard to obsolescence. On the parts side, we have kind of a formula that we run to handle our obsolescence.

And so we’ve seen an uptick in the parts obsolescence throughout this year, which we would expect to continue for the fourth quarter as well as volumes have declined and things have hit our calculation to hit that obsolescence calculation. The other thing from the standpoint of other pieces, I think, we mentioned in the past, we do have on a whole goods side, we do have some oilfield engines that we’ve had for some period of time.

We think we have some opportunities and some other applications to be able to sell those products, but it kind of remains to be seen as to whether we’d be able to do that. So that’s something that we’ll be mindful of over the next couple of quarters as well.

All right. That’s it from me.

Thanks, guys.

Hi, good afternoon. Can you comment on the gross margin outlook just given the competitive dynamics right now, you’ve seen kind of 19% to 19.5% range.

Is that kind of a new normal based on today’s mix going forward? And then just to follow-up on SG&A and a target as a percentage of sales?

Yes, it’s Mark Sara. The – I think we’re reasonably satisfied with where the gross margin set in the third-quarter.

As John pointed out, I mean, any whole goods deal particularly in mining and construction is pretty tough to come by. So to say that there’s any kind of margin accretion from selling goods into those businesses that that’s not the case.

I think when it comes to parts margins and the industrial components margins and, in particular, the service margins, which we think we can marginally improve, the kinds of margins we’re seeing today we think we can maintain. But the pressure in our business is going to come from to what extent does margin have to take a hit for moving some of the whole goods.

And I think that’s probably more of an issue in the construction business just because of the volume there than it is in the other category. So I’d say 19.5% is probably good walk at around number recognizing that there maybe some downward pressure on that driven by the construction market.

Okay. And Mark, you were commenting on parts.

So is there more ability to pass through kind of the higher FX now, or is it still dealer’s responsibility to assume some of those cost increases?

Yes, it really depends on the category. But it’s probably best to say that in general terms, we’re fairly active about moving the FX adjustments to parts through to the customer.

They may not be true in all circumstances, but we continue to focus on doing that, at least, to this point in time has been possible.

Okay. And then just switching to SG&A, it looks like a little bit sub-15% even if we add back the 700,000 in claims.

Is that a good run rate, or can you do better, I know, historically you’ve been below 15% as a percentage of sales?

The – I think that’s probably as much a function of revenue as it is anything else. We’re pretty satisfied with the absolute level of dollar expense in the business, I think, we’ve got a bit more to go.

And, as we said, the full effect of the reorganization will be felt next year. And really I think their percentage of sales is effectively going to be largely a function of what happens with their revenue.

But there’s a little bit of variability in our expenses from a revenue standpoint. But somewhere between 14 and 15 would be a pretty good aspirational target for us when you think about kind of trough revenue levels and obviously, we would want to see some leverage with that as revenue numbers went up.

Right, okay. And then maybe just commenting on working capital needs some good free cash flow generation, the net debt position came down.

Is there anything that would chew up working capital into Q4, or is it expected to – are you expecting to see a continued improvement in the trend of debt to leverage?

I just put it this way. We wouldn’t expect our leverage to get worse in Q4.

And if anything, hopefully, there’s some upside for us from the standpoint of our overall debt levels.

Okay. So from that perspective are you feeling much more comfortable with the dividend level now for the sustainable level going forward?

John, just turned off his mike, and I guess, I just turn mine on. Yes, I think it’s – the same answer is always Sara.

I think the dividend is a function of where we see earnings going and to the extent to which our earnings are going to support the dividend borrowing any alternative use of capital that has excited, I think, we’re comfortable with continuing.

Okay, great. Thank you.

Thanks. Good afternoon.

You guys saw very healthy margins for the second quarter in a row in the Equipment segment. I’m just wondering if you can comment on how sustainable you see those margins as you look at 2017?

You’re talking about EBIT margins, Mike?

Yes.

Yes, now don’t forget with the EBIT margins, yes, the $700,000 worth of the insurance claim that was – went into the Equipment segment. So the margin was ended up being quite good.

We did pretty well with regard to our parts and service business. As you know, there’s a positive mix issue there, difficult for us to say as to whether we could maintain something, I think, you’re looking at probably 7% or better, difficult to say as to whether we can maintain that.

But certainly we – if you look at where we’ve been over the quarters, we’ve been six or better, I think in some cases seven. So it can bounce around for a while.

But I don’t expect that we’re going to be maintaining that high level in terms of that kind of improvement going forward.

Okay. And then just to circle back on Mark’s comments about the parts and service sales in that business, I mean, we saw them turn positive on a year-over-year basis for the first time and a long time understood correctly what you were saying, Mark, some of that was sort of not one-time, but not necessarily going to be recurring every quarter.

But there was an element there that was – that is more of a recurring nature you see as well?

Yes, there’s some of that. Again, it’s – the increase was due primarily to mining and the mining can’t be fairly lumpy from a parts and service standpoint in the Equipment segment.

So we’re continuing to – the visibility over the short-term on parts and service remains reasonably good. But it’s real tough to make a call on mining parts and service in the next year to simply, because we’re cautious just on the utilization of the equipment.

Okay. And can you tell us how – what the value of the mining shovel you delivered in this quarter was, as well as if that’s comparable to what we should expect for next quarter shovel?

Rough numbers for the revenue side of that shovel would be $17 million, $18 million.

Okay, perfect. And then just, I guess, just lastly for me in terms of the Power Systems segment, as we look out to next year, I guess, we saw a few things happened.

So your backlog in that segment moved higher for one and we’ve seen drilling activity pick up over the last sort of a while. Just wondering what you’re seeing, what you’re hearing from your customers in terms of the outlook primarily in the offhighway and the power gen side across the country?

The power gen is reasonably good. But I wouldn’t say that has anything to do with resource markets, that’s more of a data center, water treatment type of statement.

So I’d say that, we remain pretty optimistic about the trends in Power Systems looking forward, but again it’s not driven by resources. There are some large mining projects that if they were to go ahead, we’re reasonably well-positioned certainly competitive in learning that business.

But those are the things that I think historically we would have more confidence in than we do today. So we’re really focused more on the municipal data center those types of projects for power gen.

But with our – the bid process we’re going through with the number of customers is reasonably positive. And I’m sorry, you asked – the first part of your question was not about power gen and then I’ve got to know what it was?

Yes, more on the offhighway side, which I guess, you sort of spoke to a little bit. But if is there’s any else there in terms of, we’ve seen drilling activity pickup if you’ve seen any more reasons for optimism in the Western Canadian offhighway part that’s interested?

Actually the patient has a heartbeat, but he can’t get off the stretcher this morning. So there’s a few – there’s more quoting activity for the conventional oil and gas side than there has been historically.

But it’s coming off such a low base that we’re not expecting that to be a – any kind of material driver for what’s happened in the Power Systems, at least, over the short-term.

Including on the parts and service side, or is that maybe shutting your near-term opportunity there?

Again, I don’t think it would be material, and again, I could be wrong. I mean, we’ve seen our oil and gas customers who surprised us more positive and negatively.

But we’re not counting on the oil and gas business to significantly change its trend, at least, for the balance of this year.

Okay. All right.

Thank you.

Yes, thanks. John, where did the other part – where did the other $300,000 of the million insurance go 700 went into mobile equipment?

It would have been split roughly equally between the other two segments.

Okay. And then just back to the shovels, what was – if I look at the backlog commentary of kind of infer that the shovel capital fill in the quarter was $25 million, but not sure, if you could just help us understand that?

And then, Mark, just to confirm, you said 17 to 18 would be the capital sale for Q4?

Correct. Yes the inference in terms of the main reason why the backlog went down was because of the shovel delivery, but it wasn’t all of it.

Okay. Well, how much was the shovel delivery in the quarter that…?

I think we mentioned about $17 million roughly.

Okay. And then – okay, what do you expect for Q4?

That’s about the same.

Oh, it’s about – okay, so it’s for each, okay, great. And then just thinking about the margins then in the mobile equipment business for the quarter those shovels, I think typically would come with pretty decent prep work that would be associated with that that generally, I think, would be reasonably high margin.

Is that having a positive influence on the margins for the mobile equipment and kind of trying to stay about 7 going into 2017 is a challenge just because your absent those shovels?

Yes, it would have a positive effect on those markets, yes.

Okay, perfect. And then just on Power Systems the backlog was noted as then Mark, you had said, you’re being cautious in the that that side of the business and thinking about low single-digit margins.

But it sounds like you have some decent success this quarter there?

I’m sorry. Say the last part again, Ben – Bert?

I’m sure I’ll never do that again.

Here we go again. On the Power Systems, it sounded like the backlog increased, you had some success in Central Canada in terms of winning some business in power gen business.

So your comment didn’t really triangulate with what happens to your bookings in that quarter for Power Systems. I’m just wondering how to square that up a bit?

Okay. Well, my comments – most of the increase in power systems backlog was related to power gen, so power generation projects.

Yes.

There’s a little bit offhighway in there, but considered most of the power generation. And as I said earlier, we remain pretty bullish on the power generation market.

So hopefully that helps a little bit more.

Okay, perfect. And then just last question, John, just on the corporate costs your segment eliminations for the quarter, $2.6 million, what’s the right way to think about that number now going forward and sway how much of that would have had stock issues that [indiscernible] on?

Sorry, I didn’t hear the last part of what you [Multiple Speakers] to that?

On the corporate costs, your segment eliminations were $2.6 million in the quarter, just trying to think about how to think about that going forward?

But I think on the corporate cost, we would likely see it go up a little bit in Q4, mainly because it is finishing up the cost that we would have with regard to the restructuring, because there’s some costs that are being booked in the business that are not part of the – can’t be applied to the restructuring provision. So there would be an expensive corporate.

I wouldn’t say that’s going to be a huge number, but we might see that go up a little bit. The other thing is – so for the rest of the year, I would think that would be the only major change in terms of those costs at corporate, as we go forward.

Then as we go into next year, depending on what we’re doing for our provision – the big difference could be in our provisions and our accruals will make for bonuses and incentives. But right now, we wouldn’t be expecting that to be hugely significant in terms of a change for next year.

So, yes. long story is short.

The numbers are pretty good in the quarter, as you go forward bit of an exception and potentially next quarter for some of the system conversion cost we have as part of the restructuring.

Okay. So $10 million to $11 million on an annualized basis, is the right way to think about it?

Sorry $10 million for the year?

That’s not out of the range. I’d say, it can change depending on what the incentive provision is, though.

So it can vary by a couple of million depending on what the incentive provision is.

Got it. okay, thank you.

Hi, guys.

Hi, Ben.

Good job on the cost control this quarter by the way.

Thank you.

If I could just carry on where Ben last asked there on the corporate costs, or I should Bert. Did – is there anything in those numbers that reflects any kind of beefing up on your head office as you go to the more centralized model, like I say, is there something that any kind of corporate costs we need to integrate into part of the financials that don’t go into one of the three segments.

The – I think what you’re going to see next year and we’re in the process of sorting this out in terms of how we’re going to be reporting is, you won’t – you likely won’t see a number that looks like that, because we’re going to a functionalized kind of structure.So you won’t see a corporate costs such as that, it will be in with some other function. So, I think it’s going to take us to roll the thing out in Q1 of next year for you to kind of see that.

I mean, we’re currently kind of finalizing what our plans are there. So, I think, the concern around corporate costs is really kind of attributable to the fourth quarter at this point.

So, I mean, you’re going to start – you’ll start allocating those corporate costs each of the units, or how – and I don’t really follow what you’re saying?

Well, I guess, because we won’t be reporting the kind of segments that we’re reporting now, because the organization has completely changed from the standpoint of how we’re going to be structured and how we’re evolving to a structure now. So you won’t see a number like that in terms of a $10 million or a $11 million corporate cost numbers, what I’m saying.

What will we see with the new structure in terms of reporting? Like, are you going to go, or will we see the three segments anymore?

You won’t see the three segments and we’re currently finalizing that in terms of exactly how we’re going to be reporting.

Okay. But I guess back to the meat of the question is, like is there – as you’ve gone to this centralized approach, has there been – was taken a lot of costs out of the branches, but it’s – some of that has been offset by costs at head office and support?

The number that we have given, so the $15 million savings that’s net of whatever cost increase that we’ve had. So we’ve taken quite a number of positions in the field there, and there are some new positions that have been out in the field, and there are also a few positions that have been added, call it, at the central location.

But the net effect in terms of the cost savings are going to be there, at least, $15 million.

And it’s safe to say that if you look at some of the centralized functions, you can’t see it today because of how the segment the reporting works. But the headcount in a number of the centralized functions went down also in addition to what happened in the field?

Okay. Another question I have is that, Hitachi recently announced its acquisition of Bradken.

And it look to me like some of their business units would fit nicely into your rotating products initiative and just the – the move into fixed plant and things like that, and in fact, they have a whole unit that this unit called out, I think, the Alberta oil and gas operating unit. Does this have any potential implications for what you guys do for Hitachi?

Possibly, yes. I think our relationship with Hitachi is pretty strong.

So any new business opportunity that has relevance in the Canadian market, I think we’ll always discuss with them. We wouldn’t have anything to tell you specifically right now.

Would that involve a capital outlay though like kind of what the cat dealers had to do when cat bought these tires?

Again, we don’t really have anything to report. But having said that the types of deals we’d consider likely wouldn’t be like that right.

All right. Okay.

And just finally, if I could, on the backlog, it was down I think 10%, but you still got a mining shovel in there. So, I mean, I guess it goes back to your commentary about 2017 and the whole goods forecast.

But I imagine if your order intake just even remain flat in the fourth and then you subtracted that delivery of the mining truck, you’re probably looking at another decline in backlog going into 2017, is that the cause for – at this point being somewhat cautious on the whole goods outlook for next year?

No, not specifically. The – I think when it comes to backlog, you have to separate what you might consider the day-to-day whole goods business like construction and material handling, that’s in inventory versus the larger types of transactions like mining equipment or kind of very high unit volume material handling deals that go over the course of a number of years, or the Power Gen projects.

So I don’t think the day-to-day whole goods business, that’s not something we think is going to be fundamentally different next year than it is this year. But we’re obviously pretty active in seeking out some of those larger deals in each of those three categories to get that backlog number up just simply because there’s so much revenue attached to some of those larger deals.

But not everything that you sell goes through backlog, right, like the – some of the smaller, like you’re saying, the smaller stuff you’ve thought of inventory and not necessarily backlog?

No, it’s exactly right. I mean, backlog is not always the best indicator of our business volume.

Yes.

It’s a very good indicator of the future sales of large capital goods, because we obviously wouldn’t carry them in inventory. But it’s not always the best indicator of what kind of the performance of the business is going to look like over the next three to six months.

Okay, that’s all I got. Thanks very much.

Okay. Well, thanks very much for your time today and we look forward to speaking to you again when we release the fourth quarter results.

Thanks very much.