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Executives

Mark Foote – President and CEO

John Hamilton – CFO

Brian Dyck – SVP, Wajax Equipment

Richard Plain – SVP, Wajax Power Systems

Adrian Trotman – SVP, Wajax Industrial Components

Analysts

Benoit Poirier – Desjardins Securities

Sara O'Brien – RBC Capital Markets

Sarah Hughes – Cormark Securities

Bert Powell – BMO Capital Markets

Michael Tupholme – TD Securities

Wajax Corporation (OTC:WJXFF) Q1 2013 Earnings Call May 10, 2013 3:00 PM ET

Operator

Welcome and thank you for attending Wajax Corporation’s 2013 first quarter results conference call. On today’s call will be Wajax President and Chief Executive Mr. Mark Foote as well as Mr. John Hamilton, Senior Vice President Finance and Chief Financial Officer, Mr. Brian Dyck, Senior Vice President, Wajax Equipment, Mr. Richard Plain, Senior Vice President, Wajax Power Systems and Adrian Trotman, Senior Vice President, Wajax Industrial Components.

Please be advised that this call is being recorded. Please note that this conference call contains forward-looking statements. Actual future results may differ from expected results. I will now turn the call over to Mark Foote.

Mark Foote

Thanks operator and thanks very much for joining us this afternoon. I am going to make a few opening comments and then I am going to turn the call over to John for a detail review of the first quarter. Our first quarter earnings were only moderately less than we had expected as we knew the oil and gas and mining markets would be tough. In fact, compared to last year, the softness in the oil and gas and mining markets accounted for approximately 6 million and $2.9 million respectively of our consolidated $8.3 million EBIT shortfall.

We had positive variances in certain other revenue categories and expense items. We expect the weakness in the oil and gas markets that began in the third quarter of 2012 to continue for the balance of 2013 with demand for new equipment and aftermarket services for drilling and well stimulation continuing to be soft. In mining quoting activity remains reasonably strong for both the equipment segment and power systems EPG business. However project delays and reductions in capital and development spending have limited the ability of many of our customers to commit to new equipment orders. As a result, mining related sales are anticipated to continue to be weaker than we originally expected.

Since the backlog has not improved and with the forecast for mining and oil and gas activity to remain challenging for the balance of the year we’ve become more cautious in our outlook and expect full year 2013 earnings will be less than 2012. We have therefore adjusted our monthly dividend down $0.20 per share from the previous monthly dividend of $0.27 per share. And based on our current outlook, the adjusted dividend adheres to our objective of paying out a minimum of 75% of current year expected net earnings.

With respect to cost reductions, each business has taken actions to reduce expenses in a fashion that does not hurt the traction that they have on their growth initiatives. We do expect SG&A as a percentage of revenue to be higher at year end.

We’re very confident in our opportunities for growth and we remain very well-positioned in the mining and oil and gas sectors as conditions improved. Other core markets such as construction, material handling and forestry have shown year-over-year improvement, and our strategic initiatives continue to gain traction. We are focused on investing on these initiatives while taking prudent actions with respect to cost, inventory and working capital to manage our business as we go through 2013.

Let me turn the call over to John.

John Hamilton

Thanks Mark. Our first quarter 2013 consolidated revenue was $336.3 million, that was down 6% from last year on revenue declines in all three businesses and it was really attributable to the weakness in the oil and gas and the mining sectors.

Consolidated net earnings of $10.4 million or $0.62 per share were down from $17.1 million or $1.03 per share recorded last year and on reduced segment earnings in all three core businesses. Our consolidated backlog of $180.1 million at the end of March was down 2% from December.

So turning to the individual segments, and again starting with equipment, our overall revenue decreased 2% to $167.4 million for the quarter. Equipment sales decreased $11 million on reduced mining equipment sales of $21.7 million, $7 million of which – of that amount relates to the loss of LeTourneau line. Gains were realized in construction, material handling and forestry categories.

Our parts and service revenue were up 12% to $72.1 million. This was in spite of the discontinuance of the LeTourneau mining line. Excluding LeTourneau from last year's numbers, parts and service revenue increased 23%. This was largely attributable to gains in the mining sector on growth in rotating products and the installed base of Hitachi equipment. Quarterly segment earnings decreased $3.2 million to $9.9 million. Factors influencing this were the lower volume and gross profit margin mainly as a result of the discontinued LeTourneau line and higher selling and admin costs.

Turning to power systems, revenue decreased 17% to $79.9 million. The main reason for the decline was due to reduced activity in the Western Canada oil and gas sector, which negatively affected both equipment and parts and service volumes. Segment earnings of $4.1 million decreased $4.6 million was attributable to the revenue issues I just mentioned and reduced gross margins on parts and service in Western Canada.

In industrial components, the overall revenue of $89.8 million was down 4% compared to $93.3 million posted last year. If we back out the two acquisitions made late last year revenue would have been down 10%. Bearings and power transmission parts sales were essentially flat. However most of the acquisition volume was in this category.

Excluding the acquisition volume, softness was felt in mining, metal processing and oil and gas. Fluid, power and process equipment sales decreased $3.7 million on softness in oil and gas and the industrial sectors. Bearings of $3.7 million were down $3.1 million year-over-year. Key factors in the decline were reduced volumes, lower gross margins and higher selling and admin costs mainly attributable to the acquisition.

We finished the quarter with on the debt of $290 million, an increase of $45.3 million in the quarter. The increase was mainly attributable to $44.6 million income tax payment related to 2011 and 2012 taxable income. The corporation also declared dividends of $0.20 per share for May, June, and July.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your next question comes from the line of Benoit Poirier from Desjardins Securities.

Benoit Poirier – Desjardins Securities

First question is on the inventory reduction, I was just wondering if you could provide more color about what the intention about reducing the inventory and how much is related to the introduction of new products?

Mark Foote

Sorry I don’t fully understand the question Benoit.

Benoit Poirier – Desjardins Securities

Is there any – what is – how much do you expect to – or you are looking to reduce the inventory this year in 2013, any color about the magnitude of the inventory reduction you are looking at. And what is the percentage of the inventory build up that is related to the new product introduction such as the Hitachi mining truck and new tracks product line?

Mark Foote

Without getting into – I am not going to go through an accounting of specific items for the inventory in terms of the new products. But what I can say is we would expect that usually in this business as sales soften we usually generate cash from inventory and that – we expect that to be the case in this business. What we are seeing and what you do however understand is that there are certain amounts – we do have an inventory like we did disclose that we got a little over $44 million in mining equipment inventory which would include those new trucks. And so there is additional – there are additional pieces coming in as the year progresses.

I think at the end a realistic expectation would be that the overall inventory position certainly wouldn’t deteriorate and with any luck in terms of the market that we should see some improvement. A lot of it depends on how successful we are in the mining side. But I should also reiterate we are not uncomfortable with our mining position in terms of our inventory position because one of the things we have to be careful of is that when the market does turn and we want to be in a position where we have available product to sell.

Benoit Poirier – Desjardins Securities

How is doing the marketing campaign on those big mining trucks John?

Brian Dyck

It’s Brian Dyck. We have some outstanding quotes for the trucks. We are working on some opportunities but right now the mining business in general is being awful cautious and awful slow to react. So I can’t tell you the data that I have turned them into revenue. But we do have some outstanding opportunities.

Benoit Poirier – Desjardins Securities

Any lay-off or workforce reduction that you have done in the quarter and should we expect some to positively impact your margins eventually?

Mark Foote

It’s Mark speaking. We’ve taken some actions with respect to staffing related costs. I wouldn’t say that they are dramatic – they are in pockets of the business where we – just given the revenue base we have right now we felt comfortable we could do that. The cost reduction activities we’re taking it’s important to understand are not – we’re not looking to radically down size the cost base because we do think circumstances we are under right now are temporary. But we are taking every opportunity that won’t hurt the near term and medium-term revenue base of the company’s growth. So they are modest reductions in staff count, they are not significant, and I wouldn't expect to see us have any material reduction in staff or for this year.

Operator

Your next question comes from the line of Sara O'Brien from RBC Capital Markets.

Sara O'Brien – RBC Capital Markets

Brian, can you talk about the equipment parts and service, it was up 12% which is pretty nice. Just wondering if you are cautious in any way on the oil sands spending on service going forward?

Brian Dyck

Well, that increase did come from – some of it did come our rotating equipment business which is oil sands related but not the production or mining related. So we think we can continue that on. We had some shovel rebuilds in there and quite frankly they weren’t related to the oil sands either. So even from the oil sands standpoint I think we are going to see steady parts and service out of there. The last part where our growth came from was mostly from the construction business in Western Canada and we got a relatively large install base there, had some initiatives in the past to bolster our parts and service offerings and I think we’re seeing some of that come through to that.

Sara O'Brien – RBC Capital Markets

And just – what was the addition of SG&A in the equipment group what efforts were made to increase costs?

Brian Dyck

I think for us there was just some unusual items, some timing of expenses and some selling costs that are associated with the Hitachi construction product on rent to sell them contracts.

John Hamilton

Plus last year, Sara, we had a pickup in bad debt for the resolution of the particular issue that – so the comparative is more difficult.

Sara O'Brien – RBC Capital Markets

So last year was the positive –

John Hamilton

Yes.

Sara O'Brien – RBC Capital Markets

And just there was a comment about lower parts and service margins, just wondering what’s out there?

John Hamilton

Well, in equipment the lower margin was really attributable to mix of product where the loss of the LeTourneau product line was at a relatively high margin. Rotating products, while that’s really helping our parts and service business, there is a proportion of that that is still a very good margins but lower than what we would have experienced with LeTourneau.

Sara O'Brien – RBC Capital Markets

And then power systems, just a reduced volume basically that’s going on, or was there the difference in margin as well?

John Hamilton

There were some differences in margin. I think in power systems we got a bit of a mix issue as well there have been some competitive pressures particularly in the oil and gas side of things, that have been compressing margins.

Sara O'Brien – RBC Capital Markets

Maybe just lastly on the inventory, if it is expected to be somewhat steady, just wondering if you are seeing any pricing pressure from competitors or yourself at this point to really reduce the inventory levels?

Mark Foote

Our new equipment margins were steady in the quarter, may be up slightly. But I think that question is more related to what area of the country we are in and sort of what area of the businesses you are in. So it’s not steady across the country but overall we’ve had no margin compression on new equipment.

Sara O'Brien – RBC Capital Markets

Do you expect any or is it steady state here?

Mark Foote

I think we will be okay in the future, we are not overstocked in a lot of equipment. We are certainly not in a panic mode to reduce inventory. We are actually in some cases buying inventory in areas like forestry and places like that. So I think we will be all right.

Operator

Your next question comes from the line of Sarah Hughes from Cormark Securities.

Sarah Hughes – Cormark Securities

I just wanted to ask, on the competitive pressure you are seeing in the margin on the power system side, is it just existing competitors that you are seeing – more competitive or are you seeing any entrants into the market at all?

Richard Plain

Sarah, it’s Richard Plain here. It’s existing competitors. We are not experiencing any pressure from any entrants to the market.

Sarah Hughes – Cormark Securities

And then just on the – Brian, on the equipment side, just wondering what you are seeing there in terms of overall industry conditions where obviously we’re hearing a lot of delays in terms of on the construction side –

Brian Dyck

Quarter over quarter the market is down 25%. So it’s been difficult there at the first quarter of 2013 and for a lot of reasons you mentioned.

Sarah Hughes – Cormark Securities

What would be something –

Brian Dyck

I think in the mining, the Quebec provincial government was looking at changing some royalties. There are though fundamentally not a lot of change, I think it just slows down, a lot of decisions and lot of things that people want to do in Quebec. So we’ve experienced a bit of a tough market there.

Sarah Hughes – Cormark Securities

And through – the early part of Q2, is it just tougher, any improvement on the Quebec side?

Brian Dyck

I think we are seeing some improvement in what we are quoting in our business there and there is some seasonality in Eastern Canada too that – the construction market doesn’t get going until now.

Operator

Your next question comes from the Bert Powell from BMO Capital Markets.

Bert Powell – BMO Capital Markets

Mark, in the past you’ve talked about your power system initiatives, you’ve been working on that as a way to mitigate some of the pressures in the power systems business in the oil and gas sector. Just wondering if you can give us your thoughts in terms of how that’s evolving.

Mark Foote

I will start and then I will ask Richard if he’d like to add some color to it. So you are saying – you are asking about power gen – so I think we are pretty positive about the quoting activity that’s going on. But we acknowledge a lot of our larger projects are mining related. So we are seeing pretty realistic about the near-term opportunities associated with that. We’ve got couple new staff members that have joined in senior leadership positions. They brought some pretty good insights about some of the basic operations of some of the things that we’re already doing and stand by and prime power.

So I’d say that we are quite bullish on it. Growth was pretty – growth we expect for the full year, it may be little bit less than we originally expected. But it’s still pretty respectable and we’re excited about some of the new product that we think we can bring to bear. So that remains one of the bigger parts of our power systems strategy and a nice less cyclical part of the business in the off-highway business. So we are still pretty bullish on it.

Richard Plain

I guess I would just echo Mark’s comment that we’ve been very active in building up the team which was very important part of the strategy. We’re starting to get some exposure to projects that we weren’t exposed to in the past. So that – although the large project business in mining as Mark just said, has been delayed somewhat, we are still very bullish about our opportunities there.

Bert Powell – BMO Capital Markets

And Mark, just back to cost, I mean the outlook initially for the year was a better second half and that’s fallen to the wayside and certainly it’s a tough mining environment with lot of CapEx spending. I am just interested to get your view on when do you feel or what would be the signpost that you will be looking for to become more aggressive in terms of cutting costs?

Mark Foote

I guess if we for some reason felt that the market conditions in mining and oil and gas were going to continue to be really difficult through say next year, so I think we’d have to believe there was a pretty fundamental downturn in those two markets before we did anything more radical. We are that the growth initiatives we've got are going to get some good traction, and within our organization I think it’s pretty well – within our organization we don’t waste a lot of money. So we’re continuing to invest in those things to drive the growth. We’d have to believe that what we are going through right now would be extended for another year, before we felt that we had to take any more significant actions. So as I said earlier, we are taking actions with respect to SG&A reduction because anybody under these circumstances would. We just don’t want to hurt the growth initiatives investments that we are making because we are pretty convinced that we will come out of this in the timeframe that we had originally said.

The other thing I just want to point out is that we do expect the results to improve as the year progresses. So we expected the first half to be pretty tough and that is in fact what we think we’re going to experience. But we do feel that the earnings will improve gradually as the year progresses. So we do expect to have a better half in the second part of the year than we are in the first.

Bert Powell – BMO Capital Markets

Is that because you’ve got visibility in your backlog to mix, or is that expectation that the market will be – a little bit stronger and that will help you?

Mark Foote

It’s a combination of three things. I think there are some revenue programs within the business that are going to take hold in the second half of the year and that’s what we have visibility to now. Examples would be there is large power-gen project that kicks in second half of the year and into the fourth quarter. Adrian’s business has a lot of sales force effectiveness programs that are starting to kick in which we think will drive some organic volume. Brian’s business has a number of things going, not the least of which is continued strength in rotating products. So there's – I think there’s some additional traction on revenue, there is some traction in cost reduction as I said and I think there is some traction on strategic initiatives that will have a less significant effect I think than the first two factors do but will marginally positively help our momentum in our businesses as we go through the year.

Bert Powell – BMO Capital Markets

So these are really Wajax specific things and not a bad to the market coming back –

Mark Foote

Yes.

Bert Powell – BMO Capital Markets

In the rough market, we’re going to roll harder?

Mark Foote

Yeah, I mean it’s possible that we have customers that have contracted with for timing later in the year that may shift or something like that. But as far as our business outlook is concerned right now these are things within our control.

Operator

Your next question comes from the line of (inaudible) from Raymond James.

Unidentified Analyst

I think you touched a little bit already on some of the investments you are making in EPG, you talked a bit about expanding your workforce there. But is there any more color you can provide about the investments you are making on that front?

Mark Foote

It’s been from a personal perspective in terms of high level project development personnel recently added a specific business unit vice president that were successful and came from a competitor. So we’re very – that’s why – that’s one of the reasons we have some confidence in terms of the ability of the people that we have been able to attract to the business.

Operator

Your next question comes from the line of Michael Tupholme from TD Securities.

Michael Tupholme – TD Securities

Looking at the power systems segment and thinking about the oil and gas weakness that you have in there for several quarters, do you think you can start to show some positive top line growth even if just modest once you lap the (inaudible) here?

Mark Foote

Sorry, I missed that last part of the question.

Michael Tupholme – TD Securities

I guess you are still facing some tough calls in that business and things will get easier as you move into the back half of this year, I am just wondering if by that point you think you can actually show some growth there?

Mark Foote

I think basically our outlook is that oil and gas will continue to be flat for the rest of the year. There is nothing – that’s particularly driving us towards an increase – it’s going to be flat.

Michael Tupholme – TD Securities

Things deteriorated further though or are you just sort of where you were before –

Mark Foote

The equipment business in oil and gas can’t get that much worse. So I guess if you want to think about it that way, we are – if we are not at the bottom of the trough we are bouncing around pretty close to it. So on a relative basis you are absolutely right, third quarter last year was when things started to weakened. So on a relative basis we won’t look as bad as we get into the second half of the year. It’s tough for us to say what kind of growth we expect because that does depend on correction that we aren’t expecting but we are pretty close to the bottom of the trough on equipment sales as it relates to oil and gas. So we believe there is no word to open up (ph).

Michael Tupholme – TD Securities

In the earnings release there is a comment about the year over year change in EBIT and how $8.9 million of the year over year reduction is due to oil and gas and mining, I guess of that $4 million was due to LeTourneau. So I am just wondering of the balance, ex LeTourneau piece the 4.9 million, how much of that would have been oil and gas versus mining?

Mark Foote

About 6 million was oil and gas. Of the 8.9, 2.9 was mining. Again if you look at the mining 4 million LeTourneau, we had other positives that counteracted that within equipment and then we had slight negatives in power systems and industry components with regard to mining.

Michael Tupholme – TD Securities

And then Mark, I guess going back to your answer to one of the questions about the visibility in the back half, your answer lists of three things, the third one, the strategic initiative, it didn’t sound like a major – but can you elaborate on that a little bit?

Mark Foote

It’s not major, it’s not major for us this year. It’s important for us kind of medium or longer-term but we got – as you know from our plan and if you would see our investor presentation you can see the initiatives, some of those things, EPG, rotating, we’re off to a slow start in engineering and repair services investor components but we do expect to pick up some steam as we go through the year. So they are not driving our forecast sans obvious expectations in rotating that's already in the budget. They are not driving our forecast in a material way but we do think taking traction on them as we go through the year is important because they are going to help earnings as we look beyond 2013.

Michael Tupholme – TD Securities

John, you talked about inventories earlier, but can you update on your expectations for where we end up – coming into end of the year in terms of working capital?

John Hamilton

Well, again it depends on where we are with the mining working capital. All things being equal, we would expect we would adversely be flat working capital and the expectation hopefully was we would be somewhat positive on working capital. It depends how successful we are in mining and quite frankly how much mining inventory we kind of want to keep as opposed to making other arrangements for it, because we are going to be concerned when these things turn the other way.

Michael Tupholme – TD Securities

And then just lastly, rental equipment additions, it looked they slowed this quarter relative to last, is that – am I reading that right and is that just a blip or how do we think about that?

John Hamilton

I’d view of that as more of a timing issue.

Operator

We have no further questions at this time.

Mark Foote

Okay. Well thank you very much for joining this afternoon on our Q1 call and we look forward to speaking to you again in August. Thank you.

Operator

This concludes today’s conference call. You may now disconnect.

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