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Executives

Mark Foote - President and Chief Executive Officer

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

Brian Dyck - Senior Vice President, Wajax Equipment

Richard Plain - Senior Vice President, Wajax Power Systems

Steve Deck - Senior Vice President, Wajax Industrial Components

Analysts

Peter Prattas - Cantor Fitzgerald

Sara O'Brien - RBC Capital Markets

Sarah Hughes - Cormark Securities

Gregory Jackson - Raymond James

Michael Tupholme - TD Securities

Wajax Corporation (OTC:WJXFF) Q4 2013 Earnings Conference Call March 4, 2014 3:00 PM ET

Operator

Welcome and thank you for attending Wajax Corporation’s Q4 2013 and Year End 2013 Financial Results Analyst Conference Call. On today’s call will be Wajax’s President and Chief Executive Officer, 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 Mr. Steve Deck, Senior Vice President, Wajax Industrial Components.

Please be advised that this call is being recorded. And 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 and appreciate everyone attending our call this afternoon. I will make some opening remarks and then I will turn it over to John for details in the results of the fourth quarter. I want to start by welcoming Steve Deck to our senior management team effective yesterday. Steve has got very strong background in senior leadership roles in industrial distribution and we are pleased that he has joined our team to drive improvements in our industrial components division. I will ask you to respect that it’s Steve’s second day, so we will spare him the requirement to answer any of your questions about the performance of the business, but as I said we do welcome Steve and look forward his ability to contribute to the next call.

On a full year basis, as we have reported throughout the year, the key issue on our earnings has been the weakness in the mining and oil and gas markets. Virtually all of the decline year-over-year relates to those two markets. Regardless of those current conditions, however, we remain committed to our strategies in those markets and in particular to expanding our aftermarket range to help insulate ourselves against negative equipment cycles.

During the fourth quarter specifically, revenue increased 7% on gains in all three segments. The impact of oil and gas and mining was less significant than it had been in prior quarters. The improved revenue did not translate into higher earnings due to reduced gross margins and higher costs, mostly attributable to interest, but we also did see an increase in SG&A.

With respect to SG&A, we continue to invest on our various initiatives and remain committed to managing our total expenses with the balance to what will grow our business in the future and our current earnings. Year end backlog at the end of 2013 was $155.1 million that was down 24% from the prior quarter due primarily to the delivery of four Hitachi mining trucks and a number of power generation packages that started to shift in the fourth quarter. In the current economic environment, customers continue to take a cautious approach in making commitments to buy equipment or conduct major resource projects in power gen. We continue to compete very aggressively across each of our businesses or for new orders.

Our expectation is that the market conditions in 2014 will be similar to those that we encountered in 2013 and a continuing weakness in the oil and gas and mining equipment markets is expected to create challenges for earnings growth in 2014. In particular, we anticipate earnings in the first quarter to be lower than last year. Despite these market conditions, our focus is to continue to invest in our strategic initiatives that focus on organic growth and expansion of our aftermarket business. At the same time, we are very cautiously managing total costs, our asset base and our leverage. John?

John Hamilton

Thanks Mark. Fourth quarter 2013 consolidated revenue was $391.7 million that was up 7% from last year on revenue gains in all three businesses. Consolidated net earnings of $12.2 million, or $0.73 per share, was down from the $14.2 million or $0.85 per share recorded last year on reduced segment earnings in equipment and industrial components. Financing costs also increased $1.7 million on hiring board levels and higher interest rates. As Mark mentioned, consolidated backlog of $155.1 million at the end of December was down from September.

Now, turning to the individual segments. First starting with equivalents, overall revenue increased 8% to $218 million for the quarter. Equivalent sales increased $14.7 million on gains in forestry and construction. Parts and service revenues were up 2% to $72.4 million. This was largely attributable to sales gains in the mining and forestry sectors. Quarterly segment earnings decreased $600,000 to $13.4 million. Higher volumes and lower SG&A costs were more than offset by an unfavorable sales mix, which reduced gross margins.

Turning to Power Systems, revenue increased 8% to $85.4 million. Equipment revenue increased $4.4 million or 14% on a higher power generation sales in all regions. Parts and service sales increased $2 million on higher sales in the on-highway sector and segment earnings of $6 million increased $1 million attributable to the revenue issues just mentioned, partially offset by higher selling and administrative expenses.

And then turning to industrial components, overall revenue of $89.1 million was up 4% compared to $85.3 million posted last year. This increase was entirely attributable to the Kaman Canada acquisition completed at the end of last year. Bearings and power transmission parts sales were up $3.3 million as most of the acquisition volume is attributable to this category. Fluid power and process equipment sales increased $500,000. Earnings of $2.1 million were down $1.5 million year-over-year. The decline was a result of lower gross margins mainly as a result of product mix and competitive pressures in Western Canada and a $0.8 million increase in SG&A costs. The increased costs were primarily attributable to the costs taken on as part of the acquisition.

We finished the quarter with funded net debt of $205 million, a decrease of $20.3 million in the quarter largely attributable to cash generated from reduction in operating working capital. The corporation also declared dividends of $0.20 per share for the months of March and April.

Operator, we will now open up the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Peter Prattas from Cantor Fitzgerald. Please go ahead.

Peter Prattas - Cantor Fitzgerald

Good afternoon guys.

John Hamilton

Hi.

Mark Foote

Hi Peter.

Peter Prattas - Cantor Fitzgerald

You delivered on the four mining trucks during the quarter and I am just wondering are you getting any feedback on these deliveries as yet, how long does that assessment period normally run for equipment of this nature and how eminent might the customers needs be if they do decide to keep with the Hitachi line?

John Hamilton

The test or the trial period for these trucks are 18 months, that was the contract with them. As far as other operating I would say their operating is expected for a new truck in the oil sands and we will have some good feedback from them and we had a lot of support from our manufacturer for any issues that we have out there.

Peter Prattas - Cantor Fitzgerald

So would you suspect that you have get through the trial before any further orders from them?

John Hamilton

Probably from Shell they want to evaluate the trial and after that point in time and we would look at any other opportunities that are there.

Peter Prattas - Cantor Fitzgerald

Great, thanks for that. And then my next question is on inventory, I mean it did improve there, I think it helps buy your mining deliveries, are you satisfied with the mining inventory now or is that still the primary area of focus to bring down inventory?

John Hamilton

That’s still the area of focus to bring down an inventory over 2014.

Peter Prattas - Cantor Fitzgerald

Okay, that’s it for me. Thank you.

Operator

Your next question comes from Sara O'Brien, RBC Capital Markets. Please go ahead.

Sara O'Brien - RBC Capital Markets

Hi good afternoon. Mark, can you talk a little bit about cost control and what initiatives you may have underway to right size EBIT margins here, should we expect any major cost cutting coming forward?

Mark Foote

We have got an effort underway for a while to manage costs on a kind of a tactical basis. I think given the results that we are seeing in the early part of the first quarter, we will be a bit more aggressive with costs that can be focused in parts of the business that have the lower EBIT margins right now. So at this point in time, I think you can expect us to increase the emphasis we have got on that. We have got a number of plans underway. We are not really prepared to say what the extent of that effect is going to be, but suffice it to say that the approach to reduction of cost is more aggressive given how we are ending the year and given how we are starting this year.

Sara O'Brien - RBC Capital Markets

Okay. And then just on the free cash flow outlook, understanding that inventory reductions are focused, but I mean in terms of I guess free cash flow outlook for the year and capital structure outlook, a little surprised if the dividend is still such a high payout level given flat to muted outlook, is there any rethinking at the Board level of changing the payout ratio to something that’s more manageable longer term?

Mark Foote

I will maybe comment on the dividend and ask John to talk about the cash. There is no contemplation right now for adjusting the dividend policy that we have. And as you all know we discuss the dividend in every Board meeting and it’s a function of where we see the earnings for the full year being. So at this point in time we left it unchanged because now we see that how we expect the year to turnout based on the information we have today but we’ll – as we do every time when – but we’ll make recommendation to them in May but whether or not we chose to maintain it or change it. So at this point in time we know intention to reconsider the policy that we’ve got. You want to comment on the cash flow?

John Hamilton

Sure. And in terms of looking at 2014 what you mean by kind of operating cash flow, if that cash flow generated from operating activities, less capital and dividends. We would expect to be cash flow positive in 2014.

Sara O'Brien - RBC Capital Markets

And that’s net of changes in working capital?

John Hamilton

Net of changes in working capital, so it’s cash from operating activities, less capital and dividends.

Sara O'Brien - RBC Capital Markets

Okay. Would you expect there is leftover to pay-down any kind of the – any type of debt sorry…

John Hamilton

Well by – if we’re going to be cash flow positive then effectively it does allow me to pay something down.

Sara O'Brien - RBC Capital Markets

Okay. And then maybe for Brian on the Equipment Group just wondering what the outlook is for U.S. dollar FX pass-through if there has been any pushback on pricing that you’ve seen so far from customers whether beyond parts and service or on whole goods?

Brian Dyck

Obviously we had to make some adjustments in our parts pricing and we haven’t seen any slowdown in that area and I’m going to say there is probably still a fair amount of inventory and dealer’s stock that wasn’t effective maybe as much in the first couple of months by the exchange difference. So really there hasn’t been a kind of pressure on that yet.

Sara O'Brien - RBC Capital Markets

Is it just too early to say what the impact is going to be because there is so much inventory out there or you’re getting an inclination from new orders coming in on how the pricing will fare?

Brian Dyck

I don’t know I think there is – because there is some inventory, there is – people are looking at trying to avoid that exchange gain so there is some activity there. But generally to make subject part of our business that the prices go up and down to some extent in the equipment business and the big equipment business not bad, it’s not that big of a deal right now.

Sara O'Brien - RBC Capital Markets

Okay. That’s it from me.

Operator

Your next question comes from Sarah Hughes from Cormark Securities. Your line is open.

Sarah Hughes - Cormark Securities

Hi guys. In terms of the weakness you talked about in the first quarter. Can you just talk a little bit as it coming from all three segments, one segment more than the other, just trying to get a sense of overall outlook?

Mark Foote

It’s Mark speaking. Let’s put it this way. The – we’ve seen some revenue softness coming into the early part of the year that we didn’t expect. And I think in the first quarter buying to take some one-time cost that will be dilutive to earnings. So I wouldn’t say it’s the revenue weakness despite spread with respect to the comparison to our expectations but we have seen some of it in some parts of the business.

Sarah Hughes - Cormark Securities

Okay. And then in the quarter for industrial components you talked a little bit about on the impact on earnings and pricing pressure you saw. With this new to the quarter, have you seen this delving through the year and just kind of what your outlook is on that going forward?

Mark Foote

Yes. It’s the primary driver of the EBIT margin decline in the fourth quarter for industrial components was the gross profit margin that really was a function of our product mix and competitive pressure. I wouldn’t say that, that issue is new to the fourth quarter for industrial components that something that has been going on for a bit of time in 2013 and it’s a key focus for us as we think about how the business is running in 2014.

Sarah Hughes - Cormark Securities

Okay. Are you seeing any increase in activity or signs just on the oil and gas side from the LNG potential activity in Western Canada at all yet?

Mark Foote

No. We’re cautiously optimistic, we think it’s probably a bit longer term as far as it’s effect on us is concerned. So we haven’t factored any of that into our 2014 outlook but we’re cautiously optimistic that in 2015 that will have a positive effect on us. It would be premature on our effort to try and predict how expensive that be.

Sarah Hughes - Cormark Securities

And then lastly the rotating products strong growth here this year, I was wondering if you can talk a little bit about the longer term growth opportunity kind of size of market opportunity you have here going forward on the rotating product side?

Mark Foote

Well I don’t – well let’s put it this way. It’s a very big, very lucrative market for us just in for earnings. And I think we talked before about the fact that similar products and services apply to mining markets in Ontario and the iron ore well Quebec etcetera. So we stopped sort of trying predict or trying to understand what the market size is outside of Fort Mc. But we ended the year roughly $38 million in revenue and rotating that was up roughly 80% on an year. And we see some big growth opportunities in Fort Mc and elsewhere. So, we have a really good opinion how big that business should be, but we certainly see that it is a pretty significant growth opportunity for us.

Sarah Hughes - Cormark Securities

Okay, that’s it from me. Thank you.

Operator

Your next question comes from (indiscernible) from Scotiabank. Please go ahead.

Unidentified Analyst

Hi, thank you. First question just on the Power Systems segment, this one did better than expected. It was good to see revenue growth in the quarter and also margins were back to 7%. Was there anything in the quarter that you view is non-recurring for 2014 or do you expect the worse is behind the segment?

Richard Plain

It’s Richard Plain here. We actually were able to invoice the number of large power gen projects in the quarter, which helped to boost our EBIT results. On the ongoing basis, we do expect to continue to be somewhat lumpy as it relates to projects sold out in throughout the year. We are expecting the power gen business to help us boost our EBIT margins.

Unidentified Analyst

Okay, thanks for that. And then just again on the sales of the Bell ADTs, how is that tracking compared to your target? Are you happy of the share it captured?

Richard Plain

We have really just got our product into stock and started to make some headwind. We sold some product in 2013, but I don’t think it was that significant. And we have also spent a considerable amount of time working on our product support sales relative to the installed parts base, our installed base that is in Canada. So, again, let’s say it was probably a little less than what I would hope for in 2013, but we cut some promising results. And I think it will improve going forward.

Unidentified Analyst

Okay, thanks very much.

Operator

(Operator Instructions) Your next question comes from Gregory Jackson from Raymond James. Please go ahead.

Gregory Jackson - Raymond James

Hey, just a question with your margins, was any of that pressure related to inventory reductions?

Mark Foote

On gross profit margins?

Gregory Jackson - Raymond James

Yes.

Mark Foote

No, not specifically.

Gregory Jackson - Raymond James

And how many trucks – how many the Hitachi mining trucks you guys still have in your inventory?

Mark Foote

6.

Gregory Jackson - Raymond James

Pardon me.

Mark Foote

6.

Gregory Jackson - Raymond James

6, okay. And then just last question, in the fourth quarter here your CapEx was pretty negligible and you talked about generating cash flow and that could be used to pay down debt. Where do you see your CapEx landing and yes, can you just kind of comment on your CapEx plans?

John Hamilton

I think what you saw in 2013 is probably a pretty good proxy going forward, give or take call it $5 million, when you take into account not just the capital, but you see in terms of the CapEx line, but also the rental fleet, you got to look at the rental fleet, because that’s kind of a bigger piece of it. So, if you add those two pieces together within probably within $5 million that you should be in good shape.

Gregory Jackson - Raymond James

Okay, thanks.

Operator

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

Michael Tupholme - TD Securities

Thanks. Good afternoon. Just wondering if you are able to breakdown the guidance little bit further, you mentioned some revenue weakness in Q1, but as we think about the full year is that more of a concerns more on the revenue side of the margins or both?

Mark Foote

Michael, it’s Mark. We will probably just start with the outlook. I mean, we – because of the market conditions we don’t see them changing, we are declaring at the asset that we think grow for us in earnings and revenue going to be a challenge for us this year. It’s pretty early in the year to say anything about what the trends would be. We wouldn’t – we aren’t starting in the year as quickly as we’d like. We don’t think that’s necessarily an indicator of how the year is going to progress. And we are seeing some positive signs in a couple of areas, which gives us some degree of optimism, but we are seeing fairly type of the outlook that growth for us in earnings this year is going to be a challenge.

Michael Tupholme - TD Securities

Okay. In the industrial components segment, you mentioned both sales mix issues and competitive pricing pressures having an impact on the margin weakness there. Can you – I know you had some competitive pricing issues in the third quarter as well, can you break that down between those two factors and just trying to get a sense as to whether one or the other was more of a factor?

Mark Foote

I would say I don’t know if I got the exact breakdown in front of me, but you could probably think about them as being equally relevant.

Michael Tupholme - TD Securities

Okay. And had the pricing pressures become more prevalent since what occurred in Q3 or is it just a continuation of what you saw in Q3?

Mark Foote

I probably think about it as the continuation.

Michael Tupholme - TD Securities

Okay. And then just lastly, in terms of the parts and service side within the equipment segment, you obviously had very good growth in 2013 and you talked about, I think having fairly positive expectations for rotating products in 2014, but overall how should we think about parts and service growth potential in for the equipment segment specifically in 2014?

Mark Foote

We have some positive growth in mining and then a lot of construction and forestry. And I think just to speak to mining, lot of companies are in invested CapEx and new equipment. So, there is obviously some opportunity for us to repair the equipment. We also had a pretty good run to put an installed base into the mining industry in 2010 and 2011 and we are starting to see some of that come our way. And then we also in our initiative to gain some market share in the construction equipment business and the success in the forestry business has now again increased our installed base. So, it gives us some opportunity to some more parts and service to that equipment. So, I am thinking we are pretty positive.

Michael Tupholme - TD Securities

Okay. And then just one more if I could. In terms of – it’s not a big contributor I know, but in terms of rental revenues within the equipment segment, they have been growing at a pretty good clip for I guess the last couple of years. I think you faced a tougher comp in the fourth quarter on a year-over-year basis, but we did see growth actually turned slightly negative can you just talk a little bit about the outlook for that portion of the equipment segment going forward?

Mark Foote

Our biggest rental fleet is in the material handling business. We have invested significantly in that in the last couple of years and have some good results on the revenue side, but also on the margin side and we are budgeting for that to be fairly positive again in ‘14.

Michael Tupholme - TD Securities

Okay, great. Thank you.

Operator

And we are showing no further questions in the queue. I will turn the call back over to you Mr. Foote.

Mark Foote

Okay. Well, thank you very much for everyone for attending. We look forward to giving an update on the business at the end of the first quarter in early May. So, thanks very much for participating.

Operator

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

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