Finning International's (FINGF) CEO Scott Thomson on Q2 2016 Results - Earnings Call Transcript

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Finning International Inc. (OTCPK:FINGF) Q2 2016 Earnings Conference Call August 3, 2016 8:00 AM ET

Executives

Mauk Breukels – Investor Relations

Scott Thomson – President & Chief Executive Officer

Steve Nielsen – Chief Financial Officer

Anna Marks – Senior Vice President, Corporate Controller

Analysts

Michael Doumet – Scotiabank

Cherilyn Radbourne – TD Securities

Jacob Bout – CIBC World Markets

Yuri Link – Canaccord Genuity

Sarah O'Brien – RBC Capital Markets

Ben Cherniavsky – Raymond James

Bert Powell – BMO Capital Markets

Operator

Thank you for standing by. This is the conference operator. And welcome to the Finning International Second Quarter 2016 Investor Conference call. [Operator Instructions]

I would now like to turn the conference over to Mr. Breukels. Please go ahead.

Mauk Breukels

Thank you, operator, and thanks to everyone, for joining us. On the call with me today are Scott Thomson, President and CEO; Steve Nielsen, CFO; and Anna Marks, Senior Vice President, Corporate Controller, and Treasurer. Following the remarks by Scott and Steve, we will open up the line to questions. An audio file of the conference call will be archived, at Finning.com.

Before I turn the call over to Scott, I want to remind everyone that some of the statements provided during this call and in the press release are forward-looking. This forward-looking information is subject to risks and uncertainties as discussed in the Company's annual information Form under Key Business Risks. Please treat this information with caution, as Finning's actual results could differ materially from current expectations. Our forward-looking disclaimer statement is part of our quarterly releases and filings. Finning does not accept any obligation to update this information.

Scott, over to you.

Scott Thomson

Good morning, everyone. Overall, I'm pleased with our second quarter results in two of our regions. Both Canada and South America posted solid performance in difficult environments. As we shared on our previous quarterly call, we anticipated restructuring charges in the UK and Ireland. However, these weighed on our results to somewhat greater degree than expected, partly due to the conclusion of our power systems repositioning, which I'll speak about shortly.

Let me start with a closer look at Canada. Our Canadian business results are particularly encouraging, given the significant challenges posed by the fires in North Alberta. I recently visited with our people in Fort McMurray and I want to take this opportunity to say how proud I am of the resilience and commitment of our employees, as well as all members of the Finning team who went above and beyond for their colleagues and the community.

Despite the significant reduction in activity and six weeks of loss revenue in profits in the oil sands, we achieved an adjusted EBIT margin or over 6%. This is an improvement over the previous two quarters and in-line with the second quarter of last year. From an EBITDA perspective, our adjusted margin was 10.3%, which is 100 basis points higher than the Q2 2015 despite the significant reduction in revenues. These results speak to the strength of our business model and the fact that our operational excellence focus and cost-reduction initiatives are having an impact.

Our oil sands business has since returned to normal operations and we are encouraged by the strength in demand for parts we are seeing in the sector. Although the overall economic environment definitely present some revenue challenges, it is worth noting that our product support business would have been up modestly Q2 over Q1 without the impacts of the six weeks shut down. It is also worth-noting that we celebrated the one-year anniversary of our acquisition of Saskatchewan dealership last month. The integration has exceeded expectations. In a down market, we are generating results in-line with our original forecast, capturing market share and earning customer loyalty. We will continue to capitalize on the opportunities this new territory brings.

I'm also pleased to report that we recently reached a memorandum of agreement with our union partners for a new three-year collective agreement in Alberta and the Northwest territories. This agreement is still subject to a ratification vote by all members over the next month. We believe we have come to a fair deal for both the company and our employees that will support the necessary co-structure in the current environment.

As you know, we are in the process of reshaping our UK and Ireland business. These steps are similar to actions we've already taken to restructure our South America and Canadian operations. Ideally, the timing of these actions would have been the same across all of our regions. Having said that, the management team, led by Kevin Parks, is acting with urgency to execute on our plan to transform the business and lower our cost structure – essentially Canada 2.0.

With customers' need in mind, we are optimizing our UK facility network, centralizing parts order and distribution points, consolidating new equipment preparation, strengthening field service operations and consolidating back office support. By the end of the year we expect our workforce to be reduced by approximately 10% with the 40% reduction on our facility footprint, relative to December 2015. Taken together, these changes will support us in delivering improved service to our customers while also reducing cost. In addition, we completed a strategic repositioning of our power systems division that resulted in exiting a non-core business and recording an estimated loss on two dispiuted projects.

With the actions taken in the UK, we will now have restructured our operations in all three of our regions. By the end of this year, we'll reduce our cost based globally by 20% since 2014 to position us well to navigate the current lower demand environment and improve overall profitability. Before leaving the UK, I wanted to touch briefly on the recent referendum in favor of the UK exiting the European Union. As you know, the relationship between the UK and the European Union will likely unfold over an extended period. Amidst this uncertainty, we expect some short-term volatility in the exchange rate which will impact future translated results, as well as create some pressure on our top line.

Brexit doesn't change our strategy in the UK, but it undoubtedly strengthens our resolve to lower our cost to serve materially. Going forward, we remain committed to fully supporting our customers and maintaining our competitive presence in this region and I'm confident in our ability to return to historic profitability levels by the end of the year.

In South America, end-market demand for equipment remains weak. A team has done a good job of adjusting to significantly lower volumes by lowering the cost structure of the business. In light of these market conditions, I'm particularly pleased with an EBIT margin of approximately 9%. Similar to Q1, product support is down significantly relative to last year, but up sequentially, which is encouraging. In addition, I'm encouraged by positive changes we are seeing in Argentina as the new government is slowly restoring business confidence. The main obstacles to growth are being listed. We have access to foreign currencies and the high inflation in interest rates are trending down. The government is also developing plans for an infrastructure program which is promising. Steve and I are actually in South America today finalizing our plan to accelerate market share and revenues in the coming year.

We see significant upside as the new government paves the way for our recovery. Partnering with Caterpillar, we believe we have an opportunity to restore our market share which was very strong historically and are making a thoughtful investment in equipment inventory accordingly. Today, Argentina represents the $250 million. This was previously a business with about $500 million in annual revenues.

To summarize, Canada and South America are performing well and we are executing on this plan to improve our performance in the UK and Ireland. Assuming commodity price has stabilized, my expectation is that the restructuring process is now behind us in each of our three regions. We are demonstrating strong free cash flow generation and continue to expect to be modestly over $300 million for the full year. We've been working diligently to build a solid and sustainable foundation of operational excellence and going forward, we will continue to execute on our priorities.

I will now turn it over to Steve.

Steve Nielsen

Thank you, Scott and good morning, everyone. We improved our operating performance in Canada and South America on a sequential basis to generate strong free cash flow from all regions in the second quarter. As Scott mentioned, our UK team is executing with urgency to transform its business model, reduce its cost structure and improve the performance of the power systems division. While we have adjusted our second quarter results for significant items associated with the repositioning of the UK business totaling $21 million, there were additional provisions recorded in the second quarter in response to the increased uncertainty in the UK market including Brexit.

These provisions further reduced our earnings resulting in an adjusted EBIT loss in the UK for the quarter. Our business transformation plan in the UK is well under way and we expect to see improved results in the second half of the year.

In South America, mining markets are still very soft, about 20% of off-highway trucks remain part and product support volumes are under pressure. We continue to work with our mining customers to provide product support solutions to help them achieve operating efficiencies and cost savings. In the construction and power system markets, demand in Chile remains weak. However, we are seeing potential upside in Argentina. We believe we are well-positioned to capture construction equipment opportunities as the Argentinian markets recover. Overall, we are pleased with how well our South American team has been executing. The adjusted EBIT margin of just over 9% was strong in a very tough market and free cash flow is positive.

In Canada, as expected, new equipment sales were significantly lower due to large money deliveries in the second quarter of last year and reduced industry activity in the second quarter of this year primarily in oil and gas. We have a good line of sight into the second half of the year and expect new equipment sales to pick up from the second quarter loss. Truck support revenues were impacted by the business interruption caused by the wildfires in Northern Alberta. Without this interruption, we believe we would have seen some growth and product support from the first quarter of this year.

Demand for parts in the oil sands has picked up and product support activity in the construction sector has improved sequentially. However, we expect the recovery to be slow as most markets in Western Canada continue to be weak. The unavoidable operating cost in the oil sands during the six-week evacuation and business interruption totaled about $11 million. These include salaries of our evacuate employees, the cost of unutilized facilities and vehicle fleets and some additional cost to support impact to employees in the community. We adjusted our second quarter results for these unavoidable costs, but not for the lost revenues and profits during the shutdown. We expect to rebuild activity in the Fort McMurray area over the next 18 to 24 months and possible insurance recoveries will offset some of these negative impact on our business.

Canada's adjusted EBIT margin of 6.3% was in-line with second quarter 2015 despite a further weakened market and meaningfully above the last two quarters. This improvement in profitability is particularly commendable considering significantly lower revenues, competitive pricing pressures and additional challenges presented by the fires. We also report a higher equity earnings from the pipeline machinery international joint venture. This was driven by a number of large equipment sales in the quarter which helped mitigate the loss profits from the wildfires. The Canadian team is on track to achieve their targeted fixed cost savings and we still expect to exit 2016 with an EBIT margin in the upper end of the 6% to 7% range.

New equipment inventories in Canada were down by about $110 million from the end of 2015, reflecting our ongoing focus to reduce excess inventories. This was partly offset by a thoughtful investment in equipment inventory support our strategy in Argentina as Scott mentioned and some normal seasonality in the UK. We expect to sell through about $150 million of new equipment inventory during 2016.

Free cash flow is strong at $64 million with all operations generating positive cash flow in the second quarter. We saw a notable improvement in free cash flow from the UK compared to the second quarter of last year driven by improved working capital management and supply chain efficiencies. Year-to-date, free cash flow of $94 million was significantly higher than the $162 million use of cash for the same period of last year, driven mostly by Canada. As Scott mentioned, we are on track to generate modestly over $300 million in free cash flow in 2016. Our balance sheet is healthy, net debt to invested capital is at 38% and net debt to adjusted EBITDA is at 2.2 times.

We have now taken actions in all of our regions to reposition the business for improved profitability in a lowered demand environment. On a currency neutral basis, these steps will drive a 20% reduction in our SG&A cost between 2016 and 2014, excluding significant items and as a Saskatchewan operation, which is acquired effective July 1 of last year. In the second quarter we achieved strong adjusted EBITDA margins in Canada of 10.3% and South America of 12.5%. However, the weak results in the UK reduced our consolidated adjusted EBITDA margin to 8.5% in the quarter – which was still an improvement from 7.9% in the first quarter. Due to fixed nature of depreciation of finance cost, our adjusted EBITDA declined at a significantly lower rate than adjusted EBIT and adjusted EPS.

With the business transformation in the UK well under way, we expect a sequential improvement in adjusted EBITDA margin for the balance of the year. I will now turn it back to Mauk.

Mauk Breukels

Operator, that completes our remarks. Before we go to the Q&A, we have addressed everyone on the line that as a courtesy to your colleagues, you ask no more than two questions when it is your turn. Please go to the end of the queue if you have more questions. Operator, can you please open up the lines?

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator instructions] The first question today is from Cherilyn Radbourne with TD Securities. Please go ahead.

Cherilyn Radbourne

Thanks very much and good morning. On the parts that Canada did as well as it did, considering the wild buyers, maybe you can start by just talking about the revenue impact associated with the fires and the potential for future offset as a result of rebuild activity and potential insurance recoveries?

Scott Thomson

Steve, do you want to take that, or do you want me to...

Steve Nielsen

Sure. No. Good morning, Cherilyn. We estimate that our revenue impact was mostly to product support and was probably in the $30 million to $35 million range. We would estimate the profits that were lost at about $0.2 a share. As I mentioned, we did not adjust the results for the estimated loss in profits, only the direct cost of reincurred and unavoidable cost such as the salaries and wages paid to the employees and et cetera.

Scott Thomson

I think what you're seeing in Canada, one is the impact of the SG&A cost. If you look at the cost reductions, it's down year-over-year, they're pretty significant. There has been a shift in mix in the quarter year-over-year to more product support which helps and that has been offset a little bit by pressure on new equipment margins and some rental compression on range which is I think pretty similar to industry-wide, not offending to the Pacific issue industry-wide. But you're right, the 6.3% margin and not accounting for revenue and lost profit, we feel pretty good about that quarter.

Cherilyn Radbourne

And then you spoke about a pretty significant reduction in the UK's physical footprint to come. Can you just give us some more color on what that's going to look like?

Scott Thomson

Sure. As you look forward, I think the reduction in headcount will be about 10% relative to last year and that's on top of probably 5% to 10% the prior year. Overall, it will again be a 20% reduction for the labor cost. On the footprint side, it is a very similar process to what we did in Canada last year. In all, it's a 40% reduction. It's about 10 facilities, it's been done very thoughtfully with Kevin and the team, we've kept all field service tech and service opportunities very close to the customer, used a little bit more centralized distribution of parts and we have the ability to do that right now because we have that NDC that we invested in two years ago, and it's the consolidation of the power systems and equipment solution business.

We have come to the conclusion that the high value added -- which maybe had a little bit more profitability but carry a much more risk -- power systems, solutions is not part of the business that we want to be in. We've actually sold that DMR [ph] business this quarter and as a result, I give this opportunities on the class side to run these business much closer together. So consolidating back office, some power systems and equipment solutions and also having some of the power systems branches operate in the equipment solution branches.

I see it in a very similar process to Canada, new equipment prep, consolidating that all in our main facility and so it really is a Canada 2.0 business with the customer in mind at all times. I wish we would have done this last year and we would have done Canada and the UK at the same time. We didn't, but we are on it now.

Cherilyn Radbourne

Great. That's my two. Thank you.

Operator

The next question is from Michael Doumet with Scotiabank. Please go ahead.

Scott Thomson

Hey, Michael.

Michael Doumet

Hi, good morning, guys. Just a clarification as to make sure I understood the last answer correctly. So if -- I guess in a hypothetical world, if we hadn't seen the Alberta impact, it would have been an incremental $0.2 to the adjusted number. Was that the right way to understand it?

Scott Thomson

I actually think the 6.3% is probably the right number to think about in Canada because you're right, we lost the revenue and the profit which is about $0.2, but TLM was a benefit that was a little bit abnormal and those two offset each other. I think the 6.3% margin is the right way to think about it. As we look forward we said 6% to 7% type revenue for the year. We are on track for that. We had a very low equipment revenue quarter which we I think telegraphed to you. I think we had a good Q1, a little bit low Q2 and as we look forward to Q3 I think it will be down a little bit given what we see on our backlog. And that will create a little bit margin pressure but getting to the top end of that 6% to 7% range by the end of the year is our objective.

Michael Doumet

Okay. That's helpful and just on the core industry sales in Western Canada. Now you pre-purposing of equipment and elevated construction equipment industry wide certainly pressuring new market equipment sales. Would you be able to give us sense maybe at least qualitatively of how much demand is being soaked up by used inventory and what the underlying demand actually looks like? Tough question maybe but maybe can have any expectations are outlining expectations so when you believe that excess inventory clears up?

Scott Thomson

Yes, sir. So, if you look at the two pieces of our business. Mining and construction. The mining business is quite strong from a volume perspective so I think I mentioned in my call would have been up year modestly but would have been up year-over-year without the wildfires. And as I look forward we actually feel pretty good about product support in Canada and we see some rebuild opportunities and so we are expecting in 2016 that our rebuild on support equipment is up about 15%, should be up about 15%.

Our OEM facility is having record year, our MacKay facility is full and so we are feeling good about that deal of rebuild opportunity as we look forward to 2017 we actually think we will have 797 rebuilds materialize over prior years so, so that feels good. So I think the general construction market is the weak portion right now and is primarily an Alberta issue. If you look at some of the product lines in Alberta, we are probably down except for 50% for industry activity so pretty significant slowdown. Less so in BC, BC's up to industry wide modestly and Saskatchewan kind of in-between those two.

And so, there is not a lot of new equipment sales happening and I think there is some used equipment, excess equipment out there. And what would say is you are starting to see some infrastructure spend. What we are seeing is in Slide C, I think you will start seeing that more over the next year to two years. We haven't seen that you have the shovel ready other than Slide C but when that comes I think it will soak up some of this used equipment and it will be a great opportunity for us from a product support side. So, I think those are the dynamics that are going on right now in Canada.

Michael Doumet

Okay. That's really helpful. Well done in the quarter, Scott. Thanks.

Operator

The next question is from Jacob Bout from CIBC World Markets. Please go ahead.

Jacob Bout

Good morning. Wanted to ask you a question about South America and product support and what's going on there? It was down quarter-on-quarter and year-on-year and maybe just talk a bit about some of the moving parts?

Scott Thomson

So, it is down and is a very similar dynamics down to Q1. It is down, I don't know how big is that number but probably down 12% or 13% year-over-year and there is a couple of things driving it. One copper production is down; two fleets are parked and three people are delaying maintenance and it is a pretty negative environment right now in the copper market and also in Chile. I think the encouraging news if we look sequentially, product support is up 4% over Q1 so I think we are going to work through and get to a point where people are not deferring maintenance and running their fleet and I think it is as simple as that. The market has more negative outlook for sure than what we are seeing in Canada on the product support side.

Jacob Bout

And do you want to give us, what are your thoughts on the delay in maintenance and how long that can occur for?

Scott Thomson

Well, the good news is we took a step down 2015 to 2016 but we are seeing some stability in 2016 and so what I am expecting with the 4% sequential if we can keep it at this type of level until we see the supply demand dynamics in copper in Peru, I think that's where we are expecting it to be.

Jacob Bout

And then just a question on what's happened with the Kamatsu and Enjoy Global and what that means for some of your end markets and how competitive the Pisaris [ph] product is right now?

Scott Thomson

So we all watched the acquisition obviously and you know I am not sure it changes the competitive dynamics that much to tell you the truth. I enjoy with a competitive Shovel already and being bought by Kamatsu and nobody in integration period but I suspect it will continue to be just as competitive as they always were. But just a couple of facts are worth getting out there because I think I was a little bit amused there by the conference call where someone at Enjoy had mentioned that they were having so much success with the [ph:25.45]. Just get the facts on the table, we supply the 100% of electric rope shovel fleet OFMs have mined and since 2010 we delivered more than two-thirds of electric rope shovel to the OFMs region.

And have an overall market share of greater than 50%. So I feel pretty good of our shovel and the performance in the OFMs. It is undoubtedly very competitive world and the Joy Shovel is a great shovel as well but I feel pretty good about our market share and our competitive positioning.

Jacob Bout

That's helpful, thank you.

Operator

The next question is from Yuri Link from Canaccord Genuity. Please go ahead.

Yuri Link

Hey, good morning guys. Scott, the commentary on Argentina is pretty interesting. How near term is this or not and if you are stocking up on inventory, is that equipment parts both and is the opportunity more on product support or new equipment and rentals in Argentina?

Scott Thomson

Yes. I don't want to give people a sense we're stocking up. So, that's not what we are doing. Let me give you a little bit of context so, the last 3 years have been very difficult in Argentina and we were in a situation where we couldn't get US dollars out of the country and so we restricted that business pretty significantly and restricted it to product support. So now we have a new government, he's surrounded himself with extremely capable team. He's making the right moves from a devaluation of the currency perspective from a sold in hold out perspective from the bond side from removing exchange controls.

Now we can get equipment in and cash out of that country immediately and so things have changed pretty significantly and he has talked about infrastructure spend, briefing it to be infrastructure spend. So I do feel optimistic, that doesn't come without risk so there is a transition period here and you are actually seeing negative GDP and in 2016 in Argentina but as you look forward I think expectations are for 3% type GDP growth and there is a little bit of political uncertainty because macro [ph] doesn't control the whole parliamentary system. But to date he is getting a lot of support from all parties so we feel pretty comfortable of what he is doing. So, we went through that transition period, our market share went from dominant market share to single digit market share because we were investing in product support and not new equipment.

So there is an opportunity now and we have to do it thoughtfully because there are risks what we talked about but an opportunity now to make some inventory investment to increase that market share pretty significantly and I think that will provide a little bit of support in the business because Chile is, we just talked about with Jacob, Chile is pretty negative from a GDP perspective so I think Argentina will provide a little bit of support for our overall friends of business. But it's not, we're not, this is not a material amount of inventory. What we are talking about is $30 million in terms of new equipment inventory and so feel pretty good about it.

Yuri Link

Okay. And then just more broadly, a lot of the heavy listing as you mentioned has been done on repositioning the company in terms of the lower cost base so, I mean Scott, what's next in terms of the priority, you generating good cash so in that context are we still looking at $300 million plus the free cash and what do you plan to do with the free cash flow?

Scott Thomson

Yes, so agree with you on your first comment about the heavy lifting. I think we have done the heavy lifting in two of our regions and we have got the plan in place to do the heavy lifting on the third and the charges you see in the quarter reflect that so I do feel that we have stepped this business up for profitability in a low demand environment and it has been a painful process. When you think of 20% type people reductions and cost reductions and I think the key for all of us here with these are sustainable and I think we have comfort that they are sustainable because we have not helped the sales force to any large degree. We have focused on the structural changes and optimized the facility and we have focused on the structural changes in the supply chain.

That operational excellence agenda will continue. It has to continue because I think we are only kind of half way through that process of making this company a better company. But as I look forward we are generating a lot of cash and the great thing about this business model, despite the EBITDA erosion in the year we are still going to generate over $300 million and then we are going to have options and decisions to make. I would say part of that is going to go back in to business. Part of that's going to go back into it to make a stronger business when the cycle returns and help allow profitability to expand but part of that would be tax that cash that we will have to think about whether to deploy in the balance sheet or share repurchases.

I think I have been pretty clear that we want to wait to see the cash in the door and that is a primarily a fourth quarter type exercise and then I guess the other thing I would say is things today feel a little bit more uncertain to me than things did three months ago or six months ago. I think a lot of the world events that you are seeing and you know Brexit's the front runner for me, highlights that we are in a pretty uncertain world. You have to be pretty cautious with your balance sheet in that environment and let me leave it at that.

Yuri Link

Got it. Thanks guys.

Operator

The next question is from Sarah O'Brien with RBC Capital Markets. Please go ahead.

Sarah O'Brien

Hi, good morning. Scott just going back to revenue. Looking at the new equipment opportunities, it sounds like Canada could see some uptick in Q3. Do you feel like Q2 from low below level and from here there's enough opportunity consolidated to see an uptick going forward, not just in Canada but in Argentina and then maybe you can comment on the UK cut foot print and how that's going to impact overall farewell look for the UK?

Scott Thomson

Yes. Let me take it on a consolidated basis and the come to the UK. So the start of the year I think we gave guidance or not guidance, we guided you to a revenue decline of up to 10% and we didn't think it was going to be that negative, I think that's what Cap had guided to. Year-to-date we are seeing revenue down 13% and so it's been a little bit more significant than I think we would have though at the start of the year. As we look forward to the back half of the year. That revenue decline we don't think is going to be significant for 2 reasons.

The comps become a little easier so if you look back to Q2 2015 and compare it to the year of 2015, the revenue was quite high for the first couple of quarters and then came down so the comps become a little easier and then I think we are seeing a little bit of strength on the profit on the product support side that I am encouraged about in Canada and as I mentioned we have visibility into Q3 in the new equipment side in Canada and modestly a little higher than Q2. Not as high as Q1, but little bit higher than Q2. That all being said I think as we look forward to the end of the year, we are probably a little bit higher than 10% revenue decline. I mean it's not 13% like year-to-date but we are probably higher than 10% and that's pretty consistent to what cat guided to a week or so ago. And kind of that's where we are from the revenue look and the objective process just managed to do that and maintain the profitability.

As I look at the UK, there's two impacts of the UK. One is the exchange rate volatility which doesn't impact us economically but does impact us a little bit from a translation effect so when you bring the Sterling back into our Canadian Dollars, the currency translate resolve can get impacted little bit. I think the main issue is that the uncertainty caused by Brexit which is real and you are seeing it come through some of the economic numbers is going to create top line pressure for us in the UK and it just solidifies the need to do what we are doing on the cost structure and the material and the cost conserved and the strategy doesn't change.

Steve, do you have anything to add?

Steve Nielsen

Yes. It's just that similar to Canada Scott as you mentioned earlier, Sarah, we again protected the customer touch people, the salesforce. Strengthened the field support people and then similar to Spirewood we had a similar situation where a branch was dedicated to a customer and we worked with a customer to balance the working field and to a branch nearby. So similar to Canada, we are strengthening, we didn't, in the cost restructuring and looking in the branches we have protected our sales force and the customer service touch phones.

Sarah O'Brien

Okay. So when you talk about restructuring the UK to get out of some of the high value power systems, can we assume that's not a material amount of revenue that you are going to forego?

Scott Thomson

Yes. It's not a material amount of revenue. I mean this is been over the last year; we have been getting our way out of this. And here in this quarter we just decided to sell the business and get out. It's not a material amount going forward.

Steve Nielsen

And I would maybe describe it just slightly different. We thought it will be higher value and value add services and turned out not to be so. It was engineering and construction support work that tied to our power systems, our core product and value add services and so our review determined if that was outside our strategic work. So, as Scott said it would not have a significant impact on the financials.

Sarah O'Brien

Okay. That's helpful. And then just the comments on Argentina and the $250 million revenue opportunity, is that revenue that Finning could go after or is that a full market opportunity that you see and over what time period?

Scott Thomson

Yes. So don't, that was what our Argentina business was 4 or 5 years ago. $500 million business and we have restricted it through our actions because we couldn't get exchange in and out and so now it's about a $250 million business. And you can see a path to getting back to at least where we were given, assuming the government cooperates and frankly the market opportunity is much bigger than that. And that's over time by the way. I am not trying to give you a number for the end of 2016 or 2017. It's going to take some time to rebuild that business.

Sarah O'Brien

Okay. Just so I am clear. The $250 million is what you have now in Argentina versus $500 million?

Scott Thomson

Correct.

Sarah O'Brien

Okay. That's helpful. Thank you.

Operator

The next question is from Ben Cherniavsky with Raymond James. Please go ahead.

Ben Cherniavsky

Good morning guys. I am going to go back to a couple of questions I think we have discussed before. Just on the SG&A in your outlook, you talk about it being with all the initiatives you have undertaken, you would expect that SG&A to be, I think about 20% lower than it was in 2014 if all of the charges and everything else were worked out of there, is that correct?

Steve Nielsen

That's correct Ben.

Ben Cherniavsky

Would that be than assuming your revenue base of 2016? Like that's not on a revenue base of 2014 now is it?

Steve Nielsen

If we look at our revenue base, our revenues have gone down by 26% compared to 2014, we have taken out 20% of the cost and nearly 20%, about 18% of that cost we have taken out as a fixed cost so we assume you recall we started this last year measuring back 2014 as a base year before the copper prices then followed by oil and gas started dropping. So we are using it as a base here so you can measure the change in the operations.

Ben Cherniavsky

But what you are talking about what your SG&A in 2016, that's obviously takes into account some reduction in the variable cost, correct?

Steve Nielsen

Yes. So, if we look at absolute dollars of reducing total cost from 2014 by $250 million, about $50 million of that is variable so our SG&A, it changes as you reduce cost obviously but you can think of our absolute SG&A is about 20% variable and 80% fixed and so we have taken about 18% of the fixed cost out.

Ben Cherniavsky

And so this is what we've talked about before as your business starts to scale up again. How do you guys think about the fixed versus variable? How should we think about modeling that? Seeing your revenue base double is a long way off. I don't think in anyone's horizon right now, but just conceptually, if that were to happen, you'd obviously have to be adding more SG&A back into the business. Obviously like the operating leverage here with all your savings is critical to understand.

Scott Thomson

Let me start strategic and then Steve can give you any numbers, guidance he feels appropriate. As you think about what were done and now particularly with labor agreements in the consolidation of facilities in the oil sands, and the footprint optimization for the rest of the business, we structurally change the cost base of this business. So when things come back, we are going to have improved service profitability in this business – point one. Point two, as we've gone through this downturn, we've actually added to the sales force. So we've reduced our head count globally by 3,200 or 3,300 people and we've actually added to the sales force, which is I think helping greatly on the customer loyalty and the market's share side and means when volume and demand comes back, we'll be in a good place to capture it. That's just at a high level what we've been doing. Steve, I don't know if you have any numbers you want to...

Steve Nielsen

No, thanks. That's good. And because of that, we expect our variable cost as a percent of an incremental revenue dollar to decrease, Ben, but if you use the 20-80 split between variable and fixed in SG&A and do that back to the revenues, you get about $0.3 to $0.5 per revenue dollar that would be considered variable cost in SG&A.

Ben Cherniavsky

If we wanted to do some modeling, looking at that, the potential leverage in the business based on the new footprint and everything else, you would say an 80-20 rule is reasonable?

Steve Nielsen

Of the absolute SG&A if you're looking at incremental revenues scaling. Then yes, I think that 80-20 converts to a $0.3 to $0.5 per revenue dollar. It should be at the lower end based on the strategic improvements Scott spoke about, but historically that would be arranged.

Ben Cherniavsky

And obviously sensitive to mix and all of that, too. If you had more of an after-market customer support cycle, would you say there's sort of little less operating leverage that you have to add more service tax and potentially more infrastructure to support it than if you just had a big sales cycle on the machines?

Scott Thomson

Yes. The direct labor, the mechanics, the customer service people directly providing the service would go through cost of goods. But it takes a little more SG&A to support product support, but with this service excellence initiative, it would be probably improved over historic, but yes, it would still be a little more than new equipment.

Ben Cherniavsky

Just on my second question, again, I think something we talked about before and maybe you can just update on the rental CapEx plan proceeds from rental, I believe, to exceed CapEx on rental and rental CapEx is less than depreciation. So, what's the long-term plan there and what should we assume in terms of rental CapEx and from that? If you continually depreciate more than you invest, it implies a scaling back of that business over time. Anything in that there to help us think about that long-term would be helpful.

Scott Thomson

Yes. We think longer term; we want to be in the rental business. We need to be in the rental business and we are hiring capabilities and building our capabilities to be in that business. I guess that's strategic point number one. We're on a tough spot right now in Western Canada on rental and that's around too much fleet and rental rate compression. That's not different than any would dug deep here to compare in benchmark and that's not different than any other of our competitors. That's what's happening right now and we're de-fleeting to get that utilization up, but longer term, we will invest, we'll do it thoughtfully, we'll make sure the returns are sustainable and in-line with our corporate returns, but it is something we feel like we need to be in.

Ben Cherniavsky

But is it fair to assume that would be again in some kind of a normalization scenario where the business maybe doesn't get back to the good old days, but becomes a more profitable business? You'd have to accelerate CapEx there and do some catch up on your spending and thinking about what you do with the cash going forward?

Scott Thomson

Yes, there will be some acceleration with spending for sure, but what we're doing right now, too, is we're reworking the fleet. We are disposing of some fleet, but we're also investing in some fleet right now to make sure we have the right composition of age et cetera, so when the market gets back to a normal position, there will be some investment, but it's not going to be a big explosion. We'll do it thoughtfully.

Ben Cherniavsky

Okay. Thanks a lot, guys.

Scott Thomson

Thanks, Ben.

Operator

The next question is from Bert Powell with BMO Capital Markets. Please go ahead.

Bert Powell

Thanks. Good morning, Scott and Steve. Scott, you said the restructuring is behind you in each region – and I know this has been a pretty painful process – but have you been able to go out now and say to your team, 'It's done. This is it. The cuts that we've made are the cuts that we've made. We see the bottom here and this is the team we've got going forward'?

Scott Thomson

I would like to say that, but the world is so dynamic that it's hard to ever make that statement. What I would tell you is with the commodity prices that we've seen up till the last couple of days, the last $40 to $50 oil price and starting to see some customer commentary around green shoots. When you see Halliburton, Schlumberger, Precision and Kana all come out in one week and talk about things looking better and supply coming off, rigs coming off in North America, it does feel like the bottom. In that scenario, I think we positioned the company for the bottom very effectively in all three regions. I think that's where we are, but the world is dynamic and I don't think you can ever make the type of commitment-statement that you just suggested.

Bert Powell

Okay, fair enough. And I wanted to just go back to the product support in Canada. You talked about some visibility on seven rebuilds and things picking up at least in the mining side of things. When you start to think about the planning – because obviously, your customers when you start to plan for '17, they're going to come knocking on your door five minutes before they need to rebuild. They have to start thinking about how this impacts their scheduling for production and whatnot. Like the current thinking or the current work that you're doing with your customers, what kind of line of sight do you have for '17 on the product support when they talk to you about RFPs and whatnot. Can you just give us a sense of how that's folding out and what may be some of the outcome opportunities are in that business?

Scott Thomson

Yes. It's pretty good. I mean -- and I don't want to -- I think Western Canada continues to be very challenged. That's overall statement. But when I look at product support and rebuild opportunities, I feel pretty good about the situation we're in. If you have looked at 2Q without the fires, we would have been up modestly in product support, for that OEM facility right now is at record-volumes and profit. Our Fort McMurray facilities fall -- I think we're expecting by the end of the year for our support equipment rebuilds to be out 15%, and we're in discussions with a number of customers around 797 rebuilds and they're not in the backlog and they're not scheduled for the facility, I feel pretty comfortable saying that there's going to be an increase in '17 over '16 on the rebuild side of big trucks.

Bert Powell

The construction, maybe not as meaningful -- still is a meaningful part of the product support business -- how do those things net out? Do they set out to say, 'We can keep it flattish' or can there be some meaningful recovery? There's got to be some level of pent up demand on both sides -- the BCP side and the mining side.

Scott Thomson

Yes. On the BCP side, less product support comes with that product, so you're really talking about GCI and since kind of the activators [ph]. And I'd say there is less clarity on that than on the mining side. There is a lot of equipment out there right now that is under-utilized, and I think what it's going to take is some of these infrastructure money to be spent to get this equipment back to work. And one of the great things about something like Site C is an example of that. I mean it was a combination of new equipment and equipment from inventory and this equipment is going to work 24/7. And I think we need a little bit more of that which the Central government has committed to -- both prudential governments have committed to. But I don't see that happen in the back half of '16.

Bert Powell

Would you see product support growing year-over-year in the back half of '16?

Scott Thomson

I can't comment on that. I think in Canada, if I think about Canada…

Bert Powell

I'm sorry, I meant Canada.

Scott Thomson

Yes, so if you think about Canada looking forward, one of the benefits we had in Q2 was a mix shift. We had product support became high 50s of the mix and I think we have visibility into Q3 on the new equipment side to be pretty comfortable that our Q3 equipment revenue is going to up over Q2 and therefore that mix shift will offset a little bit. And I do feel good about product support in mining. So I'm going to leave it at that.

Bert Powell

Okay. Thanks, Scott.

Operator

[Operator Instructions] Next question is from Ross Galardi [ph] with Bank of America Merrill Lynch. Please go ahead.

Unidentified Analyst

Good morning. Scott, look I realized you've -- you guys have done a great job on cost, you just talked about some of the opportunities we own with the truck rebuilds in the next and so forth. But if you look at consensus for next year, I mean, I don't know what people are thinking but they've got 40% earnings growth -- 35% earnings growth for Finning next year, and if you're run rate where you were in the first half, 70% earnings growth for Finning next year. So I realize you guys are taking out a lot of cost, realize the margins are going to get up in the second half and I also realize you don't guide but can you talk about some of the bigger puts and takes and set some type of directional expectation for next year because it doesn't seem like consensus numbers right now are doing you any favors into 2017.

Scott Thomson

Why don't I talk about the back of 2016 and then I think it's too early for me to give a view on 2017 but I'll give you my view on the back of 2016. Revenues were down more than we thought, it's going to try and bring this altogether. Revenues were down more than we thought, we thought they were going to be at the top end down 10 and they were down 13. And I think it gets a little bit better in the back half of the year because of what we talked about but it's going to be higher. So it's not going to be 13, but it's going to be higher than 10 is my expectation for the back half of the year.

And then if you look at profitability across our three regions, I feel we've been pretty consistent with keeping that similar margin and that 9% type range. I think we're demonstrating that we can get Canada to 6% to 7% range. And on the UK, getting back to historically profitability is the objective. Now why does the second half then look a little bit than the first half, not materially, felt a little bit better than the first half and I think it comes to SG&A reductions being embedded in the organization and 20% type projection, 2014 over 2016, this has been a quarter-by-quarter process and I think we've got the company where they need to be now in FINSA and Canada, the execution of the cost reduction program in the UK although provisioned for in the second quarter is going to happen in the third and fourth quarter.

And so a little bit better in the second half of 2016 than the run rate that you referred to because of a little bit better revenue performance and the SG&A reduction getting embedded. As it relates to 2017, I think the world is too volatile for us -- for me to give an outlook on 2017 right now.

Unidentified Analyst

What would be the carry over cost savings in the next year that aren't fully realized in 2016, so at least we have sense as to how much incremental cost savings based on things you've already announced and are doing, you're going to have in the next year?

Steve Nielsen

Well, I think Steve said 2014 over 2016 down 20%. And that there would be a benefit on top of that because the UK is going to see the third and fourth quarter SG&A happen in those areas. So I think that gives you guidance on where you should be thinking about going into 2017.

Unidentified Analyst

Alright, thanks a lot.

Operator

This concludes the question-and-answer session. I would now like to turn the conference back over to Mr. Breukels for any closing remarks.

Mauk Breukels

Thank you very much, operator. And thank you, all for listening. We look forward to speaking with you again after the next quarter. Bye for now.

Operator

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.

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