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Edited Transcript of NFI.TO earnings conference call or presentation 14-Aug-19 12:00pm GMT

Q2 2019 NFI Group Inc Earnings Call

WINNIPEG Aug 23, 2019 (Thomson StreetEvents) -- Edited Transcript of NFI Group Inc earnings conference call or presentation Wednesday, August 14, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Glenn Asham

NFI Group Inc. - Executive VP of Finance, CFO & Treasurer

* Paul Soubry

NFI Group Inc. - President, CEO & Non-Independent Director

* Stephen King

NFI Group Inc. - Group Director of Corporate Development & IR

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Conference Call Participants

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* Cameron Doerksen

National Bank Financial, Inc., Research Division - Analyst

* Christopher Allan Murray

AltaCorp Capital Inc., Research Division - MD of Institutional Research for Diversified Industries & Senior Analyst

* Daryl Young

TD Securities Equity Research - Mining Research Associate

* Jonathan Lamers

BMO Capital Markets Equity Research - Analyst

* Kevin Chiang

CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst

* Mark Neville

Scotiabank Global Banking and Markets, Research Division - Analyst

* Stephen C.A. Harris

GMP Securities L.P., Research Division - Head of Research

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Presentation

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Operator [1]

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Good morning. My name is Lisa, and I'll be your conference operator today. At this time, I would like to welcome everyone to the NFI Group Inc. second quarter results conference call. (Operator Instructions)

Stephen King, you may begin your conference.

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Stephen King, NFI Group Inc. - Group Director of Corporate Development & IR [2]

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Thank you, Lisa. Good morning, everyone, and welcome to NFI Group's Second Quarter 2019 Results Conference Call. This is Stephen King, NFI's Group Director, Corporate Development and Investor Relations speaking. Joining me today are Paul Soubry, President and Chief Executive Officer; and Glenn Asham, Executive Vice President and Chief Financial Officer.

For your information, this call is being recorded and a replay will be made available shortly after the call. Details on the replay can be found on our website.

As a reminder to all participants and others regarding this call, certain information provided today may be forward-looking and based on assumptions and anticipated results that are subject to uncertainties. Should any one or more of these uncertainties materialize or should the underlying assumptions prove incorrect, actual results may vary significantly from those expected. You're advised to review the risk factors found in the company's press releases and other public filings on SEDAR for more details.

In addition, we encourage all participants to review the Q2 2019 financial statements and the associated management discussion and analysis, MD&A, that are posted to our website and on SEDAR.

To start today's call, I'll provide a few highlights for the quarter, Glenn will then speak to the financial results and Paul will provide market insights and NFI's outlook. Following that, we'll open the call to analyst questions.

The second quarter was a milestone for NFI as we successfully completed the acquisition of Alexander Dennis Limited, or ADL, transforming NFI from a purely North American business to a leading independent global bus manufacturer. With the addition of ADL, NFI now has over 9,000 employees with an installed fleet of over 100,000 vehicles operating in 11 countries. ADL solidified NFI as the market leader in North America plus bringing market leadership in the U.K. and Hong Kong and provides a platform for future international growth.

Since closing the acquisition, our accounting and finance teams have been busy converting ADL's results from a private company following U.K. GAAP to a public company following IFRS. A recognition of ADL's historic results -- sorry, a reconciliation of ADL's historic results for fiscal 2018, Q1 2019 and Q2 2019 pre and post the acquisition are provided in the MD&A. Glenn will discuss the impact of ADL on NFI's overall financial results this morning.

To provide a more comprehensive disclosure of financial performance, we've decided we will no longer issue a separate quarterly deliveries, orders and backlog press release and will now consolidate the deliveries, orders and backlog information directly into our normal quarterly reporting within our MD&A.

As we have grown and diversified NFI, we found it limiting to only talk about part of our company's performance and our quarterly deliveries, orders and backlog release yet not provide the complete financial results. As such, we feel this change will benefit readers of our MD&A and financial statement to have the full picture at one time. This new reporting change will take effect starting with NFI's 2019 Q3 results.

As for our legacy business, we continue to work our way through both learning curve of launching new vehicles in production at both New Flyer and MCI's facilities; supply chain challenges; the delayed start-up of our new parts fabrication facility, KMG; and ARBOC responding from the chassis supply disruption we experienced early in 2019. All of these factors have led to an increase in work in progress or with inventories, resulting in lower-than-planned deliveries so far in 2019. We know the issues and are diligently working to recover. Paul will discuss this plan and other items when he comments on our outlook.

While there were challenges, there are also numerous positive in the quarter, all of which will help NFI continue to defend our market leadership position and achieve our vision of enabling the future of mobility.

A few highlights I'd like to specifically bring to your attention.

In May, we announced that Kathy Winter, the Vice President and General Manager, Automated Driving Solutions Division of Intel Corporation, was elected as a Director of NFI, bringing expertise and insights that can help us as we explore the world of autonomous vehicles. NFI launched the autonomous bus program for Advanced Driver-Assistance Systems and Automated Vehicles in partnership with Robotic Research, a U.S.-based innovative engineering and technology company that has provided autonomous solutions to commercial and government customers, including the U.S. Department of Defense. In addition, ADL already has an ADAS project underway in the U.K.

New Flyer's Infrastructure Solutions team completed the installation of New York's first interoperable, on route-charging solution. And as well, the Xcelsior Charge H2 fuel cell vehicle delivered 350 miles of zero-emission range in a California road test. MCI continued to deliver its new J3500 coaches with very strong market response.

Subsequent to quarter end, MCI received approval from New Jersey Transit for an additional 183 commuter coaches on its existing 6-year contract. ADL's new low -- ultra-low emission Enviro400 City double-deck vehicles were put into service by First Glasgow as part of its premium Glasgow Airport Express service, and ADL also secured a 50-vehicle order from Singapore's Land Transportation Authority for double-deck buses featuring a new 3-door, 2-staircase layout.

With that, Glenn will now take you through the second quarter 2019 financial highlights, and following that, Paul will provide some insights on our outlook.

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [3]

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Thank you, Stephen, and good morning, everyone. I'll be highlighting certain second quarter 2019 results and provide comparisons to the same period in 2018. I direct you to NFI's second quarter 2019 financial statements and the MD&A of those financial statements, which are both available on SEDAR or NFI's website. I also want to remind you that our unaudited consolidated financial statements are presented in U.S. dollars, the company's functional currency, and all amounts referred to are in U.S. dollars, unless otherwise noted.

As we previously announced, effective December 31, 2018, NFI adopted IFRS 16 for leases. This new standard provides single leasing accounting model requiring lessees to recognize assets and liabilities for all major leases. We have elected to use the modified retrospective approach in adopting the standard, and accordingly, comparative information for 2018 has not been restated.

Accordingly, all Q2 2019 numbers reflect the adoption of IFRS 16 while the comparative numbers have not been restated. Our MD&A clearly identifies the impact of the adoption of IFRS 16 on our financial results, and I recommend listeners review that information.

We incorporated ADL's financial results into NFI from the acquisition date of May 28, 2019, essentially 1 month in Q2 2019. The MD&A includes historic financial information as well as the separate post-acquisition ADL results. With the addition of ADL, NFI now delivers an even broader range of vehicles, including single deck, double deck and articulated transit buses, motor coaches and motor coach bodies, low-floor cutaways and medium-duty shuttle buses across various geographic jurisdictions.

With this broad portfolio, we believe that certain historic performance metrics, such as average selling price per EU and adjusted EBITDA per EU may no longer be appropriate to measure the company's comparable performance. As a result, we have revised the MD&A and have an additional focus on gross margins, earnings before interest and income taxes and separated unallocated cost and corporate SG&A from the existing manufacturing and aftermarket reporting segments.

We have also provided revenue segmentation by geographic region to now reflect the international reach of NFI. Both the vehicle revenue and gross margins can vary significantly from geographic region and by individual contract. This is especially true for ADL.

In reviewing our materials, you'll note that ADL did not positively contribute to NFI's second quarter 2019 results, but the results were within management expectations reflecting adjustments required from the conversion to IFRS that impacted the revenue recognition.

ADL's first half 2019 results were similar to the first half of 2018, with the first and second quarter results varying due to the timing and location of specific vehicle deliveries. In addition, some ADL deliveries that would have been recognized in the second quarter under U.K. GAAP will now be recognized in the third quarter under IFRS as a result of change in revenue recognition policy.

For NFI's consolidated second quarter 2019 results, NFI generated a revenue of $683 million, an increase of 1% compared to the second quarter of 2018. Revenue from manufacturing operations increased by 1.5% primarily from the addition of ADL. The increase was offset by lower volumes in our legacy manufacturing businesses driven by the production and delivery challenges Stephen discussed at the beginning of this call.

Revenue from aftermarket operations decreased (sic) [increased] by 1.9% primarily driven by the $8.8 million addition of ADL's parts business offset by a $2 million impact from Daimler's termination of MCI's Distribution Rights Agreement for Setra motor coach and parts sales in the U.S. and Canada and fewer fleet renewal programs.

Total gross margin decreased 21%. Manufacturing gross margins decreased 27.7% driven by the same production inefficiencies that impacted revenue, including the learning curve from new products and the start-up of KMG.

ADL experienced a $9.7 million loss in gross margin primarily driven by the unwind of the fair market value adjustments related to the valuation of acquired assets.

Aftermarket gross margins increased by 5.8% primarily due to favorable sales mix and the addition of ADL.

Total adjusted EBITDA of $81.1 million for the quarter decreased by 11%, again due to previously mentioned production issues. Net earnings decreased by $41.2 million and earnings per share was down by $0.67 per share. In addition to the items that impacted gross margins, net earnings were impacted by $13.3 million of onetime transaction costs related to the acquisition of ADL. Interest expense was also higher, primarily driven by a $12.6 million noncash mark-to-market loss on the interest rate swap and higher credit draws related to the acquisition of ADL.

The interest rate swap fixed NFI's interest rate that we pay on $600 million of the long-term debt at 2.27% plus an applicable margin. Interest rate fluctuations will cause market -- mark-to-market gains and losses, but the rate -- the fixed rate is in place until October 2023.

Adjusted net earnings of $25.8 million or $0.42 per share decreased by 50% compared to Q2 2018. This was driven by the same impacts on net earnings but adjusted to remove the onetime costs associated with the acquisition of ADL.

The mark-to-market impact of interest rate swap can not be adjusted as adjustments are expected on a quarterly basis and the amount of the adjustments is dependent on movement in market interest rates relative to the contracted rate of 2.27%.

On the liquidity position of $202.2 million as of June 30, 2019, decreased from $301.5 million in March 31, 2019. The decrease of the liquidity primarily relates to the acquisition of ADL, the amount of capital returned to shareholders through increased dividends as well as changes in noncash working capital, which are expected to recover as work in process is reduced to normal levels.

The company generated free cash flow of $41.4 million during the second quarter of 2019, a decrease of 13% compared to Q2 2018. The decrease was primarily driven by lower earnings from operations, partially offset by lower capital expenditures.

The company declared dividends increase by 12.3% from the same period in 2018 and represents a payout ratio of 49% versus 38% from Q2 2018. In March, NFI increased its annual dividend rate by 13.3% from CAD 1.50 to CAD 1.70 per share, and that's Canadian, for dividends effective March 13, 2019.

Property, plant and equipment cash expenditures decreased by 45.2% or $8.5 million compared to the second quarter of 2018. Planned capital expenditures for 2019 are expected to be lower than 2018 as major projects are nearing completion.

Return on invested capital or ROIC for the period ended June 30, 2019, was 11.2% as compared to 15.5% for the same period in 2018. A lower ROIC was primarily as a result of material investments made in KMG, which is not expected to generate benefits late -- until late 2019, plus higher inventory and lower adjusted EBITDA.

So now I'll turn it over to Paul to provide you with market insights and our outlook.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [4]

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Thanks, Glenn, and good morning, ladies and gentlemen. You've heard from Stephen and from Glenn talk this morning about the production challenges we've experienced in the first half of 2019 that resulted in us having reduced deliveries in the first half.

We make no excuses. We accept responsibility. We know the root cause. We know the path forward, and we're well into our recovery effort, which is focused on lowering our WIP and delivering the vehicles for our customers. The result is expected to have a pronounced impact on the fourth quarter of this year as we get caught up.

Now we've been asked a number of times if our due diligence and our acquisition effort of ADL in the first half of the year took our focus away from the core business. This is categorically not the case. The good news is we're now a more diverse business, more than ever, with a material backlog, leading positions in multiple markets and geographic jurisdictions, solid free cash flow generation, the highest EBITDA margin amongst our peers, a proven zero-emission bus offering and a focus on returning capital to our shareholders.

Now looking at our markets, let me start with North American public transit. As we expected, our bid universe has been growing, with the active bids up 22% in -- from the first quarter of this year. This increase supports our view that the second half of 2019 will see increased award activity, and we've already experienced this with nearly 200 EUs awarded to NFI and announced just this past week. We expect an increase in the number of vehicle awards in the second half but also expect that individual awards may be smaller in firm quantities, with fewer options or shorter contract terms. As we've discussed before, this is primarily driven by transit agencies continuing to reassess and redevelop their 5-year fleet replacement plans and consider how and when they will approach zero-emission buses or ZEB programs. As they do make that transition to ZEB's, we believe NFI will be a beneficiary of this change.

Now even North America, NFI offers what we believe to be the market's strongest ZEB platform with a variety of clean propulsion approaches, including battery electric, 35- and 40-foot single deck, 60 foot articulated and now with ADL, double-deck variants. As anticipated, we've already seen an increase in number of ZE bids in our universe and now makes up a total of 20% of that total bid universe.

To complement our ZEB, we also introduced and launched earlier this year our Infrastructure Solutions service to assist transit agencies in understanding the infrastructure requirements for zero-emission buses and to help project manage the installation of the associated charging infrastructure. This has gone extremely well.

The demand for low-floor cutaway and low-floor medium-duty buses also continues to be encouraging. And while ARBOC's chassis supply disruption for our low-floor cutaways impacted our ability to deliver those vehicles in the first half, the demand remains strong, especially for our medium-duty product where we build our own chassis. That then generates higher margins. And in addition to just the general diesel bus, ARBOC recently launched its electrification program for the Equess model.

In the motor coach segment, we expected the public market to remain -- we expect the public market to remain stable. And while private motor coach demand has declined, we've -- as we've seen in previous years, the private motor coach business continues to be heavily weighted to the fourth quarter. MCI is also deep and continues its development testing of its electric motor coach.

As for ADL's markets, the U.K. market is expected to be flat for the rest of 2019 before growing in 2020 as the large commercial operators and smaller regional players increase orders after a number of years of low activity. We expect ADL will be the beneficiary of this increased demand. ADL has the leading market share in singles and double-deck battery electric buses in the U.K. and is now selling their zero-emission buses in New Zealand.

ADL also expects to maintain its leader position in the cyclical Hong Kong market while it is coming off of peak demand of 2017 and 2018. It is moving to lower but more stable deliveries, and helping to offset that lower demand in Hong Kong is the important contract win that Stephen talked about in Singapore and further penetration by ADL in New Zealand.

Now ADL's Plaxton motor coach business, which, in this case builds bodies predominantly on Volvo chassis, is primarily focused on the U.K. market which is expected to experience moderate -- modest growth in 2019 and again in 2020. Sales outside the U.K. have been relatively small for Plaxton. However, they continue to explore opportunities to grow deliveries from new export markets.

Now as you know, last month we revised our 2019 total delivery guidance down by 3.4% to reflect: a, the low -- the impact of the low-floor cutaway sales, the lower sales; and b, to reflect the slowing demand in private motor coach sales in the first half of 2019. So with the addition of ADL to NFI, we've now added 1,400 EUs to NFI's total annual delivery guidance for 2019, which includes -- which now increases the total to 5,660 EUs.

In the case of ADL, we will count both the single and double deck buses as 1 EU given they only consume 1 production slot as opposed to New Flyer's 60-foot articulated buses that consume 2 production slots. And note that the ADL delivery guidance we just gave you covers only the period from May 28, '19, the acquisition date, to December 29, 2019.

Now as mentioned a few times in this call, ADL's unit revenue gross margins vary significantly by geographic region and by product type. We again recommend that listeners review the adjusted ADL historical fiscal 2018 and Q1 and Q2 financial information provided within the MD&A to get a better understanding of ADL's potential impact on NFI's 2019 results.

With respect to NFI Parts, they continue to be focused on numerous initiatives to counter competitive intensity and deliver profitable growth. These initiatives include added focus on these vendor managed inventory programs that we have won, and enhance product offering and capitalizing on the previously implemented common IT platform across our aftermarket business. In addition, NFI Parts is now exploring the absorption of the management and distribution of ARBOC and cutaway parts, which is expected to provide an additional revenue stream going forward to NFI Parts.

ADL's Parts business continues to focus on enhancing its own online parts and service platform, which is a branded AD 24, which provides industry-leading aftermarket support today to U.K. customers. ADL Parts business is expected to grow as its fleet expands internationally.

Now our business has changed over time with the acquisitions of MCI, ARBOC and now ADL. And with these changes, our revenue diversity has added seasonality to our results. We now expect the second half of each year to be busier periods than the previous comparable periods, especially in the fourth quarter. In addition to the seasonality impacts, we also expect the half -- second half of this year to be busy as we recover from our challenges at New Flyer and MCI in the reduction of our WIP. Our WIP production efforts, as I said, are already underway and expected to have a pronounced impact on the fourth quarter of this year.

With ADL being the market leader in the U.K., we are carefully following potential impacts from the U.K.'s potential withdrawal from the European Union, or commonly referred to as Brexit. ADL, in our mind, differs significantly from many other U.K. manufacturers as it has fewer cross-border sales with EU member states and has significant local U.K. supply base. Further, and for the most part, U.K. customer buses are made in the U.K., buses for the [packed room] customers are made in region and buses for North America are made in North America. So while the outcome of Brexit remains unclear with numerous potential scenarios, the management at ADL is taking steps to mitigate potential risks. A few things they're working on is diversifying their supplier base further, leveraging global third-party manufacturing partners, identifying components that may be impacted by tariffs or delays of entry into the U.K. and building appropriate inventories as required. ADL has an active currency hedging strategy in place to attempt to manage currency risk exposure.

ADL also has numerous exciting opportunities in Europe, Latin America and the Asia Pacific region that will help drive top line growth in the future. We're extremely well positioned to capitalize on the ZEB evolution, and we're gaining share in the employee shuttle coach space and medium-duty shuttle spaces.

NFI is a long-term business, and we think shareholders should take a long-term view, not as focus -- a focus on any specific quarter. Throughout our history, we've made accretive acquisitions and we've used our balance sheet wisely to diversifying growth. The ADL transaction is no different. And as we now focus on deleveraging over the next 18 to 24 months, we're also maintaining our leadership positions and realizing the benefit of the significant investments we've made in our operations and to provide steady dividends. Obviously, the impact we had in the first half of this year has caused some turbulence, but we will get through that.

With the half year complete, we're expected -- executing our plan to lower CapEx expenditures. We're now expecting it to be in the range of about $45 million to $50 million for the legacy NFI business, and with the addition of ADL, CapEx now total will be approximately $50 million to $55 million for 2019.

Ladies and gentlemen, at NFI, we're proud of our history, and now with ADL, we're even more excited about our future.

With that, I'll turn it over to Lisa to answer any of your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Chris Murray from AltaCorp Capital.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Research for Diversified Industries & Senior Analyst [2]

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Just maybe going back to the delivery guidance and thinking about some of the cadence here. I guess the concern that a number of us have is just how do you deal with the inventory glut? And I mean you're looking to be pushing out a fair number of pieces of equipment in the back half of the year. Can you just talk about some of the risks around that? And I think the thing that maybe is more concerning is thoughts around being able to hit the coach number because that seems to be kind of more subject to market conditions as opposed to being contracted backlog at this point.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [3]

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It's really a good question. So let's go through each of them. Start with ARBOC, we've reduced the guidance, as you know, primarily because in our production environment, without the chassis, we lost the production slots. And so we reduced that. Very comfortable with the Equess, the medium-duty that we talked about, and so there, we write it down. We're comfortable. On the New Flyer front, we built up our WIP unfortunately, primarily as a result of the delay -- implementation of KMG and the parts that it was building to go to the production lines as well as some supply challenges we have with a few suppliers and then ultimately ramping up volume at the same time as we implement electric buses inside the factories. So the New Flyer story for the back half of the year is really about 2 things: a, the buses that we line enter getting them through; and b, catching up on the excess WIP that we've created.

The MCI story, we've adjusted the private market down a little bit in our forecast for the full year. MCI too had some excess WIP that it needs to bring down. But you're absolutely right, a good portion of the MCI's work is not contractual. It's transactional. And as we look back for the last 10, 15, 20 years, the third and mostly the fourth quarter has significant deliveries, some of which are sold and we're building a custom coach for an operator, and some of which we sell from a buildup of inventory, what we call fast track, so selling a coach, if you will, off-the-shelf.

We maintain different than in the public world. We maintain our own kind of little bid universe, if you will. So we have a database, if you will, of every single operator we've talked to, what their forecast is currently, what they've bought in the past, what their fleet looks like, what we expect them to come out for, bid, their quote in the next couple of months and our ability to deliver those buses. Now some of those buses, as I said, are buses we still need to build. Some of them are buses or coaches that we actually have in the inventory. So we've effectively handicapped our historical batting average of selling rate. It's not like we're just using an average or a number. We're using individual customer-by-customer based on our selling forecast. Is there risk? Always there's risk of us not being able to sell or -- sell and be deliver on time for the year in rev rec. But the numbers we've given you are based on the latest scrubbed forecast from Ian Smart and his team all over at MCI about what we think we can deliver.

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [4]

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And it's not all just private market and the excess inventory. There's a good portion of it that's also public market sales related to new product launch. But the issues there -- and I'm sure that Paul will get to them next. The issues on that is no different than what we deal with in the New Flyer business.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [5]

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Right. The final business is ADL. So we just added the total number of units. We've had some calls from some of the analysts and investors saying, "Hey, we read your materials. How can ADL lose money in the first month that you own it?" The reality of it is the conversion of the business from U.K. GAAP to IFRS fundamentally changes the revenue recognition. And so the number of units that were actually built and shipped but not yet accepted or received by the customer causes that revenue to move over into July. And so that didn't concern us. That was the way we had expected that work to go. The number of units that Colin Robertson and his team have forecast for the rest of the year are again largely sold or defined slots with some, like the motor coach world where we actually have to secure our customer, sell a bus and then build it and deliver by the end of the year. But the numbers we've given to the market are based on our absolutely best scrub and our best estimate of ramp-up or delivery primarily in the fourth quarter.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Research for Diversified Industries & Senior Analyst [6]

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Okay. So if I were to think about -- and this is what we're trying to -- maybe even in sequence, but there's a lot of moving parts on this one. So if I think about deliveries, Q3 versus Q4, I mean historically, you've taken shutdowns in Q3 and even small shutdowns in Q4 in some of your operations. So what you're telling me though is you're comfortable with the level of inspection, the level of quality control that you've got, that you should be able to move these buses out the door by year-end, although I'm going to guess there's going to be some period-to-period variation.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [7]

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There always is that, Chris, and that's the challenge. And again, because every bus is different or largely different, the degree of variation and customization and as you've said, the inspection dynamic, causes all these -- some scenarios where we can deliver right on time and some where we have a little bit of a delay. Keep in mind that, as we've said, even with the shutdowns you described, in the motor coach world, we're selling buses that are -- some are already made as opposed to having to make them and get them through the production process. So the shutdown doesn't have the same impact on MCI as it does on, for example, New Flyer.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Research for Diversified Industries & Senior Analyst [8]

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Okay. Fair enough. Just going back, when you did the order and deliveries update, you've mentioned that your WIP had built, and I mean it looks -- from looking at it, you've got 700 and -- at the time, you said like ex-ADL, you had 700 -- close to 800 units in inventory. We saw the impact on working capital. So I guess first question on this one, ADL, what does that do to your inventory number? And then maybe a better way to think about it is what's the normalized number once we get past this kind of thing?

And then, Glenn, if you want to just chime in, what do you expect for working capital for the remainder of the year? And where do you think that, that should take you in terms of overall leverage as you sort of flush a lot of this stuff?

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [9]

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Sure. So I'll look more in dollars than sort of the actual units. So I mean if you look at it, the cash has been consumed in working capital since the beginning of the year, and it's over $100 million, right? And that's x, the added ADL. So we think for sure getting our work process back to about normal levels, essentially all of that should get recovered.

ADL obviously added some inventory, and I guess the best place -- but the best place to look at would be to look at the opening balance sheet that we have currently presented for ADL in the MD&A. And what I will do there is I would take out the fair market value bump out of the inventory because that's going to get flushed through the system and not get replaced. So really, if you look at the opening balance sheet, pre fair value adjustments, that's sort of the level that we tried to expect from ADL.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Research for Diversified Industries & Senior Analyst [10]

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Okay. And so I mean here -- to your point, I mean so fair to think that you'll flush the $100 million through the back half of the year. Is that the right way to think about it?

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [11]

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Yes. And I guess looking at it, as we said primarily in the second quarter. So if you look at that.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [12]

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Fourth quarter.

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [13]

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Fourth quarter. Look at what we actually do to achieve it. I mean step number one is to get the production line healthy against it. Buses coming off the line are shipped. That obviously doesn't deal with the off-line inventory. So that off-line inventory then get -- once we can stabilize the production lines is focused on which is the reason most of the recovery happens in the fourth quarter.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Research for Diversified Industries & Senior Analyst [14]

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Okay. Just my last question, just turning to the aftermarket business for a couple of seconds Percentage margins on an EBITDA basis were actually pretty positive, a little higher than they've been in a little while. I know their -- over the last year or so, there's been a lot of discussion around IT harmonization, some facility reorganization. Is -- was this -- is this like an odd number for the quarter? Or is this the kind of structurally some of the changes that we've been seeing over the last few years coming to fruition?

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [15]

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I think they're structurally some of the changes. We have definitely seen a reduction in the amount of operating cost for that operation as we put together the IT systems and harmonize the management groups into 1 group. So on a cost basis, obviously, that is reflective of the business post the combination.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [16]

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The other thing, Chris, that's -- on the P&L issue for the balance sheet issue is we're now in a position with the harmonized IT systems and the 1 rationalized facility where it has the ability to reduce some of the working capital with the spare parts inventory on the shelf, that's part of the back half for this year's plan. But that will be added to that, but just that much better planning systems.

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Operator [17]

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Your next question comes from the line of Cameron Doerksen from National Bank.

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Cameron Doerksen, National Bank Financial, Inc., Research Division - Analyst [18]

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Let me just take a couple of follow-up questions on the ADL disclosure. I'm just wondering if you are able to give us how many actual buses were delivered by ADL in Q2. I know it was only 1 month, but I'm just trying to I guess figure out what's remaining to be delivered at ADL based on your delivery guidance for them for the next 2 quarters.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [19]

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Well, basically, you take that -- what number did we give you -- 1,500 or whatever. You just...

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [20]

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1,500. Yes.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [21]

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So what are the deliveries in...

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [22]

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I think it was around 500 in Q2.

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Cameron Doerksen, National Bank Financial, Inc., Research Division - Analyst [23]

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What about for the 1 month?

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [24]

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It hovers around 150-ish.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [25]

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Yes. Sort of. Yes.

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Cameron Doerksen, National Bank Financial, Inc., Research Division - Analyst [26]

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Okay. So about 150 deliveries in Q2 for the month that you owned it.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [27]

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Yes.

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [28]

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Yes.

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Cameron Doerksen, National Bank Financial, Inc., Research Division - Analyst [29]

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Okay. Okay. Perfect. And can you maybe just talk a little bit more about the seasonality here? I mean I'm just sort of looking back at the sort of the pro forma numbers you provided and Q2 last year for ADL was big, maybe not as much this year. So I'm just thinking, can you sort of describe what the typical seasonality is for ADL or is there a typical seasonality? I know it's more back-end, back-half loaded, but just sort of by quarter.

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [30]

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You really have to look at it all market by market. For sure, the U.K. market is much like what we will see at MCI. So varies Q3 to Q4. Similarly, the Hong Kong market would also be back-end loaded. And I guess one of the issues there is from seasonality obviously the Hong Kong business has been falling off since the beginning of 2019. So some of that seasonality will be reducing...

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [31]

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Not falling off, but the natural cyclicality of the business.

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [32]

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And then obviously there's the North American business, which is going to behave -- most of their business is the public markets. So there should be less seasonality there, much like what we see in the transit business.

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Cameron Doerksen, National Bank Financial, Inc., Research Division - Analyst [33]

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Okay. And just on -- maybe the final one for me, that's on ADL. I'm just wondering if you can talk about your confidence here in the U.K. market rebounding in 2020. You've kind of mentioned 2019 may be flattish, but you're expecting a rebound in 2020. What gives you that confidence?

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [34]

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So there -- as we -- as you and I talked actually in the past about the market in the U.K., if you look on the Internet and look for macro bus deliveries in the U.K., it looks like it's been dropping fairly materially. And we argue and look at specifically that was largely related to kind of smaller micro or mini type buses, which ADL doesn't participate in. ADL's U.K. business is dominated by, I'm going to say, 10 operators. I may have that number a little bit wrong, but 10 major operators and then a number of regional operators. And just like New Flyer, we're not selling 1 bus at a time. They're contractually type businesses. We're customer-by-customer, year-by-year, month-by-month, quarter-by-quarter analyzing, working when their RFPs hit the street, working on our win rates historically, looking at our competitors' viability and competitiveness and building up our forecast associated with that. So the (inaudible) is largely sold out for ADL, and that's an execution play. 2020 is a win, build and deliver play.

Now the difference between ADL and New Flyer is when you start the year, a smaller portion of ADL will be actually sold by the time you start the year. It's far closer to an MCI-type dynamic. So our confidence is the diligence we did as part of the acquisition and then the subsequent review and assessment and work with Colin Robertson and his team to come up with that forecast for 2020. But it's not a market -- the size-type conversation, it's a customer by customer buildup.

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Operator [35]

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Our next question comes from the line of Kevin Chiang from CIBC.

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Kevin Chiang, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst [36]

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Maybe just going back to some of the comments you made, Paul, around the steps you're taking to kind of deal with some of the execution issues that you faced over the past year or so. Wondering, one, with the plan in place, are you starting to see some improvements already? Or is that something that likely won't start materializing in the third quarter here when you look at kind of all the various initiatives you're pursuing?

And then secondly, when you start integrating ADL here or as you integrate ADL here, just maybe lessons learned in terms of what you've experienced over the past year and would you approach the integration of ADL maybe differently than you might have otherwise, let's say, 12 to 18 months ago?

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [37]

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Okay. Great question. The primary dynamic in New Flyer is we stood up KMG, so a part fabrication business to do 2 things. One was to enhance our Buy America capability so that we would get credit for now the increased U.S. content rule. And the second issue was a profitability opportunity because as we resource stuff from Canada or internationally, to the United States, we made a decision that we thought most of what could be built through KMG, we could do ourselves. And now there was a profit opportunity. The reality is we underestimated and did a poor job of implementing or launching KMG. And the reason why that's so important is that as we slow down the sourcing of material from other places and began relying on KMG, which didn't deliver, so guilty as charged, we now ended up with buses on production lines that didn't have the parts because, as you know, in our New Flyer environment, we don't carry buffer inventories. It's a just in time, a point of use strategy of building parts. So largely did it to ourselves. No excuses than we got to fix that going forward, and we're comfortable with that.

The second issue is while that was going on, we were adjusting volumes across our facilities and introducing electric buses into every one of our production lines. And so we added a whole bunch of complexity to that average person on the line building the buses. And we thought we did a good job of planning, executing, prioritizing, training, all those things. But the combination of parts shortages and a model mix caused us to basically and, pardon my expression, to get constipated with our ability to deliver the buses. So the recovery plan is, a, fix KMG so that the parts get to the main production line and the ones that we're building right now get out on time. And then, b, because the buses have gone through the production line and they now need parts that weren't there, you've got all kinds of rectification work for that excess inventory that Glenn talked about. So the fix is get that healthy. And there will be a little of an impact in Q3, but the most part of the excess WIP gets out in Q4. So from lessons learned, I don't see -- we're not going to take ADL Parts into KMG and start building parts for them to try and grab a little profit until we're very comfortable now that KMG can actually stabilize and take on more work. So

(technical difficulty)

we're going to be very careful about that dynamic.

The other thing is that so far ADL strategy on electric buses is different than New Flyer's. In New Flyer, we basically take the same chassis frame and shell, and we basically implement the electric system on the buses, the battery systems, the motors and so forth. In ADL's case, their strategy in the U.K. is to team with somebody that provides the chassis. And so it has not had the same impact on ADL as they moved and implemented the manufacture and delivery of electric buses. There's lots of lessons learned that we can get from NFI Parts, from Motor Coach and NFI that we're going to use and work with Colin Robertson and his team as ADL comes on board. The biggest integration "opportunity" for New Flyer and ADL is in North America, which is about 25% or 30% of their business or whatever the percentage is. And that's where we can start to think about common supply chain, insourcing versus outsourcing, facility optimization over time, overhead optimization or rationalization and so forth. But that's not -- as we said, we didn't base our business case on ADL based on synergies. We based it based on being able to coordinate and grow the business. And if we grab some synergies, that's a bonus or a benefit to profit.

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Kevin Chiang, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst [38]

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That's super helpful. And when you think of the time line to all the stuff you just mentioned, especially on the KMG front, is the expectation still to be basically at some sort of normalized run rate in 2020? Or will that -- is there still a bit of a ramp-up as we kind of look in the first half of 2020 to get profitability or the cost -- the extra cost associated with the ramp-up fully out of the system?

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [39]

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The question we had earlier from Cameron and Chris on volumes and so forth, we have currently forecasted, planned and are executing to get the vast majority of the excess WIP we've created out in the fourth quarter. Because it's variable based on supply chain and customer inspection and acceptance and so forth. Could some of that bleed into 2020? Absolutely, it could. But the vast majority we expect to get out in the fourth quarter.

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Kevin Chiang, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst [40]

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That's helpful. Maybe just last one for me. If you were to look at maybe the cost -- I don't know if this the right way to think about it, but the cost or the margin impact from these issues and to the extent it -- when you look out to 2020, a lot of this reverses. Is there a dollar figure you would put on this? Like, this would have been an x -- would've been $10 million of EBITDA hit in 2019 when it's all said and done? Or is it tough to kind of quantify because there's a bunch of moving pieces here?

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [41]

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It's very tough to quantify. We got to look at a lot of the rectification costs. It's just going to be labor cost, so it's -- and when you look at the total cost of the bus, it's relatively small, about 17% of sales. So could that go up 10% or 15% on those offline buses? For sure. But again, you're talking about relatively low cost -- piece of the lower cost of the bus. No significant change in obviously the material cost. So there could be a small impact on margins as we go through the Q4 reduction, and work through this, but wouldn't think it is significant. For sure, there's far more variation quarter-to-quarter just by mix of contracts than you'd see from any impact on the cleanup of Board process.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [42]

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The biggest benefit, Kevin, is going to be the burn down of the excess WIP which generates the cash that is kind of ballooning our balance sheet right now.

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Kevin Chiang, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Analyst [43]

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Okay. And maybe sorry just -- maybe just a clarification question. I apologize if you mentioned this. It looks like you're -- based on your guidance, you're going to deliver roughly 3,400 buses through the back half of the year here, give or take. Did you mention what percentage of that would've been, say, contractual versus what percentage of that is transactional? So what is it that you know for certain you can deliver based on customer order? And what percentage you're going to have to -- you have to find the buyer when you look at that 3,400?

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [44]

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Yes. We haven't provided specific percentages. But let's just talk about them again. So ARBOC's dynamic, and again, relatively small in the grand scheme of things, but the high percentage of that, greater than 50% or 70%, off top of my head roughly, is we've already have a contract, we've got to build and deliver. New Flyer essentially, all of the slots, we know whose bus it is. It's a contractual dynamic, so there's the build and deliver the new stuff and the catch-up and execute of the excess WIP. MCI, as we talked earlier, has a reasonable portion of contractual. Most of it's government that are public-type customers. The private operators, there is a percentage of them where we actually know where we're going to sell 10 or 2 buses to these guys, but there's a lot of it that is still, you got to win the deal, got to deliver the bus, which is why we have that combination of, again

(technical difficulty)

fast tracks or prebuilt buses and some of it is we still got to build the bus for a unique customer. And then ADL is a lot closer to New Flyer, where the vast majority of 2019 is not about finding a customer, it's about building, deliver a bus.

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [45]

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I think a good thing to look at there, Kevin, is the firm orders and backlog that we gave in July and the orders released, obviously, excluding ADL for the New Flyer, MCI and the ARBOC business.

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Operator [46]

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Our next question comes from the line of Mark Neville from Scotiabank.

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Mark Neville, Scotiabank Global Banking and Markets, Research Division - Analyst [47]

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Maybe just a couple of questions on ADL. When you bought the business, I think you said a 7.3x multiple. It would suggest about $55 million of EBITDA. But I'm looking through the MD&A, again LTM and sort of last year, it looks closer to sort of $35 million, $36 million of EBITDA. So I'm just really not sure sort of what the difference is or how to bridge that gap or maybe my numbers are a bit off.

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [48]

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Yes. If you go back to our original quote -- our original press release, that multiple is really based off the U.K. GAAP number because that's all we had at that time. So when you look at what has changed between U.K. GAAP and IFRS, the biggest single change would have been the revenue recognition and the other significant change would be the treatment of their new product development cost. So I would say probably 3/4 of this difference is revenue recognition, and obviously, that's for timing issue. From our valuation standpoint, the cash flow doesn't change. So we're very clear on what the cash flow was for this business. And while the revenue gets recognized at different points, the cash still comes in as planned.

And the other part which we knew about during our diligence, which couldn't fully quantify because of some -- because they capitalized all the new product development, some of that would be true tangible assets. Some of that would be soft engineering costs, which obviously in our world we expect. So we knew the adjustments were coming. We just couldn't quantify them until we could get inside the business and start peeling back and looking at the numbers. So I guess again, right, from our standpoint, we valued the business looking at a number of different ways, probably most significant of which was based on the cash flow generation of the business. And obviously, that has not changed as a result of the changes in the accounting policies.

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Mark Neville, Scotiabank Global Banking and Markets, Research Division - Analyst [49]

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Okay. Maybe -- again, maybe I'm not just fully getting it, but the -- just on the revenue recognition, I'm just curious why or how that would cause so much of a significant impact. I mean...

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [50]

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No. Don't look at it in -- there's 2 major adjustments. So you got to look at it really their U.K. business and then their export business. The U.K. business, they were basically recognizing revenue at the time of the bus being ready to ship from the factory. Under our policies, we recognize revenue once they arrive at the customer and the customer takes control of the product. So maybe that shifts revenue, 1 to 2 weeks, right? Not a significant revenue.

The other piece was on their international work. And there, they were recording revenue on a long-term contract basis. And they -- so they basically were recording revenue at specific milestones. Those milestones being when they completed the chassis, when they finished building the bus body and when they delivered the bus to the customer or had buses ready to ship. So for sure -- I mean, obviously, now we're recording as the bus arrives at the customer. So there's a significant gap. I mean, that can be up to 6 weeks from the time they start the bus to the time they finish the bus. Say the chassis then sort of halfway through that process, so -- or say there's 4 to -- up to 4 or 5 weeks of difference on some of the components of revenue recognition.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [51]

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Mark, just some color on it. It's not material information, but just context. When they closed off June under now our ownership, historically they would have had rev rec for about 60 units. So there was, for example, 7 in the U.K. that were on their way to a customer. There was 41 that were in shipment to the Asia Pacific. There was 12 that were being delivered in Europe that again, historically, they would have had rev rec, and there was 4 in North America that were on a truck on the way to the customer. Those 60 units they would've historically recognized in June, now go into July. So over time, that'll sort itself out. But it just so happens that from the date of purchase to the end of the quarter, we found them in that -- the situation where it's a bunch of units that never actually got scored for or got credit for.

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Mark Neville, Scotiabank Global Banking and Markets, Research Division - Analyst [52]

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Okay. And you did touch on this, but I'm just -- again, just sort of curious, again the volatility in Q1, Q2 this year versus last year. Again, it sort of all ties in, I guess, into revenue recognition. But I mean, is it typical or going forward, are we're going to -- is it going to look like this in the first half or potentially where there's a lot of volatility from one quarter to the next?

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [53]

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On ADL specifically, Mark?

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Mark Neville, Scotiabank Global Banking and Markets, Research Division - Analyst [54]

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Yes. Yes, exactly. Well, sorry.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [55]

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Yes. I think so. And it's kind of, as I said before, it's halfway between Flyer and MCI, it's close to Flyer where there are mostly multiunit contracts. But it's -- like MCI, where it's not in the bag as the year starts. And so there's going to be variability in ADL quarter-to-quarter and now even more based on this rev rec dynamic or at least for a while, you'll see it amplified to what we would've seen ADL in the past.

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [56]

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I mean, if you look at their revenue split, approximately half is U.K. As we said earlier, that revenue is much like MCI where it's strong in Q3, Q4. And that's just the nature of that market.

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Operator [57]

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Our next question comes from the line of Stephen Harris from GMP securities.

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Stephen C.A. Harris, GMP Securities L.P., Research Division - Head of Research [58]

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I just want to know if we can dig in a little more into KMG, which seems to be at the root of a lot of these production issues and the inventory issues. And if you can maybe let us know on your assessment right now sort of more qualitatively than quantitatively, what exactly went wrong, where you are in fixing it and maybe -- what you would do differently if you had to do it over again?

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [59]

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Sure. So it's a multi-cell production facility. And our experience historically is adding part fabrication to our existing manufacturing plant. So cut and weld and paint brackets and put it on the bus beside it. Our desire and our wisdom was the 2 things I said before. One is grabbing the U.S. content. The second was grab some profitability based on repatriating ourselves. And for the most part, the capability or the technology at KMG is building stuff that we've done in our other plants. So we took a facility. We set up these 9 cells. We put a leadership team in place. We put an IT system in place. We trained these people. And most of the people in that area come from a warehousing-type environment. And so we are training people to get from somebody that stocks the shelves to somebody that's now assembling a part or building a wiring harness and so forth. And we got some support and assistance from state of Kentucky and the local area and so forth.

So at the same time, we started to slow down the sourcing of material as we insourced it. So we shut off vendor A, and we started building it inside KMG and there was a ramp-up period. In the first couple of months, ramp-up were fine, but they were very small volumes. As that volume started to ramp up, it became crystal clear that the leadership team wasn't probably the right ones. We made those changes. The second issue is the training and deployment and execution of the IT systems, the planning systems and so forth should have been done better. And then the third is the underestimation of the volatility of the workforce and where people in most of our plants, once they come, they stay. And in this case, you have people leaving for $2 an hour or $0.10 an hour going down the street and so forth. And so all those things conspired to have us now a product line in New Flyer sitting there, waiting for a part from KMG that didn't come and then, of course, the turbulence associated with that.

If I could do it over again, I thought we had a good project plan in place, it turns out we didn't. We thought we had the right leader in place, it turns out we didn't. So what we've decided to do is slow it back down to the core level of components. We've re-outsourced the key components that we've been holding up the product lines. We've changed the executive oversight inside New Flyer to be able to handle and manage this thing. We've redeployed numerous people to the site to back -- basically go right back to ground zero in training of systems, using of equipment and so forth. The team in place now has stabilized KMG. And so the parts past due or the hours overdue has gone from -- is down by a factor of 90% than what it was 2 months ago. So we're pretty comfortable that the parts coming out and the parts we're buying elsewhere are going to allow the product lines now -- or the build lines to build their buses. And we will now slowly ramp KMG back up to get back on to the business case plan that we set up 1.5 years ago. But we're not going to jerk it up too fast given the lessons learned from the last time nor we're going to start to put MCI or ADL Parts in there until we feel that it's healthy, which is probably a year from now. The focus is primarily now on New Flyer Parts and ARBOC parts.

So again, as I said in my remarks, mea culpa in terms of project management. We've been pretty successful in the vast majority of our project management over the last 10 years and the implementations. This one got away from us. We're on it. We're going to fix it.

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Operator [60]

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Our next question comes from the line of Jonathan Lamers from BMO Capital Markets.

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Jonathan Lamers, BMO Capital Markets Equity Research - Analyst [61]

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Do you have the number of units that ADL delivered over the first 5 months of the year up to the acquisition date?

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [62]

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So we haven't disclosed it, Jonathan. All we've -- because we just did from the acquisition period onwards. And then we've provided, I guess, the quarterly revenue and adjusted EBITDA in the MD&A. We did provide in the acquisition announcement the annual deliveries for ADL. That was on a U.K. GAAP basis. So there is a little bit of difference between the 2,533 units on a U.K. GAAP basis versus the IFRS number. But hopefully, if you look at the seasonality in the annual deliveries, it can give you an idea of what '18 looked like and then therefore what '19 looked like. But we haven't disclosed the deliveries for the previous period.

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Jonathan Lamers, BMO Capital Markets Equity Research - Analyst [63]

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Okay. I'm just trying to gauge by how much ADL unit volumes are expected to be down for 2019 versus 2020 -- sorry 2019 versus 2018.

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [64]

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Yes. So I think if you look at overall unit volumes, so we've given our guidance of 1,400. The challenge with ADL, I think the biggest issue, is the mix. It has such a pronounced impact, and the geographic region where the vehicles are delivered. They have vehicles in APAC versus U.K. versus North America. The revenue and margin per vehicle is quite different. So realize that's a challenge. I know for you as you're doing your modeling. So maybe we can take it off-line, and we can go through it. But I think looking at the '18 data that we provided tries to give the seasonality mix and the average kind of revenue per unit. But again, I think if you look at the 1,400 and then what we've talked about here, if you look at how the first half of this year played versus the first half of last year and use that as a starting point. And then I guess year -- and the quarter and the months that we did own ADL, they delivered 129 transit buses and 17 motor coaches.

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Jonathan Lamers, BMO Capital Markets Equity Research - Analyst [65]

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Okay. Paul, on the Motor Coach business, can you remind us when the new models were introduced?

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [66]

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Well, we do have a new model year of the traditional J and D models in the fall of each year. The new model, the additional model was the J3500. We, I think, delivered our first J3500 in the first quarter. So that started to ramp up kind of January, February. And it is being built on the same line as the J4500. So while they're similar buses and look the same, they are different, 1 axle versus 2 axle and tooling and a whole bunch of other issues. The other new bus model that we introduced was what we call the D45 CRT LE, which is the vestibule coach and it started hitting the production line in late first quarter and into the second quarter and it is built on the J line as well.

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Jonathan Lamers, BMO Capital Markets Equity Research - Analyst [67]

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And of all the extra production costs that you've incurred over the first half, are the costs for running 2 lines now significant? Or is the larger bucket going to roll off as you work through all of these inefficiencies during the initial ramp?

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [68]

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Well, they're both -- the answer to both is yes. Remember that the D line is a completely separate line, and we will continue to run with duplicate overheads on the legacy D lines until it is 100% gone. So you have different sourcing efforts, you have different engineering efforts, you've got different manufacturing engineers in the shop floor, different leadership and so forth. But we won't be till '20 -- I think '21 or '22 before you have completely harmonized lines. So we will, until then, all we have a higher overhead rate per average unit coming out of the facility. The challenge is associated with just like in New Flyer the same technicians, the same leaders, the same supply people handing a new product on a common line or a common J line will burn those excess costs and those things will largely be behind us at the end of 2019.

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Jonathan Lamers, BMO Capital Markets Equity Research - Analyst [69]

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Okay. And for the transit business, can you -- Paul, you mentioned that you continue to expect order sizes and attached options to be smaller than previous years. Can you tell if those are improving a bit in the second half? And can you update us on sort of what you're hearing from the customers? Are they still continuing to focus on your expectation?

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [70]

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Well, it's a good question and it's obviously very topical. It's not a 1 quarter or half year or 1-year issue. And I think last quarter and even in some of the individual conversations, I gave an example of the average transit agency that's got 200 to 300 buses that had diesels or natural gas, they've now been directed to find a way to plan for electric. The politicians in that area have said by 2020, 2030 -- sorry, 2030, 2040, whatever will be all-electric. And so those transit agencies continue to be in kind of a mad scramble to do 2 things: a, try and select somebody to have a couple of pilot buses figure out the impact on their maintenance garages and technicians and all drivers and so forth; and then, b, come up with a multiyear replacement plan without real clarity of where the incremental funding for more expensive buses A and B charging infrastructure is going to come from. So when we started the year, I thought we were hopefully clear to our investors that you're going to start to see a slowdown in the total bid universe -- in fact, not the total, but the active bid universe. The total of what people say they think they're going to buy in the next 5 years continues to be very healthy and kind of near-record levels. But their inability to put out big competitions and have smaller orders of electric to try.

So for example, I can't remember the transit agency, but about a week ago, there was an RFP on the street for 100 diesel buses. We worked on a proposal as our competitors. I think we actually even submitted the proposal. The transit agency with their local municipality decided, "You know what, we're not going to proceed with that. We're going to reissue an RFP. We're going to try 5 electric buses." And so that's the dynamic that's happening in many, many cases across the United States. Are they talking about electric? I don't think there's a transit agency that we've talked to in the last year that is not talking about electric and trying to figure that out. So what we did also expect is as people started to get their head around when and how electric might fit for them, we've seen it over the last quarter. And again we saw it here, the data we just released, a number of in the active bid universe is starting to creep back up, which is a very positive sign. And in our remarks, we just wanted to make sure people realize this isn't elastic. It's not going to go from 5,000 or 6,000 actives down to 2,000 and then back to 5,000 or 6,000 overnight. It's going to creep its way back. But we're quite encouraged with the number of RFPs that have come out. We're encouraged with what people tell us they're going to put in for RFPs. We've started to see some of the bigger electric RFPs of 30, 40, 50 as opposed to 2, 3 and 4. And all those things we think bode well.

The unfortunate part of it is that a lot of that big backlog that we have is going to burn down which is a good news. We have orders that we can actually work through that are conventional diesel or natural gas or hybrid. Some operators are nervous and skittish about going to full all-electric. And we ultimately think hybrids will go away because an all-electric makes much more sense. But in the interim, we're seeing a bit of resurgence on hybrids so that certain transit agencies that today have no electric experience can get their feet wet, can get their technicians up to speed and their drivers and so forth. So, apologize for the long answer -- Jon, but hopefully I gave you some color of what we are hearing. The other good side of that is that our buses and service, and notwithstanding some initial teething pains in deliveries, in charging dynamics, our buses and service have performed to or better than our expectations.

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [71]

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And not to add too much, but on -- Paul mentioned it, I wouldn't take fewer options on an order as a sign of decreasing demand. It's just transit agencies wanting to maintain that flexibility as they look at the ZEB transition and battery electric. So while there is more firm and maybe fewer options, it's not a change in demand, it's just transit agencies wanting to have that option going forward if they decide to procure more ZEBs in the near term.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [72]

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The other thing you don't see and quite honestly we don't see until it happens, Jon, that is we have state contracts. And historically, it was a customer by customer and then there were some agencies working together to kind of put a collaborative bid out. What's happened again in the last couple of years, and we tried to point to in our MD&A, is this concept of state contracts, where there's a schedule that the state has put out, that anybody in the state and some other named parties can actually buy off that schedule. The problem is there's no defined quantities.

(technical difficulty)

thing in our backlog for those state schedules. The minute we get an opportunity, we will bid on it. We again still don't put it in our backlog because we've

(technical difficulty)

whether it's funded or whether it's going to proceed. But the minute we get awarded, it goes immediately to firm. And you're going to see it and have seen I'm sure over the last little while, announcements of 20 buses here, probably 50 buses there which are off of a state schedule. And so we've been very successful in California and in Washington and in Florida, getting on those state schedules which is now kind of a new or a different way to buy transit buses.

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Jonathan Lamers, BMO Capital Markets Equity Research - Analyst [73]

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Okay. That's a good answer. Maybe just one follow-on that. Are there any levers that you can pull to manage through this situation, whether on pricing? And can you just talk about how you would manage through a scenario where the orders kind of remain at a similar level to where they were at the first half?

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [74]

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Well, so all the components, when we wake up on July 1 and we make our plan for the rest of the year, we know which ones are under contract. And so we know under the contract which ones are firm, and we know which customers we think they're going to exercise their option so that we can build slots. We know other people that have said they're going to put out a fast-track RFP that we think in the next number of months, they're going to put it out and we think we can build in this year. The pricing is a slippery slope because as we move to electric buses, the last thing we want to do is drop price, set new market rates for something that's maybe not sustainable for the long term. And as I said, I think a number of times, so far, knock on wood, we or any of our competitors have not been irresponsible, irrational on electric bus pricing. And part of that is there's not enough history to know what go-forward pricing and margin and cost will look like. And so we sure don't want to be price leaders just to try and grab a short-term volume. The good news is we have backlog. We have state schedules that allow us to kind of manage that. And I think it -- whoever's question before, maybe it was Chris's or somebody's, but in the New Flyer case, for the rest of this year, it's not like we've got to fill slots, it's an execution story. And we're now filling slots in Q1 and Q2 of next year, either from backlog, new bids or from state schedules.

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Operator [75]

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Our next question comes from the line of Daryl Young from TD Securities.

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Daryl Young, TD Securities Equity Research - Mining Research Associate [76]

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Just a couple of questions from me. In terms of leverage, the expectations to delever down to 2x to 2.5x, looks like it's been pushed out just slightly to 18 to 24 months. Is that a reflection of the inventory ramp-up or lower cash flow expectations?

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [77]

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I'm sorry.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [78]

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Say that again, please, Daryl. Just to be clear.

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Daryl Young, TD Securities Equity Research - Mining Research Associate [79]

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The decision to term out the deleveraging to 18 to 24 months post acquisition versus within 18 months previously. Is that a reflection of the inventory ramp-up? Or is there a lower expectation for margins going forward?

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [80]

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No. I would say a lot of it is around the inventory ramp-up, and obviously, hopefully, we're going to get that back this quarter. But I know this -- of hedging there. I guess, the other piece is revenue recognition. But again, that is not going to impact the cash flow overly. So it's really -- we don't really think -- we haven't really changed the business plan. So it's just related to the work in process.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [81]

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I think really, Daryl, it's just a way of being clear that we've got some turbulence right now. It's not changing our vision or the desire to delever back down. And just giving a little bit more comfort or clarity or headroom, if you will, on our ability to get there. We shouldn't want to set unrealistic expectations given kind of the roadblocks we've seen recently. I'm not so sure I can say or I definitely am not going to say that it's our expectation of lower margins.

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [82]

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Yes. Exactly. I think it was primarily the reflection of the WIP production. Half 2 of '19 would be the main change for that, the few extra months added.

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Daryl Young, TD Securities Equity Research - Mining Research Associate [83]

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Okay. Great. And then in terms of ADL. The CapEx expectations are very low for 2019. Do you guys foresee a ramp-up in CapEx come 2020 as you prepare for the new Berlin order?

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [84]

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First of all, it's a very different operating model than we have in New Flyer, right? So for sure, in the Asia-Pacific region, they're utilizing third party contractors to do their build. So very CapEx-light for that part of the business. The Berlin contract, I mean, we -- there's some work to be done there to see how we end up building that. I mean, it could be built in Scotland operations or we could look at other outsource providers.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [85]

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The Berlin contract has kind of 3 stages to it. The first is the pilot and proof of concept in service. The second is the first initial order which is like 60 or 70 units. And then there is options that go to a couple of years up to 400-something units. So the first pilots are being built in the U.K. facilities. In fact, I think in the Scotland facility. As we think about the first tranche, the ADL has been very smart about keeping their options open, one is a scenario of building them in the U.K. One is a scenario of building them with a partner in Europe or Eastern Europe and a third might be a Chinese build and then importing them back into Germany. And so the gang has not been definitive on the way they want to approach that. That's -- one of the things that really attracted us to ADL is this variable strategy depending on the dynamics of the time. The other issue associated with that is Brexit and making sure that we don't commit to something that has an impact on our business. We have time though before those initial deliveries beyond the pilots. It's probably a year and a bit away before they start to happen. So we've already had a lot of preliminary conversations with Colin and his team about how they might address it and they do have -- various scenarios are working on.

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [86]

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And I think, Daryl, just to add, if you look at their historic financial statements under U.K. GAAP where they used to capitalize new product developments, CapEx will probably look higher on a U.K. GAAP basis versus the IFRS, but primarily all expensed. And then the other thing in our guidance, I guess, from '19 just to note, that the kind of $5 million guidance range that we provided, that's just for the 7 months kind of from the acquisition date onwards. So in 2020, obviously, we have a full year of ADL.

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Operator [87]

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(Operator Instructions) Our next question comes from the line of Stephen Harris from GMP securities.

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Stephen C.A. Harris, GMP Securities L.P., Research Division - Head of Research [88]

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Just one follow-up from me. One of the things you're encouraging us in your commentary was to change the way we look at the company and to move away from sort of an EBITDA per EU model and focus on other metrics, like gross margin and the like. Is this really a function of the increased complexity of the business or the greater variability between contracts? Or is there something else you're seeing that leads you to think we should be focusing looking at the...

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [89]

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It's a really good question, Stephen, and we really worked hard on trying to explain what we were doing. So pardon, a little bit of a rambling here, but context. When it was just New Flyer, it was easy because it was kind of a per-unit slot. It was North America. The pricing and margins between Canada and United States was kind of comparable and so forth. We added NABI, and again, it was easy. It was a simple discussion. When -- then we got Motor Coach added to the thing, the margin profiles have been changing and moving between coach and transit, but the blend worked out okay. The minute ARBOC came in, the average EBITDA per unit for a cutaway, where we don't include the chassis or a medium duty which the quantum is 1/2 or 2/3 the price of heavy duty, started to screw up the averages. And so we spent a disproportionate amount of time trying to explain to people it's not a drop in margin, it's a mix dynamic and so forth.

And then overlaid with that, you still always have this per EU dynamics associated with 2 production slots in an artic. The minute we bring ADL into the story, you've got such a wide mix. You've got double decks that are either conventional natural gas or diesel or a hybrid. You've got double decks where you have a chassis provided from somebody else on electric. So now the average selling price and the average margin is very different. You have single decks in different regions that have very different pricing and margin profiles. And when we started to calculate EBITDA per EU number, it was like, "Oh my god, this thing is so different" and there's 10 different components that an average is now meaningless. And then we tried to figure out can we provide the same fidelity of data that we do in the North American environment based on the global markets, and it's very difficult.

So we were crystal clear trying not to tell anybody there's no hiding or no other driving factor other than the story to tell is very much different today than it was before those things. So we went back and researched a whole bunch of other reporters to try and figure out what do they do with those blended margins and mix as we looked at the global guys like Volvo or Daimler. We looked at some of different heavy equipment manufacturers and just really felt the most natural thing now with both product but also geographic diversification is a margin perspective and an EBIT perspective to be able to help the investor have a good handle on the trajectory of our business over time. And so the most natural time to do that was post the ADL investment.

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Glenn Asham, NFI Group Inc. - Executive VP of Finance, CFO & Treasurer [90]

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And in addition, I mean, we've also provided some additional information that we haven't done in the past. We've done more to break down our cost of sales between what is the truly direct costs relating to those sales versus the overheads, so you can get a bit of a feel to what variable is versus fixed cost in the cost of sales number which is something that previously was not provided.

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Paul Soubry, NFI Group Inc. - President, CEO & Non-Independent Director [91]

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Yes. Thanks for bringing that up, Stephen, because it's been an issue we wanted to make people understand. It's not to hide, it's to amplify and provide a full story. The other thing that you didn't ask about, but just a comment, providing a release 15 days after the quarter on units disconnected from the financial realities causes the investor, the analyst and us, for that matter, to spend a disproportionate amount of time telling part of the story a part of the time. And so we just felt the best way to do that is to tell the whole story as a comprehensive package which you'll now see starting next quarter.

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Operator [92]

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We have no further questions in queue. I'll turn back to the presenters for closing remarks.

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Stephen King, NFI Group Inc. - Group Director of Corporate Development & IR [93]

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Thanks, everyone, for joining us and for your questions. If you have any follow-ups, please feel free to reach out any time. My contact information is on the website and in the press releases, and we look forward to speaking with you all again soon. Have a great day.

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Operator [94]

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This concludes today's conference call, you may now disconnect.