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Edited Transcript of WJX.TO earnings conference call or presentation 2-May-17 5:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Wajax Corp Earnings Call

MISSISSAUGA May 17, 2017 (Thomson StreetEvents) -- Edited Transcript of Wajax Corp earnings conference call or presentation Tuesday, May 2, 2017 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* A. Mark Foote

Wajax Corporation - CEO, President and Director

* Darren Julian Yaworsky

Wajax Corporation - CFO and SVP of Finance

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Conference Call Participants

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* Ben Cherniavsky

Raymond James Ltd., Research Division - MD of Industrial Research

* Michael Doumet

Scotiabank Global Banking and Markets, Research Division - Analyst

* Michael Tupholme

TD Securities Equity Research - Research Analyst

* Sara O'Brien

RBC Capital Markets, LLC, Research Division - Analyst

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Presentation

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Operator [1]

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Welcome, and thank you for attending Wajax Corporation's 2017 First Quarter Results Conference Call. On today's call will be Wajax's President and Chief Executive Officer, Mr. Mark Foote as well as Wajax Senior Vice President, Finance and Chief Financial Officer, Mr. Darren Yaworsky. Please be advised that this call is being recorded. Please note that this conference call contains forward-looking statements. Actual future results may differ from expected results. I will now turn the call over to Mark Foote.

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A. Mark Foote, Wajax Corporation - CEO, President and Director [2]

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Thank you very much, and thanks for joining us today. We're satisfied with the year-over-year improvement in our first quarter results.

Revenue improved in all regions, with the majority of growth resulting from stronger year-over-year volumes in Western Canada. At a category level, we achieved broad improvement in Equipment and Industrial Parts revenue and improved Product Support Sales. Selling and general administrative expenses declined due to lower personnel costs resulting from our 2016 reorganization. And our backlog improved sequentially compared to the fourth quarter of last year.

As a result, our earnings improved in the first quarter as compared to last year. And I would like to express my thanks to the entire Wajax team, who worked very hard to deliver the results in the first quarter, with 2 specific callouts on the team's contribution. First and foremost, the team did so safely in the first quarter. We had a really strong year-over-year improvement in our safety record. And in April, while it's the beginning of the second quarter, enjoyed an injury-free month. And secondly, the team did so within a new organizational structure, wherein the broad improvements in our results are helping to demonstrate the effectiveness of the reorganization efforts that we largely completed in 2016.

Although the first quarter results are an improvement, we continue to expect that most major resource and industrial markets will remain under continued spending constraints and margin pressures for the remainder of 2017.

One of our significant focal points remains the revenue replacement of the 4 large mining shovel deliveries that we made in 2016, as we don't expect those deliveries to repeat this year. Also, we continue to focus on managing our margins effectively. While there's some signs of market volume improvement in the first quarter, margin pressure remained significant. And we have increased our price competitiveness in some categories to regain market share.

And finally, we obviously need to ensure we're delivering on the commitment for the roughly $17 million in annualized savings that we expect from our reorganization in 2017. Assuming we achieve those objectives, we anticipate adjusted net earnings this year will increase compared to last year's adjusted net earnings.

And one disclosure issue before I hand the call off to Darren. You'll recall that we had previously discussed our plans to change the presentation of our financial information once our reorganization efforts had been completed, which obviously, we announced we generally completed them at the end of the last year.

So starting this quarter, we have changed the presentation in our main disclosure documents, including our MD&A. And we're now reporting as a single segment versus the 3 segments reported previously. The single segment reporting more accurately reflects the way in which the company is now organized and the manner in which we assess performance and allocate our resources.

And I'm going to turn it over to Darren for his first official call as our CFO.

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Darren Julian Yaworsky, Wajax Corporation - CFO and SVP of Finance [3]

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Thanks, Mark. As Mark mentioned, revenues were up year-over-year. We generated revenue of $318.4 million, an increase of 11.7% compared to prior year. The improvement is largely due to higher revenue in Western Canada relating to improved volumes in construction, mining and forestry. Regionally, revenues increased 25.4% in Western Canada, 4.5% in Central Canada and 1% in Eastern Canada.

As Mark mentioned, we've changed our financial reporting to reflect one operating segment and, therefore, one reportable segment. As a part of that, we've introduced a category breakdown of revenue for this quarter as compared to the same quarter in 2016.

We've seen improvement in each of Equipment Sales, Equipment Rentals, Industrial Part Sales and Product Support. Additionally, earnings were up year-over-year. We generated net earnings of $6.2 million or $0.31 per share this past quarter versus an adjusted loss of approximately $600,000 or $0.03 per share for the same period last year. The year-over-year improvement for the quarter is largely attributed to increased revenues and decreased SG&A expenses.

Our backlog has strengthened. Compared to Q4 2016, our backlog increased $34.2 million or 27%, due primarily to higher equipment orders. As a point of clarification, we had adjusted our Q4 2016 backlog by approximately $9 million, and the 27% increase that I just referenced is reflective of that adjustment to the Q4 numbers.

Compared to the first quarter of 2016, our consolidated backlog decreased just under $46 million or 22%, due primarily to lower mining equipment orders.

We continue to prudently manage our balance sheet and financial capacity. We finished Q1 with a leverage position of 1.94x, which is within our leverage target range of 1.5 to 2x, and we expect to remain in our target range for the balance of the year. We maintain ample capacity within our credit arrangements, and I believe we're well positioned to satisfy our working capital needs and support our 4 points of growth strategy across the year.

Finally, today, the corporation declared a second quarter dividend of $0.25 per share payable on July 5.

That concludes our presentation. And operator, if I can trouble you to open up the call to any questions that someone might have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Michael Doumet of Scotiabank.

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Michael Doumet, Scotiabank Global Banking and Markets, Research Division - Analyst [2]

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So just the first question on Western Canada. You highlighted strong growth in the region. There's also solid increase in your backlog. Can you comment on whether there are any specific drivers, maybe one-timers? And maybe, have you seen a shift in spending levels from any particular customers, namely the oil sand customers?

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A. Mark Foote, Wajax Corporation - CEO, President and Director [3]

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I think that you can probably break our Western Canada gains down into, call it, 3 categories. The first is the market. The new equipment market was better in the first quarter. So a part of that is volumes in the market on the new equipment side were a bit better, and that's a statement specific to construction and forestry. Secondly, we invested in price for 2 reasons. One is we did have some old gear we wanted to move into the market in the first quarter. So we invested in some price to do that. And secondly, we were a bit more price competitive just in gaining market share in the first quarter. So part of it's the market. Part of it's us. I think on the oil sand side, we actually had a pretty decent quarter. I'm not sure if I would say that, that is some kind of fundamental shift in the market, although we had a slightly better first quarter than we had expected, with some small mining shovels and some mining class excavators that went to work in Fort McMurray. So it's a combination of things, but the market was part of it, and we another part of it.

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Michael Doumet, Scotiabank Global Banking and Markets, Research Division - Analyst [4]

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Okay. And just in your price competitiveness in some of the categories, should we expect somewhat of a drag to gross margins, but to the benefit of sales for the remainder of the year? Or is this just pertaining to Q1?

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A. Mark Foote, Wajax Corporation - CEO, President and Director [5]

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No, I think it's a basic market fact right now that the competitiveness in the equipment markets is pretty high. So in order for Wajax to maintain its volumes and increase them, then obviously, we have to participate in that. So I would say that the equipment margins we would have had in the first quarter are probably representative of what we'll see for the balance of the year.

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Michael Doumet, Scotiabank Global Banking and Markets, Research Division - Analyst [6]

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Okay. And maybe just one last one. Free cash flow and capital allocation -- sorry. I don't think that's coming from my line. But on capital allocation, could you maybe size up your Rental CapEx and PP&E CapEx for 2017?

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Darren Julian Yaworsky, Wajax Corporation - CFO and SVP of Finance [7]

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I think we would probably look at investing more in the rental fleet at the beginning half of the year and less so in the back half of the year. The [PNG] space, it probably will be flat to last year. Overall, we'll likely be investing more in our working capital requirements the front end of the year and generating surplus cash to delever and have less of investment in working capital at the back half of the year.

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Operator [8]

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The next question is from Sara O'Brien from RBC.

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Sara O'Brien, RBC Capital Markets, LLC, Research Division - Analyst [9]

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I was little surprised to hear that construction parts were up in the quarter and just wondered, particularly out West, if you are seeing a real pickup in construction activity. Just -- it goes counter to some of the channel checks we'd done. So I'm interested in how you're winning market share in the parts market in particular?

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A. Mark Foote, Wajax Corporation - CEO, President and Director [10]

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Well, we definitely think the equipment utilization is better, and the market is a bit better, Sara. Our in-stock position on parts may be a bit better, also, but I think that's as much a function of the market as anything else. So we definitely saw improvements. And, again, when we look at construction -- the construction market, we're really limiting our assessment of what's happening in the market to, effectively, excavators. So we did see some additional activity in new unit sales and utilization. So I think that went through under our parts sales.

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Sara O'Brien, RBC Capital Markets, LLC, Research Division - Analyst [11]

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Okay. And then I wondered if you could comment on the Industrial Components business, if there'd been any significant improvement in margin in that business. I know you don't report segmentally, but it is a pretty big driver.

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A. Mark Foote, Wajax Corporation - CEO, President and Director [12]

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I'd say the gross margins in the Industrial Component space are a little bit down from where there would have been at the same point last year, not materially, but a little bit down. And that's a function of the sales mix, I think, primarily, because we've got -- at this point, this year, we've got some higher contract volumes, particularly in Eastern Canada, than we would have had at the same point last year. And typically, the contract volumes trade at lower gross margins. So it's down, but it's not inconsistent with our -- with our internal budgeting.

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Sara O'Brien, RBC Capital Markets, LLC, Research Division - Analyst [13]

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Okay. So what do you mean by higher contract volumes?

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A. Mark Foote, Wajax Corporation - CEO, President and Director [14]

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When we have big mining customers, as an example, and we have multiyear supply agreements. So we'll have 1 or 2 large customers we would have this year that we didn't have last year. A larger portion of our volume will go out the door on contract pricing as opposed to kind of spot pricing as the customer needs the odd part here and there. So we have higher contract volumes in mining supply, given that the mining customer typically buys a bearing and power transmission product, which is, as a category, a lower gross margin product. Their contract volumes in that product -- in that category will be higher. So it's dilutive to the margin rate, but it's not dilutive to the margin dollars. It's good volume. It just has a -- it has a dilutive effect on the rate.

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Sara O'Brien, RBC Capital Markets, LLC, Research Division - Analyst [15]

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Okay. Is it fair to say that it's the SG&A savings that you expect to drive earnings growth this year? Or are there opportunities for top line growth as well in a margin-pressured environment?

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A. Mark Foote, Wajax Corporation - CEO, President and Director [16]

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I think, well, obviously, we're counting on the savings. That's certainly part of the structure of the P&L for this year. We are -- I think it's fair to say we do see revenue growth opportunities, but if you go back to our original objectives, we've got about $70 million in volume that we have to replace from those 4 shovels from last year. So we're really focused on doing that at an effective margin rate to pull in the earnings where we want them to be. So there's revenue growth opportunity. But for us, our first objective is to replace those mining shovel deliveries last year. Beyond that, certainly hopeful that there is additional opportunity, but that's really our focus right now.

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Sara O'Brien, RBC Capital Markets, LLC, Research Division - Analyst [17]

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Okay. And maybe just lastly, on the outlook. It sounded as though, although Q1 was very positive, that it was still very cautious for the remainder of the year. And I understand the gross margin impact. But if you talk about was there any kind of one-off in Q1 that makes you think that the rest of the year is going to be more of a challenge, year-over-year?

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A. Mark Foote, Wajax Corporation - CEO, President and Director [18]

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No. I think most of what happened in the first quarter, I mean, we did have some mining sales in the first quarter, which weren't expected late last year. So we would've sold roughly about $10 million in mining equipment that we would not have expected to sell. So that was the good news in that. But we continue to be pretty active on some additional mining quotes for the rest of this year. So there's some potential for the mining business to recover a little bit of itself. I think we're being cautious about the balance of the year not to be overly conservative, but the tougher quarters are ahead of us as opposed to the first quarter, because that's really where those shovel deliveries occurred last year. So the second quarter, we had 2 shovels and one each in the third and fourth. So I think we're just trying to be realistic about the fact we have some challenges ahead of us for the balance of the year. And we're confident we'll do quite well, but it's important to note that that's where the shovel deliveries occurred.

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Operator [19]

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The next question is from Michael Tupholme from TD Securities.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [20]

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Mark, can we just go back to the -- that you invested in price in the quarter. I guess, just first of all to clarify that's specifically on the Equipment Sales side?

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A. Mark Foote, Wajax Corporation - CEO, President and Director [21]

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Yes. And it would be specific to construction or forestry, primarily.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [22]

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And can you -- so if I understood correctly, you did that in an effort to move some older equipment that you had. If you -- had you not done that -- I guess, can you quantify sort of how much additional revenue was driven as a result of the pricing initiative?

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A. Mark Foote, Wajax Corporation - CEO, President and Director [23]

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I'm not really sure how to do that, Michael, to be honest with you. I think the amount of gear we would have moved that we dropped the price on to kind of get it off the books and into the market wouldn't have been nearly as big a factor as trying to be quite price competitive on the kind of the day-to-day construction and forestry business. So more of it has to do with an investment to improve market share, and less of it would have to do with moving some old gear in. So I don't know how to exactly quantify that, the effect of the pricing activity, but I would say it was important for us with respect to our overall results in growing our construction and forestry business.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [24]

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Okay. That's fair. I mean, I understand it's hard to break it down. I guess, where I'm trying to go with this or trying to understand is your efforts to capture additional share, that should continue -- it sounds like there's continued sort of margin pressure as a result of the environment we're in and perhaps some additional efforts on that front to maintain or capture additional share, but presumably, there's also a revenue offset in terms of higher revenues than you would have otherwise done through the balance of the year?

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A. Mark Foote, Wajax Corporation - CEO, President and Director [25]

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Yes. That's a fair assumption. Yes.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [26]

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Okay. And then, within the parts and the Product Support category, I mean, that sounds like it's not being affected by the sort of the pricing initiatives you pursued. That's sort of separate. So in that area, you did see quite strong growth, north of 11%, in both of parts and support. Is that -- I mean, can you talk a little bit about what drove that and the sustainability of those kinds of rates of growth?

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A. Mark Foote, Wajax Corporation - CEO, President and Director [27]

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Yes, it depends on the category. So I think, in construction, it was -- it kind of goes back to -- I think, it was Sara's question a few minutes ago, where the market is a -- was a bit healthier in the first quarter compared to last year. And we worked real hard on -- to move the product into the market, and we had some better utilization. So the construction thing -- the construction results I think are a function of that. The mining parts and service sales, that was additional activity, some additional projects we did, primarily in Alberta. And so we're pleased with those results. I don't -- that -- those things didn't have a lot to do with pricing activity so much as just generally better activity overall.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [28]

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And so are you -- how do you feel about the sustainability of the improved growth rates as we move beyond Q1 and into the balance of the year?

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A. Mark Foote, Wajax Corporation - CEO, President and Director [29]

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I would say we're cautiously optimistic that on the construction side that, that would continue. It's difficult to say if it will. I mean, there was a pretty big shift in used equipment availability in the first quarter. So we're waiting to see where those businesses kind of trend over the next few months. But I think we're cautiously optimistic that the parts and service side of construction will continue to be positive. Forestry is a -- you can call it as well as we can, I think, with what's happening with the softwood lumber issues right now. So it's difficult to see -- really, call the forestry market at all. And mining parts and service, we did a lot of work in the oil sands last year with a lot of activity with the new shovels and rebuilds, so I think we're looking at the first quarter as real positive, but not necessarily representative of the balance of the year.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [30]

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Okay. Anything -- I didn't see anything, but is there anything unusual from an expense perspective that we should be aware of or that should be called out?

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A. Mark Foote, Wajax Corporation - CEO, President and Director [31]

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No. I don't think so. We're focused on the $17 million in savings. I mean, part of that's in SG&A and part of that's in cost of sales. We are investing in other parts of our business that we're pretty bullish on, but we're committed to that $17 million. I think the SG&A in the first quarter was pretty much -- I mean, it was pretty much bang on our internal budget. So it was maybe a little bit higher, but nothing material. So it's trending the way we had expected it to.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [32]

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Okay. And just lastly, any update, as your pursuit of ERS acquisitions, what the opportunity -- like, in your -- I guess, just generally, your appetite for undertaking anything if the right opportunity came along?

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A. Mark Foote, Wajax Corporation - CEO, President and Director [33]

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That's real high. It's real high. So we downtooled on that thing -- on that activity last year simply because we were so focused on the reorganization of the company. So we didn't really pursue a lot beyond the Wilson acquisition. But at any one time right now, we've got 5 or 7 targets that we're interested in. And I would say that the right opportunity, we'd be pretty active on.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [34]

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And would these -- so just last question, a clarification on that. Would these primarily be similar in size to Wilson? Or are we talking about larger?

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A. Mark Foote, Wajax Corporation - CEO, President and Director [35]

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The 5 to 7, they're a pretty wide range. But if you're asking if we're looking at something more substantive or transformative, we're very interested in that, but there wouldn't be one of those examples in the 5 to 7. They would probably -- I think the average revenue range of the 5 to 7 is probably about $15 million on an annualized basis, individually -- each.

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Operator [36]

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(Operator Instructions) The next question is from Ben Cherniavsky from Raymond James.

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Ben Cherniavsky, Raymond James Ltd., Research Division - MD of Industrial Research [37]

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I know you've -- boy, that feedback is distracting. As you look at your statements now, I know that you've restated your numbers and you want us to think about the business differently, which is fair enough. I'm assuming you guys are thinking about it differently, too. But when we look back, I'm just trying to understand, like, the business itself hasn't changed in the past year. The way you represent it does. So when we look at the old numbers and how they're presented today, can you just help us understand what falls into which category? Like if I look at last year's, Equipment Rental doesn't quite add up to what was reported in your mobile Equipment Rental last year, so I assume there's some rental. Is that from Power Systems that falls in there? And then, Equipment Sales, sort of the same thing. Is that mostly amalgamation of mobile and power? The Industrial doesn't quite add up to what Industrial, or your components was last year, so I assume some of that's been segmented to other areas. Just -- you don't necessarily have to get into the exact numbers. I'm just trying to understand how you're thinking about the old businesses in the new format now.

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A. Mark Foote, Wajax Corporation - CEO, President and Director [38]

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If you -- I'm pretty sure if you check the segment notes -- is that the correct term? Yes. If you check the segment notes in the financial statements, there will be a table towards the back that lists equipment, Rental, other, parts and service, et cetera. I think that's a fairly reliable way of kind of reconciling to this. There may be some adjustments. Like we've got a bunch of services that were in the legacy Industrial Components business that would be in Product Support, I believe. But you can use the segment notes from last year as a way to kind of reconcile to the new way of showing revenue. And I think we'd be happy in the second quarter release to provide a table that kind of reconciles them to last year.

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Ben Cherniavsky, Raymond James Ltd., Research Division - MD of Industrial Research [39]

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Yes, that would be helpful. I'm just looking -- I've gone through the MD&A. And I mean, I know there's the operating segments, is that what you're referring to? Because you have the revenue by Equipment Sales, Rental, Industrial, Product Support and other.

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A. Mark Foote, Wajax Corporation - CEO, President and Director [40]

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Yes. So take the fourth quarter MD&A from last year and any...

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Ben Cherniavsky, Raymond James Ltd., Research Division - MD of Industrial Research [41]

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Oh, from last year, okay.

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A. Mark Foote, Wajax Corporation - CEO, President and Director [42]

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Yes. I'm sorry, take the financial statements, the last quarter from last year, look to the segment notes towards the end, you'll find a chart that lines up reasonably closely to the new way of reporting the revenue. And what we'll do in the second quarter is we'll make it a little bit easier for you, because it was a good question, to show how to reconcile the revenue to how it was presented last year. And just on -- just so I don't leave that one hanging. It's not really accurate to say there's not a lot of different in the business today. It's completely different. So the categories are the same, but the way in which the business runs is completely different.

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Ben Cherniavsky, Raymond James Ltd., Research Division - MD of Industrial Research [43]

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Well, that's all I was getting at is what you guys sell isn't -- hasn't changed that much. It's just how you think about selling them.

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A. Mark Foote, Wajax Corporation - CEO, President and Director [44]

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That's accurate, yes.

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Ben Cherniavsky, Raymond James Ltd., Research Division - MD of Industrial Research [45]

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Yes. Okay. Sorry about that. And just maybe a question more for Darren, although Mark, if you want to chip in, that would be great. Trying to get an understanding how you think about capital allocation going forward. You're at least at this -- if this is a new normal for a little while still, I imagine you're going to have to replenish inventories at some point if the market is improving modestly. You've still got a relatively high payout ratio to your earnings on your dividend. And that's not an alarming amount of debt, but you've got some debt, which I assume you'd like to delever, and you've got ambitions in acquisitions. So how does all of this come out in the wash? How are you thinking about you -- the way you would allocate your capital over the next couple of years?

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Darren Julian Yaworsky, Wajax Corporation - CFO and SVP of Finance [46]

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So I think the best way probably to answer your question is how we would treat our capital allocation waterfall. And typically, I think we would find is organic growth is the most accretive. So the opportunities in which we can invest in the business wisely or thoughtfully will provide us the best return for shareholders. The second rung in the waterfall is step-out acquisitions that augment the strategy that Mark has laid out for the last couple of years. So really something that's more service focused, and I'll just reiterate, the ERS space is a high priority for us. And then, the remainder kind of gets to your other sub-question on dividends. The way I've looked at the volatility -- the cash volatility of the business, maybe said a different way, the cash stability of the business, I don't think we have any issues with maintaining our dividend. With regards to our leverage position, we anticipate generating surplus free cash flow this year, which would result in an effective delevering of the company. You're right. We're going to look at ways on how we would use debt maybe a little bit differently, but that would be in concert with our opportunities to reinvest in the business and to also invest in acquisitions.

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Ben Cherniavsky, Raymond James Ltd., Research Division - MD of Industrial Research [47]

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And so your free cash flow expectations are inclusive of any M&A that you would currently be considering?

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Darren Julian Yaworsky, Wajax Corporation - CFO and SVP of Finance [48]

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Not at this point in time. It's just a run rate of the business.

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Ben Cherniavsky, Raymond James Ltd., Research Division - MD of Industrial Research [49]

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So if a bunch of great acquisitions came along, you'd be comfortable levering up to buy them?

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Darren Julian Yaworsky, Wajax Corporation - CFO and SVP of Finance [50]

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I think we've got enough room in our leverage capacity and stability of the business to go beyond our 1.5 to 2x leverage target.

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Operator [51]

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There are no further questions at this time. I return the call to our presenters.

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A. Mark Foote, Wajax Corporation - CEO, President and Director [52]

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Okay. Well, thanks very much for joining us today. We really appreciate your time, and we look forward to talking to you again in August. Thanks a lot.

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Operator [53]

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