NFI Group Inc

TSX:NFI

Earnings Call Transcript 2018-Q2

[Operator]

Good morning. My name is Karina, and I will be your conference operator today. At this time, I would like to welcome everyone to the NFI Group Inc. 2018 Second Quarter Results Conference Call. [Operator Instructions]. Mr. Stephen King, you may begin your conference.

[Stephen King]

Thank you, Karina. Good morning, everyone, and welcome to our Second Quarter Results Conference Call. This is Stephen King, NFI's new 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. We'll start today's call with Paul providing an overview of the quarter. Then Glenn will speak to the financial results and Paul will finish up with market insights and NFI's outlook. Following that, we'll open the call to analyst questions. I'll now hand it over to Paul.

[Paul Soubry, President, CEO & Non]

Thanks, Steven and welcome to our team. Good morning, ladies and gentlemen. The quarter was another strong period for NFI. We executed well on deliveries, we continued to see healthy demand for our products, we maintained our market position, and we moved numerous initiatives forward. In the second quarter we delivered 1,159 equivalent units of new buses, coaches and cutaway buses, which is up 17% year-over-year. Year-to-date we've delivered 2,152 equivalent units, up 14% over 2017 year-to-date. We received numerous awards in the quarter with 1,413 EUs and new orders, 47% higher than the same period in 2017. And over the past 12 months, we've had orders of 6,303 EUs, an increase of 67% from LTM 2017. Our total backlog is now at 11,685 equivalent units, of which 3,779 are firm and 7,906 are options, which equals $5.8 billion US dollars representing approximately 2.7x our annual current production rate. Glenn will review the details of financial results, but I'd like to highlight that in the second quarter of 2018 our revenue, adjusted EBITDA, net earnings, free cash flow and dividends all increased compared to the same period in 2017. This improvement is a testament to the quality of our products and service and our continued focus on operational excellence, or we call it OpEx, lean operations, customer service and product quality. Please keep in mind that our business can see volatility, so all performance metrics should be considered over a period of several quarters, which is why we often focus on LTM figures. The past few months continued to be a busy time at NFI. We're active on several significant projects across the company that we believe will positively impact profitability and enhance our competitiveness. We also achieved some other corporate goals and milestones. We're busy ramping up our new part fabrication facility in Shepherdsville, Kentucky that now employs about 90 people. It's already started making production parts for New Flyer business unit and once it's fully implemented in the first half of 2019, it will fabricate parts for all of NFI companies. I was in Shepherdsville last week and it's a very impressive facility and I'm really excited what this $30 million investment will bring to our company. Additionally, our $25 million investment to expand the Anniston, Alabama production and innovation campus is advancing on schedule. Once complete in the fourth quarter of this year, Anniston will have increased part fabrication capability and repatriated its weld process, moving it from an offsite leased building. IT harmonization continues to be a key area of focus with 2 significant projects in progress, one at MCI and the other in the parts business, both of which are on budget and on schedule. Once complete, these new IT platforms will enable us to better implement just in time inventory, control costs and provide enhanced customer delivery performance. I'd also like to mention that we've now successfully transferred the production and the team members from one of our fiberglass businesses in Winnipeg and eliminated a second leased building. ARBOC, the low floor cutaway and specialty vehicle business that we were able to acquire in December of last year, is proving to be very exciting and has lots of potential. Our operations and engineering teams have worked closely with ARBOC to improve plant layout, production flow and identify opportunities for insourcing. New Flyer President Wayne Joseph and I attended the ARBOC dealer meetings a few weeks ago which was a great opportunity to learn more about their products, the market segments and their sales processes. Last quarter I told you about the launch of our NFI parts brand to the integrated aftermarket parts business. The team successfully completed the transfer of inventory from the Hebron, Kentucky warehouse to the parts distribution center in Louisville Kentucky, which allowed us to eliminate yet another leased facility. At NFI, we're focused on the future of mobility and transportation. In the fourth quarter of last year, we launched the Vehicle Innovation Center, or what we refer to as the VIC, as an industry-wide leading and collaboration lab and training center to help advance the future of buses. During the second quarter we hosted numerous industry players at the VIC where they experienced our development lab, virtual learning spaces, driving simulators and other interactive exhibits. And finally, during the second quarter, sensing that NFI shares were trading in a range that did not reflect their full value, we decided to launch our first normal course issuer bid or NCIB. Full details are disclosed in the press release and the MD&A, but I wanted to point out that we had already purchased 283,800 shares for about $10.7 million at an average price of $49.07 a share. Glenn will now take you through the financial highlights of our second quarter 2018 and our year-to-date performance, and following that, I'll provide some insight into our outlook and then we'll open up to your questions. Over to you, Glenn.

[Glenn Asham, Executive VP of Finance, CFO & Treasurer]

Thank you, Paul, and good morning, everyone. I'll be highlighting certain 2018 second quarter results and provide comparisons to the same period in 2017. My commentary will focus on key financial insights. I would like to direct you to the company's full 2018 second quarter financial statements and management's discussion and analysis of those financial statements, which are both available on SEDAR or the company's website. I do want to remind you that our interim unaudited 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. Please note that 2 organizational changes have been made to better align business functions within operating segments. These changes were implemented in 2 phases. First, in 2017, over-the-counter parts and our service centers were moved from manufacturing operations to aftermarket operations. Then in 2018, the inside service functions, comprised of technical service management and customer training, which was previously managed by the MCI aftermarket operations, was moved to the manufacturing operations. To improve the comparability between periods, the related 2017 segment information has been restated to reflect these changes. The company generated consolidated revenue of $673 million for the second quarter of 2018, an increase of 9.7% compared to the second quarter of 2017. Revenue from manufacturing operations increased 10.6% for the second quarter 2018 compared to the same period in 2017. The increase in 2018 manufacturing revenue was primarily from a 17% increase in new transit bus, coach and cutaway deliveries compared to last year, as well as the inclusion of revenue to third parties for fiberglass components. Volume increased for the second quarter compared to 2017 Q2 as a result of higher transit bus and motor coach deliveries and the inclusion of ARBOC cutaway deliveries. Average selling price decreased in the quarter as result of normal volatility in the transit bus and motor coach sales mix and from the inclusion of ARBOC's units which have a substantially lower average selling price. Revenue from aftermarket operations increased 4.8% primarily as a result of sales mix. Total adjusted EBITDA for 2018's Q2 was $91.4 million, which represents an increase of 7.4% compared to the corresponding period in 2017. Manufacturing operations adjusted EBITDA increased 11.9%, primarily as a result of increased deliveries, improved margins and the inclusion of ARBOC's operations. Contributors to the increase in margin included a favorable sales mix and continued cost reductions achieved through the company's OpEx initiatives. Aftermarket operations adjusted EBITDA decreased 6.8% due to sales mix and the costs involved in consolidating the New Flyer and MCI parts business. Net earnings increased by 16.1% and earnings per share of $0.81 increased by 17.4% primarily as a result of increased earnings from operations and a decrease in income tax expense as a result of US tax reform. As you will have noted in our press release and MD&A, we have now adopted an adjusted net earnings and adjusted earnings per share calculation to provide a measure of the company's performance that is aligned with our calculation of adjusted EBITDA. Adjusted net earnings during the second quarter of 2018 increased by 21.1% compared to the same quarter in 2017, and adjusted earnings per share was up 22.1%. The liquidity position of $210.6 million as of July 1, 2018, increased from the liquidity position of $204.1 million at April 1, 2018. The increase in liquidity primarily relates to improved cash flows from operations offset by cash used to acquire property, plant and equipment, plus capital returned to shareholders through dividends and the repurchase of shares under the NCIB. The company generated free cash flow of CAD 63 million during the second quarter 2018, an increase of 19.1% compared to 2017 Q2 primarily as a result of increased adjusted EBITDA. The company declared dividends of CAD 23.6 million in the second quarter 2018, which is an increase of 15.7% from 2017 Q2 and represents a payout ratio of 37.5%. Property, plant and equipment cash expenditures for the second quarter 2018 increased by $9.7 million compared to the second quarter of 2017, primarily as a result of investments in facilities, the new Shepherdsville facility, and as a result of in-sourcing and continuous improvement programs. We believe that return on invested capital, or ROIC, is an important metric that can be used to assess investments against the related earnings and capital utilization. ROIC during the last 12 months ended July 1, 2018, was 15.5% compared to 14.9% during the 12-month period ended July 2, 2017. With that, I'll turn it back to Paul.

[Paul Soubry, President, CEO & Non]

Thanks, Glenn. In our last call, last quarter, we explained how confident we are with our strategy, our execution and our business model. And this continues to be true. NFI is the market share leader in heavy duty transit, motor coach and low floor cutaways. And while we have a leading market position, that doesn't mean we're standing still. We're focused the future of our business and what's next, not only in bus manufacturing and the parts business, but the future of mobility in those solutions needed to move groups of people safely, efficiency, responsibly and in style. We remain focused on manufacturing quality products and delivering to our customers, driving profitability, generating shareholder returns and executing on operational excellence initiatives. And while market share growth in our core market is important, we're not interested in chasing volume for its own sake. Sustainable performance, profitable returns, strong cash flow, and customer satisfaction will guide our bidding and procurement approach. We're pleased with our backlog position and we see positive signs for continued growth in the future. We expect continued robust bus procurements in the public transit agencies through North America. Supporting this expectation is multiyear US federal funding, healthy overall economic conditions, expected customer fleet replacement plans, and active or anticipated procurement programs. As for the private motor coach market, we anticipate stable demand. While some legacy fixed route or linehaul operators have experienced headwinds from reduced demand and increased competition, MCI remains well positioned to deliver motor coaches across multiple market segments. Increased demand for employee shuttles inside and outside of the San Francisco Bay Area, transit authority demand, limos and tour and charter operators are all areas of opportunity for MCI. MCI continues to enhance and expand its product portfolio with its revolutionary D45 CRT LE coach that features unsurpassed accessibility, the new smaller and agile 35-foot J3500 coach, and MCI's efforts on electric propulsion coach. Production tooling and capability to support the manufacture of new MCI models is being installed, with deliveries of the D45 CRT and the J-3500 expected to begin in early 2019. New Flyer's award-winning heavy-duty transit bus platform, the Xcelsior, which offers the broadest variety of propulsion systems in the market, continues to be procured by transit authorities across North America. One area of growing focus is our 0-emission buses, or ZEBs, branded the Xcelsior Charge. And that's offered in a trolley, a battery and a fuel cell configuration. While the current North American installed base includes just about 1% of ZEBs, or approximately 800 or 900 buses, the demand for ZEBs is expected to grow over time. In 2017, New Flyer won 46% of all ZEB awards and ZEBs currently make up about 4% or approximately 468 units of our total backlog. I do want to caution, or add caution, that adoption rates of ZEBs is not only about the technology of the bus and the propulsion system, but it's also significantly governed by the funding available and strategy for charging infrastructure. As the population ages and ease of access becomes more of a focus, we also believe demand for low floor cutaway and medium-duty buses with greater accessibility will grow from its current level of approximately 5% to the total cutaway market. This anticipated market trend is one of the reasons we wanted to acquire ARBOC and their patented ramp offerings which offers a better customer experience compared to high floor buses using lifts. ARBOC has now completed its Altoona testing of its medium-duty shuttle bus titled the Spirit of Equess. The market response has been encouraging from smaller transit authorities, airports, shuttles and universities. Equess is designed in the United States, sourced in the United States and built in the United States. Deliveries will start in the fourth quarter of 2018. With a solid master production schedule, combined with current backlog and orders anticipated to be awarded under new procurements, we again reaffirm our expected deliveries for fiscal 2018 of approximately 4,350 equivalent units. Production rates and deliveries vary by quarter due to product mix, award timing and customer acceptance processes. We also reaffirmed our expected PPE expenditures for fiscal 2018 to be in the range of $63 million to $73 million US. Although our aftermarket volume and margins remain difficult to forecast, we expect that market to remain relatively stable for the remainder of fiscal 2018. The parts team is focused on harmonizing the New Flyer and MCI parts systems, or part IT systems, which is expected to be complete in the second half of this year. There's been considerable interest and discussion about the impact that rising commodity prices and US tariffs and Canadian surtaxes will have on our business. While we use aluminum, carbon steel, and stainless steel in the manufacture of buses and coaches, these raw materials before processing comprise less than 3% of our total material costs. We currently anticipate an immaterial impact for the remainder of this year from market increases in aluminum steel pricing as our major components are purchased under fixed price or contract-specific quotations. We also expect future component cost increases should be substantially recoverable through new contract pricing or through producer price index of PPI mechanisms in multiyear contracts. We also anticipate a significant impact on results -- we also DON'T anticipate a significant impact on results from US tariffs and Canadian surtaxes. In June, 2018, the US government imposed tariffs on Canadian steel and the Canadian government responded with certain surtaxes on US steel in July. The majority of aluminum and steel used at the company's manufacturing facilities is from US sources, largely in support of our Buy America requirements for US public customers. Canadian surtaxes on the importation of US aluminum and steel used in the manufacturing of our products at our Canadian plants that are then re-exported to the United States are eligible for recovery under the Canadian federal duty relief and duty drawback programs. Now, we are consistently asked about what we're going to acquire next and thankfully the underlying strength of our core business provides us with the ability to investigate M&A for additional growth and diversification. We've looked at several opportunities, both domestic and international. But as we have in the past, any investment or acquisition will be strategic, prudent, measured and appropriate. Now before we open the call for questions, I want to formally announce that after 10 years with New Flyer and more than 40 years as an executive in the bus and heavy equipment industries, New Flyer's President, Wayne Joseph, has announced his retirement effective January 1 of 2019. Many of you know Wayne actively led the transformation of New Flyer with a company-wide lean implementation. He grew the business with successful Xcelsior model launches and followed by leading the integration of NABI and ARBOC and the launch of the vehicle innovation center. I'm excited to announce that Chris Stoddart, New Flyer's Senior Vice President of Engineering and Customer Service, has been selected to succeed Wayne as the business unit president. Chris joined our team in 2007 after 9 years at National Steel Car as the VP of Engineering Services, and numerous leadership roles over 10 years in production supervision and process engineering at General Motors. The impact Wayne has had on New Flyer is nothing short of remarkable. Wayne's continuous pursuit of excellence and commitment to lean operations has fundamentally changed the way we do business. We're very fortunate to have someone like Chris, his background, skills and expertise to assume the role at the start of next year. Chris has personally driven the product electrification, autonomous drive and telematics roadmap for our company and now has the opportunity to make it all come true. Wayne will work closely with Chris over the next 5 months and then remain connected with NFI Group in an advisory capacity to support growth and operational excellence initiatives. We're truly grateful. So I'd like thank you for listening to our call today. NFI is well positioned to continue as North America's leading provider of buses, motor coaches, cutaway buses and parts. We're proud of our history, we're excited about our future. With that, we'll invite your questions. Can you please provide the instructions to our callers?

[Operator]

[Operator Instructions] Your first question is from the line of Chris Murray with AltaCorp Capital.

[Christopher Allan Murray]

Good quarter on margins in the manufacturing side. So I guess a couple of questions to go with this. I mean first of all, anything unusual in terms of mix this quarter that may have skewed them up a little bit? And I guess the second part of that, can you talk a little bit about how you are continuing to see the margins at ARBOC evolve as you drive up some additional volume?

[Paul Soubry, President, CEO & Non]

Thanks, Chris. First, as you know from our Investor deck, one of the key slides that we continue to put in is the adjusted EBITDA per EU on a quarterly basis. And it's always volatile. Last quarter we had a mix that was detrimental to the average and this quarter we had a mix that was right in line with the average, or the LTM type average. I wouldn't suggest that there's anything abnormal inside there. We still are building a good balance of US and Canadian customers. There's a good mix of different types of propulsion systems in there. But I wouldn't highlight anything that made it abnormal in this quarter. As far as the ARBOC business, and as you know, it's really an interesting one where the cutaway businesses, in fact the customer asks the dealer to buy the chassis. The chassis is then delivered to ARBOC. We then put the body on it. So our invoice is just the body portion of that bus. What Wayne and Don Roberts now, the President of ARBOC, are working on is a strategy of what things that New Flyer might be able to help from a fabrication perspective. And so we think there's some opportunities to insource. In fact, there's a few parts we've already insourced. So there's two issues I guess, or three, that will drive margin on ARBOC going forward. One is the volume and pricing in the market on a day to day basis, and so we think we are really competitive at ARBOC. Two is the efficiency of the factory and the production facility. Wayne's team, as I said in my notes, has gone in there and assisted Don at looking at the flow and the layout of the facility which gives us labor efficiency and cost of quality and those kinds of things. And then the third element is where we're just now starting to look at what parts or elements of the bus that we might be able to fabricate. The other dynamic that will affect ARBOC's performance going forward is going to be the introduction of this Equess. Because in the Equess case, we make the chassis and we make the bus. It's not like we just make the body. And so the average sale price will be higher and the average EBITDA per unit will be higher. We're starting to deliver those in the fourth quarter of this year. It won't be material for 2018, but we'll start to see good volumes we think in 2019.

[Christopher Allan Murray]

Okay, that's helpful. One of the other things that was in your Investor deck, and I didn't hear you talk about it yet, but it was kind of also tied maybe to ARBOC, maybe not, was something about TCB and perhaps looking at reallocating resources from there. Kind of curious about what that means in terms of supply chain and does this have anything related to creating additional capacity for ARBOC? Because just geographically, they're fairly tightly -- well they're basically about 20 minutes apart in that area of the world. So any thoughts around what you're doing there would be great.

[Paul Soubry, President, CEO & Non]

TCB was a small fabrication facility largely around stanches and lighting and a few components that we acquired back in 2010. And as you'll remember, that was the first acquisition we do so a great learning opportunity. TCB is in a very interesting part, Elkhart, Indiana, very labor-intensive area with lots of fabrication and RV and bus manufacturing and so forth. When we did the analysis of really making a step change into our own fabrication facility that ended up being in Shepherdsville, Kentucky, we are now in the process of assessing what capability we might leave in ARBOC inside Elkhart, Indiana and what will migrate to this much larger, much more sophisticated fabrication capability. The distance isn't really an issue because most of what, or all of what TCB makes goes either to Aniston, Alabama, St. Cloud, Minnesota or Winnipeg, Manitoba. So that kind of thing isn't an issue. It's all part of the master fabrication strategy on those core commodities that we're going to put into Shepherdsville.

[Christopher Allan Murray]

Okay, great. I guess one follow-up question for me, you talked about tariff impacts on your sales, but one of the other things, it looks like some of the discussions between I guess US and China, is that it looked like they are imposing duties on Chinese made buses. Just wondering, you've got a couple of competitors that are Chinese based, some of them do have US domestic operations. Just wondering if you're seeing any either feedback in the market or any thoughts around how those tariffs could impact some of the market dynamics over the next year or two.

[Paul Soubry, President, CEO & Non]

I would say, Chris, that that's kind of new news and early in terms of the customers' response. We do have one competitor that is principally a Chinese company that has set up shop in the United States. And so we're trying to monitor how that affects where we bid and how we bid and the competitive dynamics. But they are a relatively small player today. The number of buses delivered is relatively small, the number of competitions we see them in is relatively small. It's too early to say how that's going to impact. And in fact, that competitor only makes battery electric buses, so it's a very, very small portion of the market. If the US government proceeds with that and however it works and is that an impact? I would say it would be a mildly positive impact to our business. We remain focused on that Xcelsior platform with all the propulsion variations and a really, really positive and strong evolution of our zero emission and then our fuel cell offering that is now taking some real positive response from the customers. It's not going to change what we do and I don't think it's going to change our share or any of those things. It's really just a noise in the marketplace at this point.

[Operator]

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

[Cameron Doerksen, Analyst]

So just a question on I guess the ARBOC deliveries for the full year. You haven't changed the guidance there for the full year deliveries. But if we look at what you've done in the first half of the year, it would sort of imply a decline in the second half. And I know this was brought up on the last conference call, but I'm just wondering if there is any reason why we should think that the ARBOC deliveries would actually be lower in the second half. And if that's the case, why would that be the case?

[Paul Soubry, President, CEO & Non]

Well look, we're whatever it is, 6 or 7 months, or 8 months now into ARBOC. We're starting to learn about any dynamics it may have from a seasonality perspective just like New Flyer and to some extent MCI. ARBOC builds buses based on customer orders, so we know the schedule for a period of time going out. We know exactly which customers we're building for. We don't build for stock. In the ARBOC case, it's a little bit different because we build not based on the ultimate end customers' demand, we build based on purchase orders coming from the dealers. So we've left our guidance exactly where we put it based on what we know is in the schedule and what we think we're going to sell, and we're confident that that's what we'll be able to deliver for the full year. There could be delivery timing quarter by quarter just like the dynamics we see in the motor coach or the New Flyer world. The other thing that's very different now right now with ARBOC is learning the variation in margin. If we sell a small cutaway versus a large cutaway versus one of these upcoming Equesses, we're going to have a very different EBITDA per margin. So I'm not sure we're being too conservative, I think we're being prudent in our current forecast. And if there's an opportunity to over perform, we'll absolutely try and do that.

[Cameron Doerksen, Analyst]

Okay, maybe just second question for me. Just on I guess sort of the mechanics of some of the tariff impact. I guess specifically on the Canadian surtaxes on imports into Canada that are exported back by you guys, I'm just wondering how that works. I mean there's a recovery program I guess here in place. I mean do you recover the cost or the cash impact immediately or is there some sort of delay with that?

[Paul Soubry, President, CEO & Non]

Remember that it's not New Flyer or MCI that actually imports the steel. It comes from the mills to processors. We have a freight forwarder if you will or a handler in the middle that brings this up. So it's not as simple as us just making an application for duty relief or duty drawback. It's a fairly complicated process. But we're not going to be out cash, if you will, waiting to try and draw back duties. That will be worked through ourselves with the chain.

[Operator]

Your next question is from the line of Kevin Chiang with CIBC.

[Kevin Chiang]

Maybe just following up on some of the ARBOC discussions, on the back of the dealer meetings you mentioned in your prepared remarks, just wondering if you have a better sense of what the ultimate growth opportunities are for ARBOC. It seems like there's still significant opportunities to kind of build on the 500 units you've guided to this year, especially with the introduction of the medium-sized bus. Is there a better sense of what this could be over a multiyear time horizon?

[Paul Soubry, President, CEO & Non]

Well again, I'm not trying to make excuses, but we're early, we're learning, we don't want to push ARBOC too fast. There's as much about promising volume and having to deliver. It's a business that has grown quite dramatically. I mean 300 and something units last year, a 40% growth this year, there's upside in the next couple of years we see on that. We're quite excited about it. And as we've talked about in the past, we really like ARBOC's approach to the low floor cutaway approach. Many of our investors won't understand that, but we're actually a pretty significant modification to the chassis to accommodate the ramp to allow the mobility of the handicapped, the senior citizens to get onto those buses, on and off faster and all those kinds of things. And there's a segment of the market that really likes that. The problem that we have or the dynamic we have is that those buses cost more and therefore are sold for a higher price than low floors. And what Wayne and Don Roberts are doing is really trying to go after the cost base and the efficiency to allow us to grow volume and margin at the same time. So we're quite encouraged. The other part of that is this medium duty class, Kevin, that we've always said we don't think to be a massive, massive segment, but is a niche. Smaller transit agencies, universities, shuttles and so forth. And we think the offering of the Spirit of Equess, the price point, again, I walked through the bus with a bunch of customers 2 weeks ago, the price point, the life of the bus, the maintenance profile and so forth seems to be very, very attractive. So we're not going to get too ahead of ourselves, but we're quite encouraged about ARBOC's opportunity.

[Kevin Chiang]

That's helpful. And then just on MCI and your outlook for the private bus market, you're calling for that to be stable. You're obviously investing in some new products there, you've seen a nice pickup in your market share since you've taken ownership of that. I'm trying to get a sense of do you see your delivery rates through a stable market basically in and around what you're doing now? Or do you see an opportunity to continue to take market share here? I know the high-water mark for MCI is significantly above what you're doing now, but trying to get a sense, do you think there's still market share opportunities for MCI? Or is this effectively moving with the market overall now?

[Paul Soubry, President, CEO & Non]

That's a really good question. And just a little bit of color. I'd guide you to have a look at our updated Investor deck that Steve's been working on here. What we did this time is we've actually broken down for the last 20 years the subsegments of motor coach. Transit, while there's different size customers, it's a much more homogeneous type operator. Public transit agencies buy buses to move people through inner cities. The motor coach market, and in our Investor deck as I said, we've broken out into the various subsegments. The public transit portion of motor coach can be volatile based on some of the larger agencies, like New Jersey or New York, buying buses and then buying them in waves over time. The linehaul fixed operators, which is about 29% of the installed fleet, has had some headwinds. We've all read about Greyhound or First Group and others having some challenges in those legacy linehaul operators. But the tour and charter operator over the last number of years has been fairly healthy. And what's happening is now you're starting to see new types of operators, almost seat aggregators, that are selling seats and then buying capacity to move people, not from the linehaul guys, but from the tour and charter operator guys. And that's where we've been fairly strong and that's where Ian Smart and his team did a lot of work on the products, the size of the coaches, the styling, the Model 18 and now 19 features have really helped sell. There's 2 other segments that have kind of taken on a bit of a new flavor. One is the limo type operators that have moved up from cars to kind of larger cutaways now into these motor coaches. And then the last one, which has been massive growth, albeit relatively small in the grand scheme of things, is the employee shuttle segments. Now I give you the longwinded answer only to say that motor coach is not homogenous and so we've got a strategy for each of those individual segments. We're excited about the work that's being done at MCI and as you saw, Kevin, when you walked through the factory, we have this dynamic of trying to synchronize two production lines into one which doesn't happen overnight. We're harmonizing the IT system with New Flyer to allow for efficiency of data information and layout, and so forth. So we know that there's going to be turbulence up and down if you will, there's opportunity as well as challenges in some of those subsegments. But we're pretty comfortable with where MCI is headed over the next little while. I don't see us having massive, massive market share increases, nor do I see us losing market share. It's really about getting through this window of harmonizing the production lines, then there we get an opportunity for cost reduction and therefore improve our competitiveness in the long term.

[Kevin Chiang]

That's very helpful. And just last one for me, more of a housekeeping, I noticed your effective tax rate this quarter was just a tad under 25%. Just trying to get a sense if kind of that high 20% is still a good run rate moving forward? And are there opportunities to lower that tax rate through the right type of tax planning here in the subsequent years?

[Glenn Asham, Executive VP of Finance, CFO & Treasurer]

Just a quick comment on both of those, on that question. So I guess first of all, lower this quarter, I mean we're learning more as we dig into tax reform and get some guidance from that. So I think our conclusion was we were a little bit conservative on some of the asset write-offs in terms of foreign tax credits that we rolled off in Q1. So we saw some recovery there. Our guidance for this year would remain in that 29% to 31% range. Always opportunities for tax planning. We are looking to see what opportunities there are, and actually investigating some, but nothing that has been implemented yet.

[Operator]

Your next question is from the line of Jonathan Lamers with BMO Capital Markets.

[Jonathan Lamers, Analyst]

Just following up on the Equess, what are the selling prices for those units? And for the sales process, is it the same where you're recording revenue for just the body and not the chassis?

[Paul Soubry, President, CEO & Non]

The selling price is based on competitive bids to some extent. It will depend on the features, but the average selling price will range around $250,000, $260,000, maybe up to close to $300,000 US per unit. And the second part of your question again please? The chassis is embedded in that.

[Jonathan Lamers, Analyst]

Just on the sales process, right, so the sales prices do include the chassis?

[Paul Soubry, President, CEO & Non]

Correct.

[Jonathan Lamers, Analyst]

And do you take a margin though on the chassis?

[Paul Soubry, President, CEO & Non]

Well the margin is effectively embedded as the sale of a whole bus. No different than we do on New Flyer and MCI. The way it works, Jonathan, is that we design the chassis, we source the components, the steel components. We assemble the chassis, we dress the chassis, we put the engine on and so forth. Unlike a cutaway where this literally drivable chassis shows up and then we do surgery on the chassis. But that, in the cutaway world, that thing never runs through our P&L.

[Jonathan Lamers, Analyst]

Okay, so are you able to tell us whether the EBITDA per unit for those would be higher than the existing cutaways?

[Paul Soubry, President, CEO & Non]

The EBITDA dollars will definitely be higher. And I guess the margin, we're not yet sure. Depending, again we haven't delivered any production units. We're starting to ramp up production in the fourth quarter, so we'll be able to give you more color in the future about the margin percentage.

[Jonathan Lamers, Analyst]

Okay, thank you. And the new 35-foot J Coach, have you started to receive any customer orders yet that would give you a sense of how many units that could represent? Or is it too early?

[Paul Soubry, President, CEO & Non]

So that bus is currently -- we modified the production lines. We have buses that have gone through testing, we're demoing them. We actually have 4 orders in hand for the buses that will be delivered late end of this year, likely first quarter of next year.

[Jonathan Lamers, Analyst]

And can you give us any sense yet of how big the market could be for those 35-foot J Coaches and what kind of share you might be able to go after?

[Paul Soubry, President, CEO & Non]

I think it's premature to give you too much detail or too much focus on that. Remember that the traditional operators in North America operated 45-foot coaches. A number of years ago, a Turkish company showed up with a 35-foot coach and it appealed to a portion of that segment. The total market is call it 2,500 units and we think the 35-foot segment might be up to 10% of that opportunity.

[Jonathan Lamers, Analyst]

Sorry, the total market might be 2,500 units?

[Paul Soubry, President, CEO & Non]

The total market of motor coaches is 2,500 today. You'll see that in our materials. The go forward opportunity for 35-footers could be about 10% of that or 200 to 250 units.

[Jonathan Lamers, Analyst]

How will your price point when you go to market compare to the Turkish coaches?

[Paul Soubry, President, CEO & Non]

Well obviously we're selling at MCI, we're selling a product that's built and designed in America, that's really focused on continuing the family legacy of the 45-foot. And it is likely, well it's not likely, it is, our 35-foot coach will be more expensive than the Turkish unit.

[Jonathan Lamers, Analyst]

Thanks. And just circling back on the new D model coach that I believe went into production this quarter, like are you now running the D, the new D on the new line? And can you give us any estimate for the incremental costs of running the 2 lines in parallel?

[Paul Soubry, President, CEO & Non]

Well the 2 lines run in parallel today. We have a J line which the new D will go on, and we have a legacy D line that in the next 3 or 4 years, depending on the contracts, will be discontinued. So they'll ultimately end up on one line. The incremental cost is really the capital we spent over the last number of quarters to invest in making the current J line capable of building the new D on the same fixtures and processes. But from an operating cost perspective, it's a nonmaterial cost differential. But unfortunately, while you build 2 lines, you kind of have sub-optimized overhead.

[Jonathan Lamers, Analyst]

Right, okay. And on the Alabama upgrades that will take effect in Q4, will there be significant cost savings from operating expense savings from that? And how much do you think you can increase the line rate as a result of the efficiency improvements you're realizing there?

[Paul Soubry, President, CEO & Non]

As you know from seeing the place when you joined us earlier this year, the strategy in Alabama was a couple of things. A, the weld facility is down the street in a tired, old facility. So we're welding processes, putting shelves together in a fairly suboptimum environment, we're shipping or dragging the thing down the street, inducting it into a facility. So the biggest part of the Anniston physical change is the expansion of a building to actually do now state of the art welding, build a frame of a bus, and induct it right into the production process. That has nothing to do with volume, it has to do with the efficiency of that and leasing a facility and so forth. The second part of Aniston was the addition of fabrication capability. So certain tubes, pieces of steel, brackets and so forth that we're actually fabricating locally to be able to put right into the weld process immediately. At this point in time, we have increased the capacity of the Anniston facility from something like when we acquired NABI, around roughly 11 or 12 buses a week to now roughly 15 buses a week. But right now, we have no plans to expand that beyond that from a capacity. It's really around the efficiency of the existing facility and the cash payback based on the investments in the weld facility and the parts fabrication.

[Jonathan Lamers, Analyst]

Okay, one last question if I may. The US tariffs on China have been topical recently. I understand that that won't be material for your business because of the Buy America requirements, but do you have any estimate for the small amount of annual purchases New Flyer or its primary suppliers might be making from China?

[Paul Soubry, President, CEO & Non]

Currently we have a build schedule in all of our businesses for the next little while. We have quotes of the material, the components and so forth that we embed inside our products. We're not at a point here where we can say we've got X or Y price increase or cost increase associated with any of those components. We just guided in our materials here that we do not see a material impact on our business for 2018.

[Operator]

[Operator Instructions]. Your next question is from Stephen Harris with GMP Securities.

[Stephen C.A. Harris, Head of Research]

Just 2 quick questions. Some of the others have been already covered. On the working capital side, it looks like there was quite a difference in working capital consumption this year versus last year in the quarter. And that was one of the things that contributed to the strong free cash flow performance. Was there anything going on behind that that you freed up more working capital whereas last year you consumed quite a lot? Anything we can read into that?

[Glenn Asham, Executive VP of Finance, CFO & Treasurer]

Working capital is always fairly volatile in our business and it's really contract specific on the transit side. I would say the one issue that has freed up some working capital is we have had a number of contracts with some very large retainages. Those retainages have come down this year relative to last year, so that has added some. Over and above those retainages, our collections have been very strong and we haven't seen any production issues which tend to be the cause of our delay in cashes. So as long as the buses are coming offline and are acceptable to the customer and obviously our quality has continued to improve over time, the cash there comes back very quickly. And I guess maybe the last part of it is on the transit side we saw very significant orders right at the end of the quarter, or sorry, deliveries right at the end of the quarter on the private side. A lot of that is cash on delivery, so we saw a very rapid shift between inventory and cash as a result. So those would be some of the factors that would contribute to it.

[Stephen C.A. Harris, Head of Research]

Okay, so normal course of business for the most part?

[Paul Soubry, President, CEO & Non]

Yeah, there's nothing, Stephen, there's nothing abnormal other than what Glenn said where the motor coach guys delivered a bunch in the last week or two which converted again with if you will the cash immediately. But that's must the normal ebbs and flows of our business. And as Glenn said, the dynamic of retainage where you have transit agencies that over the last number of years used to be in kind of a milestone payment world, now we are in a pay after you deliver plus some kind of retainage. That's just a factor of our business. Some will pay faster, some will pay slower, but it's not really anything structurally different.

[Stephen C.A. Harris, Head of Research]

Great, thank you. I just thought I would revisit the competitive environment on the transit side. We talked about that a bit on the last call and it seemed like in general the environment was strong, but you had one of your major competitors every now and again behaving somewhat erratically. Have you seen any change in that behavior? Is it continuing about the same pace? Is it getting better or getting worse?

[Paul Soubry, President, CEO & Non]

Well look, there's 3 main competitors. There's New Flyer and our friends at Gillig and our friends at Nova. Nova and us, for the most part, are head to head in almost every competition. Every once in a while, we see what we deem to be kind of irrational pricing, not really sure we understand that. Having said that, when we look at every competition, we look at our current order book firm and what we're building for the next window of time. We look at our backlog and how far out that works. We look at the capacity and the stability of supply chain and so forth. And so I wouldn't say there's anything materially different this quarter than there was last quarter. There are times when we see some pretty aggressive pricing, but as I said in kind of our opening remarks, we're laser focused on continuity of our business, profitability and cash flow. And based on the number of competitions we see and based on our core customers and where we're focused, we're pretty comfortable in the next period of time of our schedule and being able to continue to grow our backlog. So the market is kind of it is what it is.

[Operator]

Your next question is from the line of Daryl Young with TD Securities.

[Daryl Young, Mining Research Associate]

Just one quick question for me. On the high floor cutaways that have a lift, and this is with respect to ARBOC, what do you guys see as the biggest factor required to dislodge the existing high floor cutaways and replace them with the low floor ARBOC product?

[Paul Soubry, President, CEO & Non]

Well I think there's 2 issues. One is, as I said before, us getting more and more focused on the cost of the low floor cutaways. And whether it's the efficiency at the factory, the sourcing, the first-time quality, all those kinds of things. The other dynamic is that what we quite like now is that ARBOC has behind it New Flyer and NFI Group from a credibility, sustainability, financial viability, the ability to invest in new products and so forth. And so it's not going to be a light switch overnight in terms of the whole market converting from high floor to low floor, but as we travel around and saw you see the dynamics, I don't know if you've ever seen it, but watching somebody get onto a bus with a mechanical lift and the disruption to service, the impact on the other people on or waiting to get on the bus, weather dynamics and so forth, we really think this low floor approach is compelling. And so it's as much about us continuing to invest in ARBOC to grow capacity at a measured, calculated pace and then being able to again bring the costs down and add credibility to their sales process. As I mentioned in my notes, Wayne and I went to the dealer meeting and to watch the dealers, their confidence in ARBOC, not that it wasn't that good before, but their confidence now that what we bring to the table. And as we move for example into electrification of those types of platforms and so forth, we added a whole bunch of credibility, speed, expertise and so forth to that ARBOC business. So really, again, we're really excited about our ability to grow that business. But it isn't going to go from 350 last year to 500 this year to 2,000 units tomorrow. It's going to be very measured growth and very much focused on happy customers and profitable business.

[Operator]

Your next question is from Julian Hutchinson with CIBC Wood Gundy.

[Julien Hutchinson]

Just two general questions. One, there seemed to be some articles in the press about intra urban transit declining because of the intensification of cities, i.e., people live right next to their work, example Toronto or Calvary in Canada. And the second is of course in the New York Times this weekend, the dire state of our planet because of carbon dioxide, etc. I would think that your environmentally friendly buses would get a major wind behind your back because of that. So one is adverse and one is positive. They are very general but I'd like you to comment on them.

[Paul Soubry, President, CEO & Non]

Well I think you are absolutely dead-on on some of the issues, the macro issues that impact our space. So the first one, the whole concept of intra city and moving people around. And yes, we're seeing bigger cities, we're seeing congested cities. There are some areas where you see a decline in ridership. Overall, it's true that bus ridership on a macro level is slightly down. But when you drill down into some of the subsegments, an area that we're very strong, things like rapid transit or bus BRT type routes and so forth, that ridership is actually up quite dramatically. And so we're seeing cities in our own case in Winnipeg for example with dedicated roadways, lane signaling and so forth to try and make people move faster through that city. Our view, based on the demand that we have from our customers of what they think they're going to buy in the next 5 years for example, continues to be very, very robust. There will be different changes in different cities. But overall, we don't see a decline. The other real reality is, city transit is an essential service. So whether you have 50 people on the bus or 48 people on the bus, that bus is still operating on its route. So it's not like an airline that will switch routes and capacity and pricing overnight. The essential cities, and public transit is much slower to respond, which is why we've decided to get into motor coaches, we've decided to get into the smaller cutaway buses to diversify and try and grow our business. The second question or the second comment about our planet and the environment and so forth, I think you're absolutely dead right. I really think what Wayne and Chris and the crew have done on New Flyer in terms of taking exactly the same bus platform, this Xcelsior, and continuing to evolve our propulsion offerings. So whether it's a clean diesel or a hybrid or an electric trolley or a natural gas or an all battery electric or now fuel cells, we're going to see over time migration to those much more environmentally friendly propulsion systems. And the math is starting to be very, very compelling. The challenge will be the pace of adoption. And it's not just the bus that's the issue, it's the charging infrastructure. So one of the things, once we get legitimate standards across North America and so forth, is going to be the pace at which municipalities, states, provinces, the federal government can afford to put in the charging infrastructure, and that's not trivial. But I think our approach to be able to offer all of those kind of clean propulsions on the same platform has allowed us to continue to grow our business and our profitability.

[Operator]

There are no further questions on the phone at this time. I now turn the call back over to the presenters.

[Paul Soubry, President, CEO & Non]

Thanks, everyone. Now we'll wrap up the call as we have no further questions. I just wanted to remind everyone that there is a new Investor presentation on our website, so we mentioned that a few times throughout, hopefully you can check that out. And as well for ARBOC, I'd welcome everybody to check out their website. They have a great video that shows the difference between a high floor bus and a low floor bus. Thanks for listening and we look forward to speaking with you again soon.

[Operator]

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