Wajax Corp

TSX:WJX

Earnings Call Transcript 2017-Q4

[Operator]

Thank you for attending Wajax Corporation's 2017 Fourth Quarter and Year-end Financial Results Webcast. On today's webcast will be Mark Foote, Wajax's President and Chief Executive Officer; Mr. Darren Yaworsky, Senior Vice President, Finance and Chief Financial Officer; and Mr. Trevor Carson, Vice President, Financial Planning and Risk Management. Please be advised that this webcast is being recorded. Please note that this webcast contains forward-looking statements. Actual future results may differ from expected results. I will now turn the call over to Trevor Carson.

[Trevor Carson]

Thank you, operator. Good afternoon, everyone, and thank you for participating in our fourth quarter results call. This afternoon, we will be following a webcast, which includes a summary presentation of Wajax's Q4 2017 financial results. The presentation can be found on our website under Investor Relations, Events and Presentations, Webcasts. Additionally, we will be making reference to our 2018 strategic update presentation that can also be found under the Events and Presentations section of our website.To begin, I would like to draw your attention to our cautionary statement regarding forward-looking information on Slide 2. Additionally, non-GAAP and additional GAAP measures are summarized on Slides 14 through 16 for your reference.Please turn to Slide 3, and at this point, I will turn the call over to Mark.

[A. Mark Foote, President, CEO & Director]

Thank you, Trevor. I'm looking at Slide 3 and there's some high-level numbers on our business for the fourth quarter. Revenue was a pretty positive story at plus 20% on a year-over-year basis at approximately $377 million. Saw a corresponding increase in the EBIT to $18.4 million, a 21% gain year-over-year, and that translated into an adjusted basic EPS number up 24% at $0.56 a share. Our TRIF number, while it was quite positive for the year at 1.45, we did have a slightly higher TRIF in the fourth quarter year-over-year at 1.9. That was unfortunately 2 additional injuries in our business versus the prior year, but we did -- to the extent that the team members are listening, we did want to say thank you very much for a superb year on safety at 1.45 on TRIF. That was the safest year Wajax has had on record.I'm going to turn to Page 4 and talk about revenue by region for a moment. So our fourth quarter is on the left side of your chart. You can see that we enjoyed some considerable gains in Western Canada at plus 40%, Eastern Canada at plus 14%, and we're a bit softer in Central Canada. In Central Canada, the core categories of construction, material handling, et cetera, they actually performed quite well. The softness in Central Canada on a year-over-year basis was related to primarily our power generation project business, which did not perform at the same level it did in the prior year, but our core categories, upon which a lot of our growth depends going forward, performed quite well in Ontario.When I look at the full year basis, you can see the regional breakdowns that are listed there. We enjoyed a lot of success in Western Canada. Obviously, market conditions were part of that, but I'll come back to market share in just a second. We had a pretty solid year in Eastern Canada, and we were comparable revenue-wise on a year-over-year basis in Central.If to the extent that there's a question on how much of the revenue increase is market share versus market conditions, while we have benefited from market conditions in Western Canada being more positive year-over-year basis, we've actually gained market share in some pretty big categories for us being construction, material handling. So we're quite pleased that both the market was better and our performance from a sales effectiveness perspective was also better year-over-year.I'm looking at Page 5, which talks about the revenue analysis essentially by sales type. You can see down the -- at the left-hand side of the page the big difference in revenue in the fourth quarter when you compare that to kind of the sequential performance to the end of Q3 was a pretty positive change in the equipment volumes. And there were a number of categories that benefited from that, that you can see listed on your page. So very pleased with the Equipment business in the fourth quarter. And if you look at both the Industrial Parts business and Product Support, those businesses in the fourth quarter on a year-over-year percentage increase basis performed equally well to where they were at the end of Q3.And looking at categories on the following page on Page 6, we'll -- if you've had a chance to look at our strategy deck, you'll -- we'll be resequencing these categories in accordance with the ways in which we've classified the businesses in the strategic plan. But for now we've listed them in order of their total contribution to revenue. And when you look at the fourth quarter business, you can see the numbers down the side, we're quite pleased with the performance in some of the bigger Equipment categories, such as construction, forestry, material handling. We had a really solid quarter in Q4 in the Engines and Transmissions business. The difference there was the Oil & Gas business, albeit it was -- a lot of that business was actually packaging work we did for U.S. customers. So that was quite positive from Oil & Gas standpoint recognizing that, that business was shipped to customers outside of Canada. And when you look at the year-to-date basis, you can read down through those numbers. So year-over-year, we're very pleased with the total revenue performance at up almost $100 million, and that's -- we consider that a pretty solid performance when you consider the mining shovels that we had to comp off that did not repeat in 2017.And Darren, I'm going to ask you to talk about a few charts here.

[Darren Julian Yaworsky, Senior VP of Finance & CFO]

Thanks, Mark. I am on Slide 7 for everyone's reference. As Mark mentioned, we experienced a strong improvement in our EPS year-over-year as well as full year basis. In the fourth quarter of 2017, adjusted basic EPS improved to $0.56 from $0.45 from the same quarter the previous year, representing a 24% increase.Earnings improvement relates primarily to higher revenue and lower finance costs related to the retirement of our senior notes on October 23, 2018 -- sorry, 2017. We experienced higher SG&A expense related to increases in our incentive compensation accrual, and on a comparative basis a pretax accrual of $2.6 million from the prior year for insurance proceeds related to the Fort McMurray fire.Full year adjusted basic EPS increased to $1.71 from $1.01, representing a 69% improvement after adjusting for after-tax gains recorded on the sales of property of $1.2 million and after-tax senior note redemption costs of $4 million.Moving to Slide 8. Our Q4 2017 backlog increased $53.1 million on a year-over-year basis and $8.6 million from Q3. The year-over-year increase relates primarily to new power generation and construction Equipment orders as well as higher Industrial Parts orders. Since Q4 2016, we've experienced increasing backlog in Equipment, Industrial Parts and ERS. We remain encouraged by the strength and breadth of our sales pipeline as we enter 2018. This increase in backlog is also tied to our higher inventory levels, which I'll discuss on the following slide.So moving to Slide 9. This is some new disclosure that we're introducing for this quarter, just to provide a little bit more color on and greater transparency into our operations. For the purpose of this presentation, we're including consigned inventory, which is not included on the balance sheet, to give a clear representation of our total available -- total inventory available for sale. Inventory on consignment was largely Hitachi construction excavators. Inventory and including consignment increased $85.5 million compared to -- sorry, Q4 2016 and it's higher across all product categories as a result of improving market conditions. This reflects our higher revenue expectations for 2018 relative to 2017. We've also been more aggressive with respect to equipment orders as manufacturing slots have became scarce due to improving market conditions. It's important that we place these orders early to guarantee our manufacturing slots and the associated delivery dates. We do not have any concerns with our current inventory levels, which align with our growth objectives for the year, and we are clearly managing our working capital levels, which we'll talk about very shortly.So moving to Slide 10. I'll provide a bit of an update on our recent completed initiatives aimed at improving our capital structure, enhancing our financial flexibility and optionality. On October 23, we successfully completed the redemption and cancellation of our 6 1/8% senior notes, which were due in October 2020. We used the proceeds from our amended credit facilities to fund the same. The result was a significant reduction in our cost to debt, resulting in an accretive transaction for shareholders. We've also hedged a portion of the debt to reduce our floating rate exposure and take advantage of the current low-interest rate environment, consistent with our risk management policies.Costs associated -- excuse me, costs associated with the redemption were recorded in the fourth quarter and included $3.8 million make-whole premium plus a $1.6 million write-off of noncash deferred financing changes. The combined after-tax costs associated with these redemptions was $4 million. Our year-end leverage ratio was 2.06x, which is slightly lower than Q4 2016 and Q3 2017, and we continue to target a leverage range of 1.5x to 2x. We're not concerned as we are slightly above our leverage target as we maintain inventory and CapEx to drive our higher growth prospects in 2018.We're also continuing our focus on working capital efficiency, which is the key component in managing our overall leverage targets. As you can see, our sales have grown. Our working capital to sales ratio has declined steadily over the past year and our inventory turns have increased relative to Q4 2016 and Q3 2017.Finally, the Board has approved our first quarter dividend at $0.25 per share payable on April 4, 2018 to shareholders on record of March 15, 2017. We remain confident in the -- I don't think that's right. I think it's -- yes, we remain confident in the sustainability of the dividend at this level across the business cycle.With that, I'll turn to -- the call back over to Mark.

[A. Mark Foote, President, CEO & Director]

Thanks, Darren. Darren and I are going to partner on the next couple of charts before we get to the outlook. Our company has spent a considerable amount of time in 2017 looking at the way in which we're growing our business. And post the reorganization of Wajax that completed in the first quarter 2017, the management team, the board and a large group of our manufacturing partners have kind of reconsidered the way in which we're growing the business and how we want to think about our growth and our infrastructure, et cetera. And we've posted on our website a brief update on the revisions to our strategy, and 2 pages of that presentation are summarized in the deck we've got in front of you now. So we're going to look at Page 11, which is the diagram we've used to deal with the why invest category -- with the why invest question. And I'm going to talk to the first 3 bullets -- I'm sorry, the first 3 circles quickly just going clockwise around this diagram, and ask Darren to speak to number 4 and number 5.The most important aspect of our business is sustainable revenue growth. And we'll show you in a second just how we think about leverage in the business on the cost, et cetera, because of how we reorganized the company. But really, our big focus is on making sure that the revenue growth that we have is sustainable. And we've got two aspects of that growth, obviously, to consider. The first is organic growth, and you'll see from the presentation available on the website and a number of the disclosures that will come out of the company over the next little bit, including the annual report, we're looking at categories on a very specific basis for the 10 businesses that we're in, and we're classifying those businesses for purposes of where we want to invest our time and our capital and our staffing resources in order to drive the growth in the business. So that -- in the second bullet point there under sustainable revenue growth says category-specific investment thesis, that's what we mean. Not all businesses are necessarily created equal in Wajax and some will drive higher levels of growth because of market share opportunities and profitability than others. And so you'll see from the presentation available on the website how we've categorized those businesses and how we think about the growth opportunities inherent in them.The second thing you'll see in the presentation is the focus on acquisitions. And we'll continue to reiterate that the largest portion of the planned growth in our business is expected to be organic. Having said that, we have opened the lens a bit on how we think about acquisitions as a company, and the presentation describes how we think about acquisitions in Canada and considerations that we have for purposes of looking at acquisitions in the U.S. market, participating in a lot of the consolidation that's going on in the dealer channels in North America.So again to reiterate, the largest portion of our planned growth is organic, but we have tried to be fairly structured in our thinking about acquisitions, both within Canada and outside, and tried to give you a little bit of color on how we think about that and you'll see that in the presentation.The second circle, again, going clockwise around the diagram is operating leverage. And we -- the team at Wajax has done, I think, a very, very good job in the last couple of years in dealing with a very new business model for our company and going away from product-centric divisions to a much more functional organization. It has given us a lot of leverage that we both anticipated and that we start to see coming forward with us in some of the investments we're prepared to make in our infrastructure. Obviously, we'll talk about the outlook in just a second, but growth in earnings at stable -- growth in revenue with stable margins on a very well managed cost structure should lead to an EBITDA expansion in the business, and that comes from a number of different aspects of both the way in which we organize the people in the business, the assets in the business, et cetera, but leverage is something that we're quite dedicated to demonstrating how those changes will help our overall margins going forward.And the third piece of news for us, before I turn it back over to Darren, is the infrastructure. And we have some very exciting new technology plans that are coming into the business. They're further described in that presentation that augment a lot of the systems investments we've made in the last 2 years, particularly supporting the sales force. Lots of change in our branch network where it continues to, a, become more efficient, but also the footprint of the business gets smaller and less expensive and our cost to serve customers continues to be a focus for us. And some additional information about something we call customer support centers, which are new ways in which using technology and a One Wajax business model we've got some new sales channels we can open to customers, which will both improve the consistency of our service to customers and also give us some more effective ways of dealing with both inbound and outbound service of our customers on a day-to-day basis. Okay. Darren, can I ask you to talk about 4 and 5?

[Darren Julian Yaworsky, Senior VP of Finance & CFO]

Certainly. For the optimized capital structure, probably the point that I should focus on the most is more around our leverage targets. So on a going concern basis, we're looking at maintaining our leverage between 1.5x to 2x leverage measured by debt to EBITDA. We have reworked through the efforts of Trevor and his team, enhanced our liquidity and access to capital particular bank financing that will allow us to easily finance tuck-in acquisitions. If we are, to Mark's earlier point, looking at any kind of transactions that are bigger than what we classify as a tuck-in, we do have additional capacity in our leverage to relax our leverage covenant, our target from 2x to somewhere as high as 3x. But our intent is to make sure that we maintain 1 turn of EBITDA from a leverage perspective to make sure that we have a buffer against market and economic disruptions.From a maximized shareholder value perspective, I think it was in the Q2 2017 Analyst Call where we showed our capital allocation waterfall and the discipline associated with that. Just to remind everybody what that waterfall looked like. Our first bucket of investment was to fund organic growth that would be accretive to the overall enterprise. And then secondly would to be -- would be to fund accretive -- acquisitive growth, again, which would be beneficial to the shareholder base. And then the third bucket was returning capital in the most efficient way to shareholders. As it stands right now, the core operations of the business and the associated organic growth can be funded by our cash flow and working capital requirements. So we don't see any needs to change our dividend. If we did do a meaningful transaction, I think at that point in time, we'd have to reevaluate our capital allocation priorities of the business.And with that, Mark, I'll turn it back over to you.

[A. Mark Foote, President, CEO & Director]

Page 12 has a simple view of the outlook, and I'll speak to the top half of the page and let Darren speak to the multiples we've shown at the bottom.Our strategy is a pretty simple story. It starts with what we consider to be very reasonable expectations from an organic growth standpoint. And again, we'd encourage you to look at that presentation because it identifies the categories where we see the most growth opportunity and how we plan categories, which are inherently a bit more cyclical [ where we've ] placed less emphasis from a dependence standpoint, but certainly remain very well positioned competitively.So we consider our revenue expectations to be reasonable, and we provided an illustrative range on the right-hand side of that chart that shows you various levels that we consider to be within our capabilities. Obviously, we've considered mid-cycle, we've considered -- we've made the assumption that the market conditions for the next 3 years will be what we commonly refer to as mid-cycle. And that -- so we're not assuming any fundamental improvement in commodity prices or anything of that nature. We're considering -- most of our growth is coming from businesses, which are inherently more stable. And again, if you check the presentation, you'll see some of our specific market conditions by category that are worth noting. And we're also assuming our gross margins to be reasonably stable. And that would be stable in the context of how you might see them in 2017. We do have a lot of expectations with market share improvement in some big categories, like Material Handling and Construction. Having said that, we have margin opportunity as another part of our business that we think will allow us to invest in price and market share improvement while still holding our gross margins relatively constant.The EBITDA margin expansion really does come from improving the revenue base on the costs. And I think that's a big focus in our business today is while we will invest in the strategic initiatives that are necessary to drive our growth, the technology plans that we have, some of the new buildings that we see coming into the market, et cetera, we have a correspondingly rich group of plans that we feel will continue to take cost out of the business that will both fund those SG&A investments and also allow those percentages to stay within the ranges that are covered in the presentation. So you can see at varying levels of success on the revenue line how those EBITDA margins can change over the course of that range of revenue. You can compare those ranges to our peak performance. Our peak earnings year was 2012. That was obviously at a very different part of the commodity cycle where our revenue was about $1.47 billion and our EBITDA margins were 7.6%. So we think we can put up some good numbers from a historical perspective without any fundamental improvement to commodity cycle -- commodity prices and leave those more cyclical categories as upside in the business as we look forward. Darren?

[Darren Julian Yaworsky, Senior VP of Finance & CFO]

Thanks, Mark. In the bottom half of this chart, what we try to connect is the EBITDA margins in the upper right-hand side to a trading multiple of us and our peers. And we find that there is a fair amount of correlation between EBITDA margin expansion and EBITDA trading multiple expansion, almost [ so ] one-for-one basis. So the premise that we have is as we execute our plan and have the ability to expand our EBITDA margins, we'd like to see or we anticipate that the market would respond correspondingly with our EBITDA trading multiples. At this point in time, we see that there is a gap between our, what we would say is our direct peers, and we're working hard to be able to close that gap.Mark, over to you.

[A. Mark Foote, President, CEO & Director]

Yes, we'll just -- we'll end on Page 13. It summarizes the outlook that was in our press releases from I believe it was last evening. So we do expect our 2018 adjusted net earnings to increase versus 2017, due primarily to organic revenue growth. We do have market share improvement expectations in 2018 in some pretty competitive categories. So we continue to believe that gross margins will be under a bit of pressure. And as I said earlier, we'll continue to manage the productivity side of our business to either wholly or partially offset the effect on the gross margin level of some of the pricing activities that either we will take or we expect our competitors [ to take ].Regionally, the market conditions that we're expecting -- we do expect Central and Eastern Canada to be generally stable to their conditions today. And we did see material improvements in our Western Canada market conditions while we believe that it's certainly more than possible that Western Canada will continue to improve in 2018, we're a bit skeptical that the year-over-year improvement will be as significant as it was when you compare 2017 to 2016. Okay, so we've got less expectation with respect to the conditions in Western Canada driving the types of revenue that we saw in 2017. Okay. And that is a summary of our comments. So I think we'll turn it back over for comment -- for questions.

[Operator]

[Operator Instructions] Your first question comes from Michael Doumet of Scotiabank.

[Michael Doumet, Analyst]

Nice to see revenues up strong and operating leverage work so well on the quarter. Maybe first on revenues and a continuation to your 2018 outlook. This seems to have a -- been a midyear pickup in end market strength in 2017. How should we think of sales growth in 2017 -- '18 as it relates to first half and second half expectations?

[A. Mark Foote, President, CEO & Director]

You know what, I don't know if we want to guide you too, too much on that Michael. I suspect the year-over-year gains would be potentially a bit less than they were in 2017, and that may be a bit skewed, where the front half of the year is stronger than the second half. What -- it's not just Wajax, I think what the industry may face a wee bit in the second half of the year is whether or not all the equipment that you can sell, you can actually get your hands on. But we're expecting the overall year-over-year revenue growth to be a bit less this year than it was last year.

[Michael Doumet, Analyst]

Okay. And if I just turn to the updated strategy. If I zoom right in on the targeted areas of organic growth, namely construction and material handling, the figures you disclosed in the extended presentations suggest you've lost some market share over the last 5-year period. Could you give us some back story as to what happened? And maybe as we look forward, how you think the drivers -- what you think the drivers are to get the market share back, call it in the short to medium term?

[A. Mark Foote, President, CEO & Director]

Yes. I'll keep it at a high level because I think there's a couple of different stories if you look at it regionally, but I would say in construction there were probably 2 significant factors. One was, given the financial performance of the company in 2015 and '16, in particular, we would have been holding on the margin a little bit harder than we might be today, just given some of the other positive aspects of the business. So that may have hurt our market share a bit more than we had originally anticipated. The second thing is that for the last few years and this -- 2018 is really the first coming close to clean year we've got is that we were not necessarily participating in construction equipment that was below the Tier 4 level, and a lot of our competitors were still selling Tier 3 products. And because we really only had access to interim Tier 4 product, we think that hurt our market share because our price competitiveness was not as strong as somebody who is selling Tier 3 products. So those 2 factors would have affected construction. On the material handling side, other than saying that there were a -- the vast majority of the material handling business from a unit standpoint is Central and Eastern Canada. I think it's about 70% of the available market is really those 2 areas. [ I know ] you're talking about from Windsor through to Montreal. There were a number of big warehouse deals that were generally low profitability that we chose not to participate in. And that -- the market share in that business can be a wee bit skewed in the sense that some very high volume, very low margin product can swing your share pretty dramatically. And if we choose not to participate in because we're guarding our profitability, that would be one of the reasons our share would decline. So we're working quite hard with a number of our manufacturing partners to reset some of the profitability in some of the categories, but we feel more bullish about market share improvements looking forward, and I think 2017 was a good example of that. But we feel more bullish looking forward simply because the business can afford to make some investments in gaining share as opposed to, for the right reasons, having to guard profitability.

[Michael Doumet, Analyst]

Mark, just maybe a quick question. I mean, when you -- in the outlook that you've provided on the revenue and 3-year CAGR, anyway to give us a sense of what your organic assumptions are for the, I guess, Canada in general versus what you can gain structurally through market share?

[A. Mark Foote, President, CEO & Director]

We -- you know what, I shouldn't just toss a number out there because the -- roughly speaking, Michael, roughly speaking, and assuming that our calls on commodity-oriented categories are correct and they're reasonably conservative, roughly speaking, it's not hard to believe about 2/3 of our total revenue growth will come from the 3 categories that we call invest to grow. And you could probably split them just as a good walking around number, kind of half and half between some degree of market expansion and some degree of market share improvement. As a matter of fact, that's probably incorrect as the way to think about it. It's probably about 3/4 market share improvement and about 1/4 of market expansion.

[Michael Doumet, Analyst]

Okay, that's helpful. And maybe just one last, before I turn it over, on the rental strategy. I know there is some focus there, so -- maybe increased focus there. Could you give us a big picture sense of where you want to take that business? And I'm also assuming rental should help alleviate some gross margin pressure into next year and maybe going forward?

[A. Mark Foote, President, CEO & Director]

Yes. Our rental strategy historically has been really only in 2 categories. It's been material handling, so the forklift rental business and then power generation. We're pretty significantly deemphasizing our power generation rental business and reallocating our capital to slight increases from historical levels for material handling, which we continue to find is a very profitable business for us, both on a short-term rental and more of a long-term rental standpoint. And beginning to allocate capital to the heavy rents business in construction, which we plan to start this year.

[Operator]

Your next question comes from Ben Cherniavsky of Raymond James.

[Ben Cherniavsky, Managing Director of Industrial Research]

Mark, where does the rotating products fit into this? Is that an initiative that, upon a second evaluation, you're not really pursuing any further?

[A. Mark Foote, President, CEO & Director]

No. Just to confuse you, Ben, that's the ERS strategy.

[Ben Cherniavsky, Managing Director of Industrial Research]

ERS? Okay.

[A. Mark Foote, President, CEO & Director]

Generally, it's a category within ERS and it's a fairly big one, but that was a bit -- we had a bit of an acronym switch a year or so ago. So rotating products historically, that's rolled into the ERS business.

[Ben Cherniavsky, Managing Director of Industrial Research]

Right. And that stands for?

[A. Mark Foote, President, CEO & Director]

Engineered repair services.

[Ben Cherniavsky, Managing Director of Industrial Research]

Right, okay. I'll make that note. So M&A, is that still part of that ERS strategy?

[A. Mark Foote, President, CEO & Director]

Potentially, yes. I think we've discussed before that we have found that the size and fragmentation of the market, the targets in that market, can make swinging the needle from a scale standpoint difficult. So we've had a couple of really good successes, but they're small shops that do very specialized work in it. It's not a big number from a revenue standpoint. So I would say that, that remains of interest to us if we have opportunities that are at a reasonable scale. But we're probably less active on the small acquisition front than we've been historically simply because it's a lot of work and not necessarily a very good kind of total return.

[Ben Cherniavsky, Managing Director of Industrial Research]

Right, okay. And I know we had discussed that, but I just wanted to clarify it to make sure I had that right. And then also I apologize for any confusion, there seems to be a lot of -- or a few moving parts to the margins. And I'm trying to reconcile the pressure in the quarter on the margins, the comments around protecting market share and competitiveness going forward with the margin expansion strategy, like are you -- and also at a higher level, are you trying to gain share by being sort of a low-cost leader? Or like what is the -- what's the thought behind where you elect to discount product to protect share or hold your ground and forego revenue? I know in the previous question, you've made a few comments around that, but I apologize, I'm still trying to figure it all out here.

[A. Mark Foote, President, CEO & Director]

Yes. No worries. The margin expansion statement had to do with EBITDA margins, not gross margins. So we are planning our business on the basis of gross margins remaining generally stable and the EBITDA margin improvement really a scale on the expense base just driven by revenue growth. At the gross margin level, I guess -- and I may not have done a very good job. So at the gross margin level, we believe that the way in which we can mix the business from a category standpoint will allow us to continue to invest in being price competitive in the categories where we need to gain share and recoup some of that margin pressure from other businesses that we're in. I would say that we plan to be a price leader. I don't know if that's really that -- I mean, people are buying the bigger gear categories not just on the basis of price. Obviously, product support is at least and arguably a much bigger factor. There are deals where we have walked away to protect margin, which did cost us share because of protecting our profitability, which we're unlikely to walk away from unless they're silly, obviously. But we do want to be very price competitive with the market leaders without necessarily leaving the impression that we're planning to bring prices down.

[Ben Cherniavsky, Managing Director of Industrial Research]

Yes. I guess, the other thing I'm struggling with and it's not just with your commentary, but everyone in the sector is, at least in Canada, still talking about price competition, but at the same time in the same breath, they're talking about tight market conditions or backlogs are up, revenue sales are up. Where -- why are we not seeing pricing power? Where is this competitiveness coming from?

[A. Mark Foote, President, CEO & Director]

It's a really good question, Ben. And you would expect that if demand is up and supply is down, that margins would expand. That may in fact be the case in some specific areas. We're not planning our business on that basis though. So we're expecting to have some degree of margin pressure in our particular case for no other reason than trying to gain share. If you are a 25% share player, you may think about it differently, but we're trying to gain share. So we're at least planning our margins to be under pressure on the equipment side.

[Ben Cherniavsky, Managing Director of Industrial Research]

Right, okay. One final one, if I may, just with some of those 3 targets on an EBITDA basis. What about the DA or at least the capital requirements to get there? And in particular, you mentioned a little bit on rental, a lot on technology and digital. I don't know if you want to quantify what the needs are, but do you have any ROIC targets to hit on that, so you can target your growth on the earnings or EBITDA, what kind of capital requirements are going to be needed to get there?

[Darren Julian Yaworsky, Senior VP of Finance & CFO]

Good question, Ben. So there is 3 buckets that I think you talked about. One was inventory investment to be able to support the expansion in our market share and organic growth. The second bucket is CapEx that would be related to investment in a rental fleet, either the introduction of the heavy rents that Mark spoke about or the -- and the additional to the rental fleet that we have in the material handling. And the third bucket would be infrastructure area. And I'm going to leave that third bucket to Mark to answer. So on the first bucket, we're very comfortable that using the financing arrangements that we have with our manufacturers, and you'll see the addition of the consignment inventory and our disclosure this quarter that, that coupled with the capacity that we have in our credit facility, we should have no problem satisfying our organic growth requirements in investment in inventory. The second element with regards to rental -- investment in the rental fleet, Mark kind of touched on it. I think that we start cycling out some of the rental assets that we have in the power gen space that cap -- frees up capital for reinvestment into the heavy rent space. And we're going to work our way into that space slowly to be able to make sure that we do it properly. The second element did not -- second bucket is the material handling. We already have a very healthy rental fleet in that space. It's probably a bigger investment that we'll be making on a relative basis to construction, but it's not immaterial or it's not material in the context of our overall existing rental fleet. And as we flip through and rotate out the holder assets, that almost becomes a self-funding requirement or self-funding initiative for the new asset purchases. So that was a really complicated way of saying that the CapEx program is not that material, that it would put strain on our leverage or our cash flow. And it's well purposed and structured in such a way that we've got a bunch of different financing opportunities or optionality to be able to affect that. And Mark, I'll turn it over to you for the infrastructure side.

[A. Mark Foote, President, CEO & Director]

Yes, Ben -- I'm sorry, the infrastructure side is a pretty simple story. I mean when it comes to real estate, typically we're not actually investing our own capital, in that we're much more likely to lease facilities than own them. When it comes to the technology investment, the more significant project that we have is the replacement of our ERP. And the total project investment in that is 15 -- about $15 million, and call it roughly $10 million of that is capital investment. And that will occur mostly between 2018, '19 and '20. So it won't may show up as a major kind of cash flip just because of the roughly 2-year duration of that project, but that is really the largest kind of infrastructure capital investment that we've planned right now.

[Ben Cherniavsky, Managing Director of Industrial Research]

Is that inclusive of sort of a digital strategy, online procurement and things like that, like where are you guys with that part of the business, telematics and all of that?

[A. Mark Foote, President, CEO & Director]

Yes and no. There's a whole bunch of foundational stuff -- well, there's a whole bunch of foundational stuff that exists in the business today. So -- and we continue to make some advancements on the digital strategy. If you check the presentation on the website, you'll see reference to both the technology investment and the customer support centers. And customer support centers are -- we think they're a game-changer for our company in that there's a bunch of technology investments that gets made so that it doesn't matter where a customer is or in what -- through what channel they would choose to want to do business with us or what category they happen to be buying. Those customer support centers will be designed to make sure that customers get very consistent levels of service on pretty much anything we sell or any category that we participate in and technology is a big part of that. We wouldn't expect to see our [ pre CSE ] go into the market, at least for customer use, until 2019, and that we have some technology investment involved in that.

[Ben Cherniavsky, Managing Director of Industrial Research]

So sorry to belabor it, but just to summarize, is there a way to quantify what -- like holistically over the next few years, what kind of capital you're going to require? And work -- use that to work into some kind of return on capital metrics or do you have -- go the other way and tell us what your return on capital targets are? And we can sort of back out what the capital needs are going to be? Just like it's -- there are some ambitious goals, I think that's good that you guys see the growth there. I'm just curious like what is going to cost to get that growth?

[A. Mark Foote, President, CEO & Director]

Yes. Well, probably a decent planning number would be to assume the following. You're probably talking about $5 million to $8 million a year in what you might call infrastructure capital. You're probably talking about between $25 million and $35 million a year in material handling or rental capital, and I'll come back to the returns in just a second. And the construction number, right now we consider variable. So we've got some modest expectations in 2019, which really has to do with 2 factors. One is, that's a new business for us. We want to make sure we're servicing the customer correctly. And secondly, because there is a shortage of supply on some of the inbound equipment, we may or may not allocate as much of what we have available to us to rental as we originally anticipated. So it's tougher to give you a rental capital number on construction. In material handling, in construction, we're very comfortable with the returns that we're expecting to get. The return on investment, actually, in the infrastructure investments is pretty strong, just because of the cost that it takes out of the business. And I shouldn't say that the return on capital number -- the business plans, its return on net assets, which I realize is a different number, but the business has a target of a return on net assets of about 14.5%. Okay, so that's kind of how we think about it today. We don't really want to kind of divulge the individual return on capital numbers, but rental fleet expectations, they're quite good.

[Operator]

[Operator Instructions] Your next question comes from Michael Tupholme of TD Securities.

[Michael Tupholme, Research Analyst]

Mark, I just want to circle back on the 2018 commentary as it relates to margins. I think you were clear, but I want to be sure about what you said. Is it your expectation that efficiency gains on the SG&A line will allow you to essentially offset the gross margin pressures you expect to face in 2018?

[A. Mark Foote, President, CEO & Director]

We expect that to be the case right now, Michael, yes.

[Michael Tupholme, Research Analyst]

Okay, perfect. And then if we turn to the 3-year plan you've outlined in terms of the financial targets, I think you've been clear on the call that the gross -- pardon me, the EBITDA margin improvement that you're talking about realizing is not really driven by the gross margin line, but rather by leveraging the fixed costs. I'm just trying to triangulate those comments with the guidance you've given in the presentation around SG&A as a percentage of revenue remaining in this 14.5% to 15.5% band. I'm not quite sure how we can get to the sort of leverage you're talking about with that SG&A numbers or percentage of revenue staying in that band. Can you help me with that?

[A. Mark Foote, President, CEO & Director]

Yes. I guess, the band exists primarily, Michael, and I think we've learned this through ways in which we've tried to provide guidance in the past. The band exists because it's possible, and we don't consider it to be necessarily likely, but it's possible that our revenue expectations are not necessarily achieved because of some market factor that we're not anticipating. And that's why the range exists. I mean we don't -- at the revenue expectations we have in our business over the 3-year period -- and I'd ask you to remember over the 3-year period, at the revenue expectations we have over the 3-year period, we would expect to sit a lot lower in that SG&A range than anywhere else.

[Michael Tupholme, Research Analyst]

Okay. And you brought it up there, Mark, but just in terms of this being a 3-year plan, how should we think about progression? I mean, is this -- you gradually make your way to these kinds of levels as far as the margins go? Or is this something whereby by the time you get to 2020 that's when you really see most of this come together sort of towards the end of the plan?

[A. Mark Foote, President, CEO & Director]

Let me just say it this way. We want you to take the chart that we have on our page as illustrative. We consider it reasonable, but we're trying to stay away from calling it guidance for obvious reasons. The -- I wouldn't say that the path between where we are today and 2020 is a hockey stick, but it's probably a bit more modest in the first year and a bit more aggressive in years 2 and 3. But it's not a huge change in trajectory, but it may be a little bit softer in the opening part than it would be in years 2 and 3.

[Michael Tupholme, Research Analyst]

Right, okay.

[A. Mark Foote, President, CEO & Director]

I'm sorry, Michael. By the time you get there, those are the range -- that's -- obviously, that's what we consider to be a reasonable expectation is the range that we've shown on that page.

[Michael Tupholme, Research Analyst]

Right, okay. That's helpful. Just turning over to the acquisition portion of the strategy. You mentioned, and I think this is the first time, maybe you can confirm, but the first time I've seen mention of the U.S. market. Can you just talk a little bit more about what you would initially be looking for in a U.S. acquisition? Including sort of initial preferred end markets? I know you have certain areas you've outlined that are your focus areas, but is there one of those or a few of those that you would prefer to go to first from an end market perspective, from a regional perspective? What sort of size would we be talking about if you were to go to the U.S.?

[A. Mark Foote, President, CEO & Director]

On scale side of things, a couple of things that we've looked at would admittedly be materially higher than things we would have considered for Canada. They're typically regional equipment or power dealers, but I'm going to stay away from saying what the exact revenue ranges are because I think it might mislead you a little bit. But it's enough to change the trajectory of the company in total. So it's certainly more significant than what we would consider historically with things like our ERS strategy. I don't know if I would say that we have a particular regional preference. We've looked at a couple of different opportunities and they're not -- we're not necessarily bound by a particular region. I think we are more bound by an interest in the types of equipment dealers that come with enough physical infrastructure to allow us to employ the full model of the categories that we participate in. So what we wouldn't be interested in would be a limited infrastructure play, somebody who is in a particular category and may have winnowed down their infrastructure to something they can't practically be levered beyond the category within which it operates today. And what we -- the opposite of that is what we would be interested in, which is something that has a more meaningful physical infrastructure, bigger branches, et cetera, that we can practically use to bring some of the other categories to play that -- to make us successful here. What -- the real distinctive feature of Wajax is the fact that we're in 10 different categories, and there aren't that many people that can say that. And we bring expertise in vendor relationships and all sorts of other things that have to do with how a business that has that kind of breadth can be managed. We think that, in a denser market like the U.S., the opportunities for us are -- to take advantage of all that intellectual capital is just that much greater. But we can only say that's true if a, something passes the financial hurdles that we have; and b, it has an infrastructure that is leverage-able for us to organically grow its business through the introduction of more businesses than it trades in today.

[Michael Tupholme, Research Analyst]

Okay, that's great. And I realize you've just unveiled the updated strategy. But how far down the path of that particular element of the strategy would you be? I mean you've talked about acquisitions for quite a while in Canada, but I mean, it sounds like you've put a fair bit of thought into this already, but is this something where there is a fair bit more work to do? Or are you -- should the right opportunity present itself in the relatively near term, you've done enough work and you're comfortable enough that you would be willing to act if it sort of met all the hurdles?

[A. Mark Foote, President, CEO & Director]

It'd be the last. You would know the acquisition business the same way we would. I mean we know what we're looking for. We know what the hurdle rates are. We know what the criteria is. We got a fair amount of internal support for doing that kind of thing. We've got some excellent manufacturing relationships, but we haven't found the right opportunity yet. So when the right opportunity presents itself, we would be prepared to act.

[Michael Tupholme, Research Analyst]

Okay. Shifting gears to -- just back on 2018 as far as the business, Darren, how should we think about free cash flow in 2018 and changes in noncash working capital?

[Darren Julian Yaworsky, Senior VP of Finance & CFO]

I think it's probably a tale of 2 halves of the year. The first half of the year will likely have more capital tied up into inventories and receivables. And depending on the availability of manufacturing slots, we might see us harvesting that inventory and receivables into increased free cash flow at the back half of the year.

[Michael Tupholme, Research Analyst]

So for the full year, are you -- what would be your expectation on changes in working -- on cash working capital? Is it -- you would expect it to be neutral by the time you get to the end of the year?

[Darren Julian Yaworsky, Senior VP of Finance & CFO]

I think it would be modestly positive. Again, it depends on whether or not we need to invest in inventory to get manufacturing slots to be able to satisfy the 2019 sales activities.

[Michael Tupholme, Research Analyst]

So a modest source of cash for the year.

[Darren Julian Yaworsky, Senior VP of Finance & CFO]

That's correct, after dividends.

[Michael Tupholme, Research Analyst]

Sorry, just to be clear, are you talking about free cash flow or just the working capital piece of it?

[Darren Julian Yaworsky, Senior VP of Finance & CFO]

Both. So from a working capital perspective, I think we're likely going to see subject to inventory requirements for 2019. We'll likely see a release of value from the net working capital assets. And from a free cash flow perspective, we should be modestly cash flow positive after dividends and CapEx.

[Michael Tupholme, Research Analyst]

Okay. And then can you talk a little bit more -- perhaps this is for Mark, but about the ERP implementation? How you expect to do the actual cutover? I mean, it sounds like you're going to be laying the groundwork this year with a view to beginning the implementation in 2019. But are you running your current systems in parallel or how does this actually practically happen?

[A. Mark Foote, President, CEO & Director]

Practically, we anticipate that the first batch of branches will begin to convert in -- after we kind of clear the year-end for 2018, so it's early 2019. And the focus will be on branches that were historically part of the Equipment and Power Systems businesses. And we'll work our way through those branches, and we won't be running -- we'll have backup plans if they're required, but we won't be planning to run parallel systems. So we'll be cutting over the new systems for those branches starting in the beginning part of next year. And we anticipate -- we could probably go with what used to be the industrial branches sooner, but just for risk mitigation purposes, we're planning to convert them starting in the beginning of the following year. So we've got 2 conversion tranches, one that starts in the beginning of 2019 and one that starts in the beginning of 2020. And we're delaying till 2020 simply from a risk management standpoint. If we think that we're doing great and we can go faster, then we probably will. But right now, we're seeing it as approximately 18-month kind of total conversion time, start to finish.

[Operator]

And there are no further questions at this time. I return the call back to our presenters.

[A. Mark Foote, President, CEO & Director]

Okay. Well, thank you very much for your time. That was some great questions. We look forward to talking to you more about the strategy when we have the opportunity. And if you have any questions after the call and you'd like to call anyone of us, that would be a real welcome, okay. So thanks very much. We'll talk to you again in May.

[Operator]

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