Finning International Inc.

Thank you for standing by. This is the conference operator. Welcome to the Finning International second quarter 2021 investor call and webcast. As a reminder, all participants are in listen only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. Analysts who wish to join the question queue may press star then one on their telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and zero. I would now like to turn the conference over to Greg Palaszczuk, Executive Vice President and CFO. Please go ahead.

Thank you, operator. Good morning, everyone, and welcome to Finning's second quarter earnings call. Joining me today is Scott Thompson, President and CEO. Following our remarks today, we'll open the line to questions. This call is being webcast on Finning.com. We've also provided a set of slides that we will reference during our prepared remarks. The slides are posted on the events and presentation page of the investor relations section of our website. You can also view the slides on our webcast page. An audio file of this call and the accompanying presentation will be archived on our website. We'll also make several references today to our June investor day, Similarly, those audio files as well as the presentation are available on our website. We're happy to be taking this call today from our Surrey branch campus in the greater Vancouver area. We have closed our corporate head office at Great Northern Way in Vancouver and are transitioning to a hybrid model of working from home and working from our branches. Before I turn it over to Scott, I want to remind everyone that some of the statements provided during this call are forward-looking. Please refer to the slides 10 and 11 for important disclosures about forward-looking information, as well as currency and non-GAAP financial measures. Please note that forward-looking information is subject to risks, uncertainties, and other factors as discussed in our annual information form under key business risks and in our MD&A under risk factors and management and forward-looking information disclaimer. Please treat this information with caution as Finning's actual results could differ materially from current expectations. Scott, over to you.

Thank you, Greg, and good morning, everyone. On today's call, I will speak about our second quarter highlights, our positive outlook, and how we are executing on the plan that we laid out at our investor day in June. Greg will then provide more details on our regional performance in the second quarter and our progress on reducing SC&A and delivering on our mid-cycle targets. Please turn to slide two. We are pleased with strong execution and results in the second quarter. All of our regions delivered outstanding performance, demonstrating operating leverage in a recovering market. I am very proud of how quickly our teams were able to ramp up and capture market upside while keeping costs low and executing our strategy to drive product support. Market activity began to pick up in mid-February and continued strongly through the second quarter. We have seen a recovery in new equipment demand, which was widespread across all of our regions and was driven by the construction sector. Our new equipment sales were up 47% from Q1 2021, with the UK showing the strongest growth as we started delivering to HS2 customers. Our equipment backlog continued to grow in the second quarter to 1.4 billion by the end of June. Order intake in Canada and South America outpaced deliveries in QT. Based on the recent mining deals with Codelco at the Radomir Tomic and Minister O'Halley's mines, which we announced last quarter, we are pleased to have been selected as the auxiliary equipment supplier for Codelco's Andina mine, which is now included in our backlog. This order is valued at about U.S. $40 million for delivery in the first half of 2022. In addition, we will be providing 27 Caterpillar underground loaders to Codelco's Chico Camada mine Ten of these machines are included in our Q2 backlog. Our backlog in the UK and Ireland remains at near record levels and includes 54 million pounds of equipment orders related to the HS2 project. We have begun to quote for 2022 HS2 orders and believe we are well positioned to continue to capture significantly more than our typical market share of the remaining opportunities for Phase 1 with the assistance of our QVIC platform. In fact, we expect the machine opportunity in 2022 to be at least 50% higher than in 2021. This broad-based backlog build across all regions supports our confidence in the mid-cycle market as we continue to see economic recovery gaining momentum in the second half of 2021 and beyond in all of our territories. An acceleration in demand for equipment has placed an industry-wide constraint on the supply chain. Lead times have extended for some product lines, especially in construction equipment. We are working closely with Caterpillar and our customers to meet their equipment needs, including actively sourcing used equipment and offering equipment rebuilds and rental purchase options. We've also improved our supply chain capabilities, including visibility and planning with Caterpillar. At this time, we do not expect the supply chain challenges to materially impact large project deliveries that are currently in our backlog. Our product support revenue increased in all regions and all market sectors from the first quarter of 2021. Recovery and customer activity was a key driver coupled with our strategy to accelerate product support growth in construction. We are offering more compelling product support solutions including a broader scope of customer value agreements and flexible options for construction rebuilds. In Canada, for example, the number of construction machines we are rebuilding has grown significantly this year, and we continue to see a lot of rebuild opportunities as customers are ramping up project work and lead times on new machines are increasing. Product support revenue in mining is also recovering in both Canada and Chile, and we expect continued improvement in the second half of 2021 and into 2022. We have recently seen a strong uptick in rebuild quotation activity in the oil sands. And in Chile, mining customers are resuming major maintenance work as COVID-19 restrictions are gradually lifted and customers are ramping up production to take advantage of the strong copper price. We are particularly pleased with the strong operating leverage in the second quarter, which demonstrates the progress we've made on our cost structure. Savings from our 2020 cost reduction program and continued productivity initiatives to further reduce fixed costs played a key role in achieving strong profitability in all of our regions. Our SCNA was up just 2% from Q2 2020 on 28% higher revenue. If we compare our results to the second quarter pre-pandemic, Q2 2019, we are confident that we are on the right path to significantly improve the earnings capacity of our business. While our consolidated revenue was still 15% below the pre-pandemic levels in Q2 2019, we were able to exceed Q2 2019 EPS by achieving higher profitability and lowering our finance costs. Our employees should be proud of these strong results. We are also realizing cost and capital benefits from our improved supply chain performance. Our working capital to revenue ratio of 24% was the lowest since 2012, down 430 basis points from Q4 2020. Our inventory turns continue to increase. Compared to the pre-pandemic performance of Q2 2019, our inventory turns are up 20% despite a 15% reduction in revenue. We have been using data and insights from connected machines to order the right inventory at the right time. This has allowed us to get ahead of the present lead time challenges which put us in a good position to deliver equipment to our customers on time and meet our mid-cycle revenue targets. We will continue to become more efficient and agile in how we serve our customers. This will not only improve the customer experience, it will also reduce our cost to serve and drive better working capital performance and stronger free cash flow generation. The market recovery is gaining momentum. As discussed at our investor day, we have seen significant return on capital improvements in all three regions this quarter, as improved market activity that we had projected for the back half of 2021 started to unfold earlier, and we expect to see continued improvement in our return on invested capital going forward. In Q2 2021, our ROIC of 13.3% was up 370 basis points from Q4 2020 to with a significant increase in all regions driven by both improved profitability and higher invested capital turnover. This was a great quarter from an execution standpoint, and our outlook remains positive as the global economy recovers in 2021 and beyond. We have announced a 10% dividend increase, which marks our 20th consecutive year of dividend increases. Looking ahead, we are in an excellent position from a cost, inventory, and capability perspective to capture the next phase of market growth. With the recovery maturing, I'm confident in the earnings potential of our business going forward. Now I will hand it over to Greg.

Thank you, Scott. I'm going to provide more details on our regional performance in the second quarter while highlighting our progress on reduced SG&A and delivering on our mid-cycle targets at Investor Day. Our consolidated second quarter results are summarized on slide three. Our results in Q2 of last year were heavily impacted by COVID-19. While we're still providing the comparison to Q2 of 2020, in some cases we've provided comparisons to Q1 of 2021 and other quarters as we believe these are more indicative of our performance. Net revenue is up 28% from Q2 2020 and up 16% from Q1 2021. Sequentially, our revenue growth was driven by strong recovery in new equipment sales and higher product support revenue in all regions. Strong operating leverage in a recovering market drove significant growth in adjusted EBITDA, up 83% year-over-year and up 26% sequentially. Savings from our 2020 cost reduction program and ongoing productivity initiatives have been instrumental in achieving earnings performance in the second quarter. EPS of 56 cents was a record second quarter. with higher earnings in all regions and lower financing costs compared to Q2 of last year and Q1 of 2021. Slide 4 breaks out the increase in net revenue by line of business compared to Q2 2020. We saw strong revenue recovery in all regions. However, as expected, our net revenue in Canada and South America were still below Q2 2019 levels. Significantly higher new equipment sales were driven by improved demand in the construction sector in all our regions and large project deliveries. An increase in product support revenue reflected improved customer activity and our strategic focus to grow product support market share. Turning to slide five, higher gross profit compared to Q2 2020 was driven by broad-based revenue recovery and improved margins in all lines of business. We've been successfully managing competitive pressures and maintaining our gross profit margin by focusing on growing market share and equipment models that have the most product support opportunity, improving deal execution, including procurement initiatives, and using more robust data to drive inventory decisions, improve inventory health, and enable pricing optimization. STNA's percentage of net revenue is 18.3%. As our three-month run rate continues to decline, and demonstrated significant progress towards our mid-cycle target of 17%. If we compare our Q2 2021 SG&A at $313 million to the most recent mid-cycle quarter with a similar net revenue level, such as Q2 2018, you can see that we have reduced our absolute quarterly SG&A by about $30 million, while also absorbing four refuels SG&A. Further productivity initiatives that we highlighted at our investor day are in the categories of people productivity, facilities, productivity, and supply chain, and are currently underway in all regions. With progress on these SG&A initiatives and revenue momentum underpinned by a growing backlog, we expect to see continued progress toward their SG&A target this year. Moving to our Canadian results and outlook, which are summarized on slide six. Net revenue increased by 25% from Q2 2020 and by 14% from Q1 2021, driven by strong demand for new equipment, especially in construction and higher product support activity in all sectors. Compared to Q1 2021, a seasonal increase in demand for new construction equipment in the spring contributed to higher revenue in the second quarter. As we had expected, our revenues were below Q2 2019, which was an exceptionally strong quarter for revenues in Canada, particularly in new equipment and product support. Product support revenue was up 18% from Q2 2020, And compared to Q1 2021, product support was up 4%, driven by improving demand in all sectors, coupled with our strategy to grow product support in construction. SG&A was up 3% from Q2 2020, on a 25% increase in net revenue, driving significantly higher profitability. Our EBIT as a percentage of net revenue was 9.3% in the quarter. Our outlook for Canada remains positive. Growth from the construction sector accelerated in the second quarter as project work has been ramping up. We're seeing an increase in construction order intake and improved utilization of construction and heavy rental equipment. In the oil sands, customers remain disciplined on capital expenditures, driving improved demand for rental equipment and a strong uptick in rebuild quoting activity. Stable production and an aging equipment population are expected to support stable and growing product support activity in the oil sands for the foreseeable future. Coating activity in hard rock and precious metal mining in Western Canada continues to be robust, and we are well positioned to capture these opportunities, including the BC's Golden Triangle. Please turn to slide seven. Net revenue is up 23% from Q2 of 2020 in South America and up 9% from Q1 2021 in functional currency. Driven by market recovery in all sectors, new equipment and product support. Compared to Q1 2021, new equipment sales were up 14% and product support revenue was up 8% in functional currency. Chilean mining customers have been lifting COVID-19 restrictions and returning to a more normal operation. driving higher parts and service revenues. In construction, product support activity also improved with the easing of pandemic protocols in both Chile and Argentina. EBIT as a percentage of net revenue was 9.8%. The team has done a great job to capture market recovery while operating with a lower cost base. SG&A was comparable to Q2 of 2020 on 23% higher revenues. Second quarter margin benefited from fewer larger mining deliveries than we expect to see in the second half of this year. We continue to closely monitor the political and economic reform process in Chile, leading to the general election in November of this year and the review of the mining royalty proposal. We expect that mining royalty rates will increase given the political and social situation in the country. However, it is becoming increasingly clear that given the latest debate in the Senate, that the current royalty proposal will be modified. We have built our plans with a view that mining royalties will increase moderately, and currently this appears to be the direction that the Senate is heading towards. Chile's government has expressed the hope that the royalties legislation would be considered more seriously and calmly as it progresses through the Congress's more conservative upper chamber. This process will likely extend into early next year. We believe that Chile will remain a globally competitive copper producer. However, until the situation is resolved, International miners are unlikely to spend significant new capital. The electrification trend accelerating demand for copper globally and lower near-term capital deployed in new mines, we believe will support the currently high copper price. The good news is that the existing mines will continue to operate. Equipment will need to be maintained, repaired, and rebuilt. And we're seeing strong quoting activity as customers are looking to maintain and refresh their aging fleets so they can ramp up production and take advantage of high copper prices. Next, I'll turn to the UK and Ireland, and I'm on slide eight. Net revenue nearly doubled year over year and was up about 50% in functional currency from Q1 of 2021. Our strong new equipment sales were driven by deliveries to HS2 customers, our system project deliveries to data center customers, and a widespread demand recovery in the construction sector, including general infrastructure, quarrying, and demolition. Product support revenue is up 37% year-over-year and 5% from Q1 2021 in functional currency, with significantly improved activity in all sectors. EBIT as a percent of net revenue is 5.3%, with great profitability from the UK and Ireland, which demonstrates improved operating leverage and strong execution by the team to capture growth opportunities. The UK and Ireland continues to lead the recovery globally. The equipment markets are expected to be very active, driven by economic recovery and a ramp-up in HS2 construction activity. Robust demand for our power system solutions, particularly in the data center market, is expected to continue. We have a strong backlog of power systems projects with deliveries planned for the second half of 2021 and into 2022. Slide 9 summarizes our simple execution plan that we discussed at our investor day. drive product support, reduce costs, and reinvest the compound, and our associated mid-cycle targets for the period of Q3 of 2021 to Q2 of 2022. We are confident in our mid-cycle plan, and the quarter is a great example of our strong execution and momentum. As we discussed at our investor day in June, we expect to have about $250 million reinvestment capacity during this mid-cycle period. We have set up a competition for capital between business development and share repurchases. When it comes to business development, our current focus is on complimentary bolt-on acquisitions that are highly aligned with our strategy to drive improved outcomes for our customers. In 2021, we expect to deliver strong annual free cash flow. However, the amount will depend on our backlog build and delivery schedule. We have a lot of quotes currently out of standing. Some of those are large and straddle year end. The timing of those deals and general deliveries may impact 2021 EBITDA free cash flow conversion, which we had previously projected to be modestly below 50% for the year. Over the next 12 months, we expect our net revenue to be in the range of $7.1 to $7.5 billion, driven in part by 8% growth in product support. Over this period, we expect to achieve our target of SG&A as a percentage of net revenue of 17%, silver annual EPS above $2 per share, and demonstrate significant improvement in consolidated ROEC at more than 15%. Operator, I'll now turn the call back to you for questions.

Thank you. We will now begin the question and answer session. Analysts who wish to join the question queue may press star, then 1 on their telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star, then 2. We will pause for a moment as callers join the queue. The first question comes from Yuri Link with Canaccord Genuity. Please go ahead.

Hey, good morning and congratulations on a great quarter. It's nice to see. Thanks, Yuri. Yeah, so just dig in a little bit on Canadian product support in the quarter. Still below 19 levels, as you mentioned. I think it's actually below 2018, so that's probably an opportunity longer term, but Is the strategy to offset some of the weakness in oil sands with construction? It sounds like that's the way the market is evolving right now. And if that's the case, are there any margin differences between those two markets that should be called out when we think about product support?

Yeah, thanks, Yuri. Yeah, so there's, as we highlighted, there's still room for revenue recovery in both new equipment and product support relative to pre-pandemic levels. You know, the oil sands producers are in pretty good shape right now. You know, with the prices where they are, differentials where they are, and their current level of CapEx, they're really repairing their balance sheets quite quickly. And so we are expecting in the back half of the year some improvement and some some ability to spend more and we'll anxiously look to see what 2022 capital budgets are, but we expect them to be up. So, you know, we can see some activity picking up and we expect that to continue in the back half of the year. But as we talked about at Investor Day, you know, it's an and thing and we're also pushing really hard on growing construction product support. We're looking to grow that at twice the kegger of the oil sands and the broader mining complex. And so we think that layers on top. And so it's an and thing. And I don't think comments on the margins, but they're not completely different.

Okay. Second and final one from me. Just on the CapEx guidance 170 to 210, could you just tell us the portion of that that's going towards rental?

Yes. That's something that we've broken out. It's usually about a third. Ultimately, you know, the rental fleet's in good shape. We're seeing good utilization uptake, particularly on heavy rents at the moment. We're probably in a situation where we'd like to add a little more and where it's a bit constrained. And so, you know, I think we've ordered what we're going to order. You can see that there was a bit of a net build in the quarter. And so I think we're in a healthy position and it's well within range, but we won't be pushing to any upside on rental capex.

Okay, very good. I'll turn it over.

The next question comes from Jacob Boot with CIBC. Please go ahead.

Good morning. Good morning, Jacob. Yeah, the first question is just on how you're thinking about the ramp in discretionary spending as things open up, as we think about more travel, labor costs a little bit more expensive, and then maybe comment on paying the gains is the motto that we've got.

And so there's no doubt that there'll be some discretionary costs that come back in. We're being very conscious on that. We're looking to bank as much of the improvements and efficiencies that we've seen, whether that's in the sales force or an administrative staff. One good example is just how we're going on hybrid improvements. And on labor availability.

Sorry, go ahead. No, go ahead.

You just asked about labor availability improvements. And it's something that we continue to work on. We added 30 technicians to our RRR network in Canada, for example, this quarter. They are in demand, and so we're very happy to be a premium employer and brand that can attract people, but it still takes effort to get them all in the right places. And so, so far, so good, but no doubt that it's competitive out there and something that we manage every week.

Second question is on It revolves around Chile mining product support. And, you know, you talk about how you expect to see, you know, a ramp in product support in the back half of this year as COVID restriction ease. What are you seeing in third quarter so far? And do you expect levels to return to pre-pandemic levels given the political environment?

Yeah, so we expect continued momentum. You've seen it for a number of quarters in a row now. It keeps coming back. There's a lot of maintenance that needs to be done. This quarter was good evidence of managing that upturn very effectively, and so that momentum continues. And, you know, these operations are running hard. You know, production has been a little light for some producers, although Codelco has been very successful year-to-date on ramping up production. And so we think it continues. People will push for production given prices. I don't think that the political piece will have an impact on operations near term. It would be more capital outlays in the medium to long term. So we think it's solid and, you know, the business is obviously in good shape and progressing well.

Okay. Thank you.

The next question comes from Michael Dumont with Scotiabank. Please go ahead.

Hey, good morning, guys. So first off, great quarter. My first question is on margin expectations. I think last quarter we talked about margin trends into the second half, and I think you indicated that, you know, mix was going to be somewhat dilutive, but cost and pricing would be an offset. You know, what should we expect in terms of margins And is there room to build on the Q2 margins into the second half?

Yeah, thanks, Michael. I mean, it was definitely a healthy quarter, made a lot of good progress, you know, and some favorable mix in that we have quite a large backlog, particularly in mining. And so in the second half, and particularly in South America, we've got quite a lot of larger mining deliveries, which will, as you mentioned, put some pressure on on margins, but we'll continue to work on other areas to help offset that. And so back half of the year is more new equipment. You know, we continue to work in every area to try and offset that and walk through that a bit at investor day. But, you know, I think solid progress, but more new equipment mix in the back half.

Gotcha. Okay. And then can you discuss how equipment margins and product support gross margins are trending versus historicals. I guess what I'm thinking here is, you know, when I compare this mid-cycle versus the last mid-cycle, should I assume, you know, earnings growth will be largely explained by lower SG&A and lower interest costs, or is there a case here for gross margin expansion by line of business as well?

Hey, Michael, Scott. So, one, SG&A is obviously you know, a big component of it. And you're seeing the benefits of that when you, as Greg had highlighted, compare to 2019 or 2018. So that's a big component. But I also do think there's gross margin opportunity. And I think the gross margin opportunity is around a couple of things. Just being tighter around, you know, what I would call is some leakage that, you know, sometimes occurs when you're growing a business. And we've spent a lot of, resources on quoting tools, technology, incentive plans to make sure that we minimize that leakage, and then also solution selling. And this cubic platform, I think, is a real driver of not only market share but value added. I mean, that's the obvious example, but there's lots of other examples to the business, customer value agreements, solution selling, not just selling the piece of equipment. And I think the increase in sophistication of pricing, really tight on process, and much more solution selling value-added services to the customer allows you to expand gross margin over time.

That's great. And just, Scott, I mean, are you seeing that now, or is that something you expect to see, I guess, in the next couple of quarters?

I think you've seen it. I mean, if you look at those numbers across every single business line, gross margin expansion. in a very competitive market and in a market where we are not increasing pricing, being very sensitive to pricing for our customers who are in a tough spot still. But I think the combination of solution selling, value-added services, a constrained supply chain, you're seeing the impact of that. And it's nice to see across, I think, every single business line. this quarter.

And I'll just add on inventory health. I mean, the inventory is in a really strong position, and having the right inventory at the right age at the right time, you know, makes a big difference.

That's great, guys. Thank you.

The next question comes from Ross Gilardi with Bank of America. Please go ahead.

Hey, good morning, guys. Morning, Ross. Scott, I know you're making good progress with the electrified underground loader, and you mentioned, I think, the 10 units in backlog with Codelco. I'm curious more on the surface mining side with, say, for example, like the CAT ultra-sized trucks. How much urgency are you sensing from CAT's large mining customers for Caterpillar and Finning Together to present more of like a comprehensive roadmap on how and when they're going to decarbonize that part of the product catalog, given some of these very bold emission target reductions that many of those same miners have presented to the market. Is that a big deal right now, or is that just something that's out there like a decade from now that they're not really that preoccupied with yet?

Yeah, okay. There's a lot of layers to that question, Ross. So let me take a couple of stages of time. One, thanks for noticing the underground. You know, we're really pleased with the underground. You saw the Codelco underground, and actually just walking into this meeting, I understand we got another PO for 10 pieces of equipment for another miner in underground in Chile. And so we're really pleased with that underground activity. And as you said, you know, underground is the logical place to start. on battery-powered equipment. And when you look at CAT's offering, they've got a battery-powered underground loader that we're really excited about. So I guess that's point one. Point two, as you think about ultra-class truck surface mining, I think there are some misconceptions out there. We talk about a mechanical drive truck, an electric drive truck. I mean, both of these trucks are combustion engines, right? So there is no battery-powered ultra-class truck out there right now from anybody, right? You know, that being said, You know, as you think about the energy transition and, you know, what our customers need, they are increasingly looking towards, you know, a battery-powered or hydrogen-powered, you know, lower-emission solution. And I do think the roadmap for that is longer term. It's not immediate. It's not next year. It's not, you know, it's not the year after. But there is pressure on that. And I think the great news from our perspective is we're partnered with Caterpillar on that. And, you know, you saw Caterpillar's announcement last week when they did the results. They used a case study of the mine in Quebec where they are partnering with, you know, a customer to provide zero emissions type equipment. So I guess my point is no one's figured it out yet. There is a lot of urgency around it, and Caterpillar is very focused on it. And so I do think, you know, over the next couple years, progress will be made. But right now, you know, the option for a customer in the ultra-class side is a combustion engine. Now, I do think because of, you know, this transition, you probably see some customers wait a little bit on the capital expenditure to have big new fleet renewals until the transition and, you know, where the OEMs are heading is a little bit clearer. And does that result in a little bit of capital constraint over the next couple years? Potentially. And for us, obviously, that's an opportunity on rebuilds and maintaining the fleet. So that's something we'll be very focused. So hopefully I answered the different layers to your question there.

No, that's great, Scott. You just at the very end answered part two of my question. So do you think that is part of the reason why Rebuild activity sounds like it's picking up yet again, even though the fleet is very old at this point, that they're essentially trying to maybe buy some more time until they get more clarity on what's going to be available in the next kind of five to ten years?

Yeah, I do think that is – I do think that's potentially the case. I mean, I think there's a lot of things going on right now, right, where you have balance sheets that need to be repaired, you have a capital constraint environment, you've got this energy transition. And so that's all contributing to maybe a little bit of, you know, hesitancy on big new fleet renewals. The other thing that I would say is autonomy plays a major role in this transition, right? As you think about, you know, the energy transition, autonomy plays a massive role. And it is, you know, I think one of the reasons we're in those conversations with all of our customers, and we couldn't be more pleased with the progress. And we do believe Cat's got a competitively advantaged company. solution on that from, you know, retrofitability, interoperability, scalability, speed. And we've got, as you know, the two no longer pilots in Canada. I mean, these are real operations that are up and running. And now in South America with Codelco and TAC, you know, we're moving hard on those implementations. And I think that, you know, plays a large part in the energy transition as well.

Got it. Thank you so much. Thanks, Ross.

The next question comes from Sherilyn Radborn with TD Securities. Please go ahead.

Thanks very much, and good morning. Good morning. As you think about current activity levels, I'd just be interested in your thoughts as to whether we're seeing, on the one hand, a bit of a release of pent-up demand from last year, and on the other hand, maybe a bit of a pull forward as customers try to get their orders in early in anticipation of extended lead times and maybe some constrained availability for a certain model. Just your thoughts on those dynamics.

Yeah, a little bit different by each region, but it's healthy in all three. And so, you know, we're not seeing a particular pull forward, no doubt. I think customers are having an easier time making decisions. I wouldn't say we're seeing A lot of examples of people accelerating at scale. I think it's a healthy market. Order intake's strong. Backlog build's healthy. I wouldn't say that we're seeing a large pull forward. We really ramped up inventory purchases last fall. We were having inventory arrive and go out the door quickly and we got some inventory to sell. Our inventory was actually up year to date, quarter over quarter. We feel like we're in a solid position, but don't feel like that was a major theme for us.

Okay, that's helpful. And then in terms of Argentina, that really hasn't been mentioned very much. Is that still just a pretty constrained place, or is there a scenario where maybe that offers some upside?

Yes, Cheryl and Scott. Argentina has been difficult, as you know, and I think the good news is the team has done a fantastic amount of great work to get that business repositioned from a cost and inventory perspective. And now it's unfortunately still a little dilutive to the overall South America earnings. but it's doing better than break-even. And so we've still got some more progress to make that accretive, which you would expect it to be, given the risk profile to the overall South American business. I think just saying that, that also highlights how well Chile's doing, because even those results incorporate Argentina. Right now, Argentina's, I don't know, it's a $150 million business, and until we get a little bit more comfort on exchange controls, on the devaluation. We're going to be pretty careful. That being said, we've got some really very important, good customers like Barrick and Newmont who are investing money there, and we're trying to support them from a product support perspective. And so it's something that's kind of day-to-day combat, in all honesty, around this team and making sure that we protect ourselves while at the same time and service our customers.

That's great color. That's my two. Thank you.

Once again, if you have a question, please press star, then one. The next question comes from Brian Fast with Raymond James. Please go ahead.

Thanks. Good morning, guys. Good morning, Brian. Just looking for more color, I guess, can you elaborate on the increased market share regarding the HS2 opportunity? What do you believe has been, I guess, the key driver there?

Hey, Brian, it's Scott. So listen, I think this story goes back three or four years ago. You know, we engaged with a number of customers on the Qubit platform. We developed an extremely strategic relationship around how they wanted to run their operations. We became a technology partner to them as it relates to Cubic, and that positioned us well for market share on the new equipment side. And so this is not just one customer. It involves a whole bunch of contractors as well. but our market share is, I think, you know, we said significantly higher. It's kind of three times higher than what would historically be the case. And the benefits to the customer around the Qubit platform are significant, and we hopefully showed you some of that at Investor Day. And so, you know, beyond the kind of the regular sales excellence and, engaging with the customer and all those things that we do day in and day out, the big differentiator here for that whole project has been Cubic.

Okay, thanks Scott, that's pretty clear. And then just one of the large Canadian contractors recently talked about a feasibility study for the blending of hydrogen and diesel fuels for some of the heavy equipment. I believe this is something you highlighted during the investor day, but would this also represent a longer-term opportunity for the forward fuel side of the business?

Yeah, thanks for mentioning that, Brian. I should have highlighted that when Ross talked about the energy transition. I mean, you know, another great example of Caterpillar's ingenuity and leadership is the 3500 engine, the dual gas blending engine where you can do diesel and natural gas. And, you know, this may have been a little bit under the radar, but you may have noticed that Caterpillar signed an MOU with Sorteros around, you know, natural gas distribution into primarily the Permian. They're customers, they all serve customers in the Permian. And we are now, have just set up a couple-day event here in – in Calgary or Edmonton, I can't recall which one, sorry, in the next month and a half, where we're going to bring our oil field service customers on site with Sartaris, with Caterpillar, to show them the 3500 engine dual gas blending and inserting hydrogen. And that hydrogen, what we're seeing is 20% tight blend on hydrogen. into that 3,500 engine. Now, and here's an example of CAT leadership. I mean, no one has the DGB engine like CAT does. I mean, the market share for CAT in that engine is off the charts. And what we're seeing with our customers in oil field services, they're still losing their purse strings, but this whole transition from, you know, diesel engines to dual gas blending engines is win-win, right? You get lower prices because of the gas price. similar performance, and then the optionality down the road, and this is, again, piloting stage for hydrogen blends, so another great example of CAT leadership in this area.

Yeah, that sounds like a great opportunity. That's it for me. Thanks.

The next question comes from Asabahat Khan with RBC Capital Markets. Please go ahead.

Great. Thanks, and good morning. Just to follow up on the HS2, I think you indicated that you are coding for 2022. Can you maybe share the competitive dynamic there, I guess, in having been a partner to them and being involved in 21? Is there any sort of a lake up relative to competition, or is there sort of like a jump ball in terms of securing more business there?

Yeah, thanks, Saba. So I think we said, you know, we expect environment, and we deal with that every day. Again, I come back to Qubic. and the platform and the differentiator. And our competitors don't have that. And that's really important if we think about execution of that project for all of our customers.

Great. And then I think Greg mentioned the $250 million of potential investments and the internal competition for that. I guess is it largely just you know, ROIC-based, how are you thinking about allocating that money? Or is a competition purely sort of, hey, look, whoever can bring the highest ROIC project gets a capital? Just wanted to get an idea of how you're prioritizing the investments.

Yeah, the way we look at it is, you know, discounted cash flow per share. So, you know, it's really about, you know, the net asset value of whatever business we're looking at versus, you know, what a share buyback can do to your near term. And we'll check that versus a share buyback. And, you know, You know, when the share price, with the business plan that we've got, that we have a lot of confidence around, that's really compelling, that we don't feel like we get full credit for. You know, share repurchases are pretty attractive, and so it takes a pretty high bar for acquisitions to get past. It either needs to be a lot of synergies and very accretive, or it needs to have a really high NAV impact over the medium term. So that's how we'll do the balance. You know, as of today, you know, share buybacks win in most cases, but we're looking at some smaller bolt-ons that have some pretty attractive returns that might get above the threshold.

Great. Thank you.

The next question comes from Devin Dodge with BMO Capital Markets. Please go ahead.

All right. Thank you. Good morning, guys. Good morning. um maybe you know at the investor day um i think you were highlighting that the vast majority of equipment sales uh included some form of customer value agreement so you know in the current environment where you're starting to see some stresses on the supply chain you know lead times are extending out i think product availability it probably depends on specific components and equipment but it's probably less than optimal generally um how should we be thinking about the risk of we'll say higher logistics or even component costs. I'm just trying to get a sense if these potential costs are shared with the customer or Finning bears all this risk and maybe what levers are available to Finning to mitigate maybe this cost inflation.

Yeah, thanks, Evan. So, you know, I think we're managing quite well. You know, we've done this through many cycles and, you know, we're managing, you know, our metrics around availability of parts really well. And so, Well, no doubt there's certain spots where there's longer lead times. You know, I think we've got higher safety stock in some of those and really collaborative with CAT and feel like we're managing through that well. So we feel like currently we're in a good spot. You know, wider gaps happen to emerge. You know, there are some degrees of freedom in the CVAs on timing and whatnot that, you know, will allow us to work with customers to execute, you know, at the appropriate time and with a little wiggle room. But also, you know, In many cases, there's annual resets on pricing and whatnot that allow for some sharing of that risk if there was higher costs and whatnot. But for now, we think it's really manageable and a day-to-day challenge, but we think we're managing through really well.

Okay, good color there. I believe there are currently a few mediation processes underway in Chile between the unions and the miners. I think there's one at Escondida as well. Just not much visibility into how this unfolds, but from Finney's perspective, is there some deferred maintenance work at these sites that could be done to mitigate the impact of a potential strike, you know, at least for a brief period?

Yeah, thanks, Devin. So I guess a couple things. One, I think we'd highlighted there was a lot of labor activity in Chile. And so, you know, status update, I think we've worked through any challenges we've had, which is good. So we've got some stability on the labor side, but some of our customers are still working through that. And Escondido is obviously the highest profile case. You know, I think that will come to a head here August 10th or 11th. And so they are in mediation right now and going back and forth. You know, we've been through this before. So as you recall, I think in 2017, There was a seven-week strike in 2018. We went right to kind of the cusp, but before they came to a solution. And in both of those cases, we were very well ingrained with the customer and trying to help them mitigate the impacts and work through it. It's similar to right now, and so we're standing by to help Escondida to the extent we can. I think if you look back at those examples, it wasn't a material impact to us from a financial perspective, and I expect that to be the case here as well, and hopefully this is an opportunity to help Escondida and show them what an important strategic partner we are for them in times of challenges, and we'll stand by and do that with them.

Okay, thanks for that, and congrats on a good quarter.

Yeah, thanks, Devin.

The next question comes from Maxim Sitchevo with National Bank. Please go ahead.

Hi, gentlemen. Good morning. Good morning, Max. Scott, and I guess maybe Greg, if you don't mind, to potentially chime in. I mean, one of the things that, I mean, I know that historical investors looked at, you know, CAD sort of from incremental, decremental margin perspective, but, you know, we kind of, you know, like that approach. And when I look historically, you know, like it's been quite volatile, and it's only now that I'm seeing, obviously, there was a positive incremental margin build in 2020 than in 2021 and potential for 2022. So do you mind maybe like, you know, highlighting what you think is kind of structurally different right now is the fact that the footprint is sort of properly sized for the revenue opportunity, the SG&A, kind of all of these combined. So, because I think that's obviously could be potentially pretty exciting part of the investment thesis as, you know, incrementals are really coming through.

Yeah. Thanks, Max. I mean, as you know, even, following this for a long time and we've had lots of conversations. I mean, this has been, you know, a pretty heavy lift from a cost perspective to get, you know, the organization in a place where, you know, we were maintained our competitiveness. We're able to continue to, you know, grow our market share and at the same time, you know, service our customers and, and grow profitability. And I think the encouraging thing is, you know, you're starting to see that. And so if you look to 2018, which was a similar revenue base, you see the impact of those reductions. And I think now you're seeing the impact on the competitiveness too. Like if you look at the market share in terms of these new big mining deals and some of the progress we're having in South America around Codelco and tech, you know, just highlights, I think, you know, the progress we've been making. And I feel really confident we're going to get to 17% on that SG&A sales. And, you know, I think there's more, right? And I don't think it's people productivity. I think a lot of it is, you know, supply chain redesign, facility productivity. You know, as Kevin and the team that we're replicating across the whole company implements this RRR strategy, I mean, this is probably one of the biggest challenges changes definitely during my time around how we operate our business. You have the right work done in the right place by the right people. And that sounds easy, but it's a huge change management exercise. And Kevin's taken that on as well into the implementation of that. And that will bring even more cost and productivity efficiencies. And so when Greg was asked a question around cost coming back into the system, I mean, of course, there'll be some discretionary costs and travel, et cetera, but I continue to believe that there's a lot more fixed cost opportunity here. I've given you just one example. I could go to the warehouses. We've got three or four warehouses in Edmonton that Alex and the team are addressing. I could go to e-commerce. And look at the progress we've made on e-commerce. Now 50% of our parts online are e-commerce, but we haven't yet thought about the back end and how do we reduce the cost base to reflect that. And so as you get into this and you get the company thinking about it in a low-cost kind of fashion, more opportunities come. And I think as you look forward here, you'll continue to see that. So that's point one. Point two, when it comes to Michael's comment on gross margin, We've been in a very difficult spot around commodity prices and reacting to our customers and trying to help them through that, which we've done. And that's created, obviously, some gross margin pressure, which we've offset through the FCNA. As we look forward and we talk about things like QVIC, we talk about things like customer value agreements, we talk about things about more sophisticated pricing and focusing on how we sell and linking that to the supply chain. you know, you start to see enhancements in the gross margin as well. And I think that is really exciting. And we're, you know, in the early days of that, you're starting to see that through the business, through HS2, the HS2 project, and, you know, through some of the results you're seeing this quarter. And that will continue as well. So I do think there's a structural change here that allows us to increase the earnings capacity of this business going forward. And I haven't even talked about the ROIC side. As you know, I think about ROIC and supply chain and the fact that sales down but inventory turns up by 20%. I mean, when you combine those two things, increased profitability with more velocity on the supply chain, good things happen. And so you look at Finza right now, 17% ROIC in an environment where you have COVID. I mean, that team has got both the supply chain and the profitability working together, and that's gonna continue to increase. And so I'm really encouraged about where we are from a cost inventory and capability perspective right now.

And I'll just add on one piece is just, I mean, that was the investor day framework is, you know, it's been quite some time since we've had a sustained up cycle and we're pretty confident given, you know, consensus GDP and commodity prices that we're in, you know, kind of a multi-year version of this, you know, 18, 19 was kind of three or four quarters together. So it's been a while since we've had a sustained up cycle and we think that that'll be really helpful for our, and we've got early momentum.

No, that's great, and thanks a lot for a very comprehensive answer. I appreciate it.

This concludes the question and answer session. I would like to turn the conference back over to Craig Palaszczuk for any closing remarks.

So thanks, everyone, for joining today. I appreciate your attendance, and have a safe day.

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