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New Flyer Industries Inc.'s Xcelsior CHARGE zero-emission, battery-electric bus.

New Flyer Industries

North America's largest transit bus and motor coach manufacturer and parts distributor, New Flyer Industries Inc., has seen its share price travel to a record high in January.

The company's President and Chief Executive Officer Paul Soubry recently spoke with the Globe to discuss the potential impact from tariffs, NAFTA, and his business strategy.

Here is why Mr. Soubry believes the company can capture further value for its shareholders down the road.

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U.S. President Trump's announcement on tariffs, can you discuss the potential impact to your company?

NFI Group buses and coaches are built predominantly with U.S. steel and aluminum products. The more concerning issue with respect to these potential tariffs, if Canada is included, is the impact they could have on the integrated North American supply chain, as well as the impact on a positive outcome in the NAFTA negotiations.

Let's discuss NAFTA then, what are the potential implications?

The moral of the story is NAFTA for us, we think is more of a speed bump than a roadblock. If NAFTA went 100 per cent away, we would mitigate some of our build strategy, instead of building a full bus in Canada, we would build it in our facilities the U.S. and so forth. We have 32 facilities, 65 per cent of our productive labour is physically in the United States today, and so we would adjust some of what we build at what locations and we might change some of our sourcing strategies, but it's far from a fatal issue for our business.

Let's shift to your operations. You have three core business segments: transit buses, motor coaches and after parts, with the acquisition of ARBOC Specialty Vehicles LLC, should that be considered a separate business segment or should it be included in transit buses?

They are clearly different buses, but here is how we are looking at that. ARBOC's customers are largely public transit agencies. ARBOC is a business early in its development so going from five or six or seven buses a week to 15 to 20 to 30 … So what we have decided to do is not to create its own segment at this point but to put it under our transit business so that we help it grow and develop in what parts we make for their buses, how we scale their production lines, how we enhance some of the propulsion offerings there, for example, that our transit business has lots of experience with natural gas, or hybrids, now electrification and so forth, all those kinds of expertise that we can bring to ARBOC. Today, it's a relatively small business, last year I think it delivered 360 units, this year we are targeting 500, we want to keep growing the thing, and it could ultimately be its own segment. Today, we are birthing it from inside transit.

Are you the market leader in all of your market segments – bus transit, motor coaches and after parts?

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Yes.

I believe ARBOC has 70-per-cent market share in North America.

Yeah, it's quite interesting … but this expression of cutaways was birthed many years ago in the industry and we have those when we go on airport shuttles and hotels and those kind of things. What ARBOC decided to do was modify the chassis to allow it to be low-floor so that people could roll on and off with their roller bags and also with a wheelchair or scooter if you need it.

The total cutaway market is somewhere around 15,000 units of which the low-floor cutaway is only something like 500, so what is happening, the low-floor, we think, can upset or disrupt the high floors. What ARBOC does is they have 70 per cent of the low-floor, but it's effectively only like 2 to 3 per cent of the total cutaway market so we think there is a lot of runway there.

You are an industry leader with a strong earnings growth track record. Looking forward, should investors moderate their growth expectations?

There are two things in play going forward. We still have a very strong balance sheet so our ability to continue to grow by making targeted and strategic acquisitions is absolutely still there. We think we've built a bit of a track record of being prudent in how we buy and strategic in the types of things we go after. The second issue is that we still think there is earnings and cash flow in our current business.

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Speaking of acquisitions, is there a vertical that you are not in currently that would be a logical fit for you?

Well, the two major verticals, or segments of buses if you stay in the bus definition, one is the high-floor cutaway space [buses that range between 21 and 35 feet in length such as shuttle buses]. We don't play there today, we are going to try to disrupt it with the low-floor, it's a very large market. The second one is school buses … We are going to continue to try and look at where we've got core competencies and where we can apply these. We've got a strong balance sheet, and, if we can find the right opportunity, we can definitely do what we've done in the past, which is execute on acquisition.

School buses seems like a logical fit to me, does it to you down the road?

We say we'd like to play where there is both an OE element of it: design, build and deliver the buses and also a parts story to it. And so absolutely both high floor cutaways and school buses could be scenarios where we would go and say, hey that's something we could play at.

For context, the average selling price of a school bus is somewhere around $90,000. The average sale price of a New Flyer or a motor coach is something like $500,000.

However, margins are something that you have stressed, not price. You have emphasized looking at the EBITDA margins.

The reason we say that is the variability of sales prices is highly dependent on the customer specifications … so you can see the exact same bus in one city and another city but by the time they finish putting cameras and special windows and different kinds of seats … the price of the bus can dramatically change so that's why we guided our investors, don't get too excited about volatility around price, look at what we are making off of those buses as a way of assessing our performance.

What are its margins like for school buses?

The pure dollar margin is going to be materially less than what we see, probably closer if not even less than what we see in this ARBOC segment. The offset though is that in the school bus world there is massive volume. There is somewhere around, just to compare and contrast, in our transit space, we think of about 5,500 to 6,000 units a year in North America. In the school bus space, that's 35,000 to 40,000 units at play. The build lines are different, the takt times on how you build it in the plant, the volume is different, the margins are different. They are both buses but they are very different in how they are built and how they are sold and the margin profile. The good news is we are going to continue to try and look at where we've got core competencies and where we can apply these. We've got a strong balance sheet and if we can find the right opportunity, we can definitely do what we've done in the past, which is execute on acquisition.

School buses is something you are exploring and it could a segment that you are involved in down the road, perhaps in the next two years?

We are continuing to explore all type of buses in North America and now quite honestly, we think we've got some really neat core competencies … and so we are starting to look at those core competencies, how they might apply in North America but also how they might apply to buses in other parts of the world.

That leads me to another one of my questions, are you considering expanding geographically outside of North America?

Well, it is a good question and if you think about the history of this little ol' Winnipeg business that kind of was a Canadian business that then grew up and expanded in the U.S. and then expanded to coach and now other stuff. At the same time, today we're a North American focused business, largely U.S. oriented, 90 per cent of our revenue is from the United States and so we absolutely are starting to look beyond our current areas of comfort…I would suggest that the areas that we're starting to look might be places where the approach to buses are similar ... which might be places like the U.K., or eastern Europe or Australia.

Your prudent and disciplined acquisition strategy, is it limiting your buying opportunities? Are prices expensive right now? The last acquisition you paid 10 times 2017 adjusted EBITDA for ARBOC.

I would say it's limited our M&A [merger and acquisition] basket because we've limited ourselves based on the definition of what we'll go after.The 10 times is well beyond what we've paid historically based on trailing EBITDA. ARBOC we felt was different because when we started to look at their order book and their sold slots for 2018 and beyond, they proposed a business that was going from 360 or 350 to 500 units in 2018 of which two-thirds of that was already sold before the year started so we felt very comfortable that we could value the business, in that case, on a forward multiple more than a trailing multiple, it was a more appropriate way to look at it.

So it leads to think that the pace of your growth may moderate because prices for acquisition targets have increased, limiting your acquisition targets?

We don't look at it that way... Our perspective on anything that we've been able to buy is not only purchase price but also how much money have you got to put in to the business to get it to where you want it go. For example, when we bought MCI, the business for 20 years went though I think six ownership changes, it went through bankruptcy, it went through private equity, they weren't investing in the machine or the products and the IT system so in that case we knew in addition to buying it, we had to pump a bunch of money into it. Then the issue is how much can we bring to the table to add value by combining it with New Flyer.

The same thing applies going forward. I mean we think we've got a list of core competencies and expertise, and so purchase price is only one element. Where can we take [it] and what can we bring to the table from a competitive perspective to make that payback and deliver value to shareholders [are other factors to consider] so it's not just a purchase price driven issue to be quite honest. The good news, again, is that we've got a very solid balance sheet, we've got a bit of a track record over the last 10 years that if we find the right opportunity, we can definitely execute on it, and I think we get credit from the banks and the investors that based on our track record of decision making that it's been very balanced and very focused and that we bring something to the table.

What's your debt-to-EBITDA at?

Well, we are just in the process of issuing our Q417 (fourth quarter 2017 financial results) so I can only really focus on Q3 public results but its roughly slightly less than 2 times.

Do you have a comfort level were you aim to have your leverage ratio?

We've always publicly stated that we would like to run in the 2 to 2.5 [times] range. In the case of MCI, we went to 3 leverage, but we had a very clear path to de-lever the business, which we did at a quite aggressive pace in terms of getting back down sub kind of 1.7, 1.8 I think it was within a year and a half. We are not afraid to stretch our comfort zone if we believe that there is a clear path to bring it back down.

You have previously stated that the competitive environment in the transit and motor coach market has intensified. What competitive pressures are you seeing and how is this impacting you?

In the transit space, the real area that's adding a competitive dynamic and pressure is that we've got a couple of companies now exclusively selling electric buses and not that their volumes are material yet but the introduction of competitors who are making promises around range or capacity or charging standards and so forth has caused a little bit of a competitive pressure if you will on pricing and performance. In the motor coach space, there are no U.S.-based manufacturers. You have us and you have a company that's in Quebec and then you have guys that are importing buses from Europe or Macedonia or Turkey and so forth, and there's discussions by some of them about setting up capacity in the United States … Which is why our strategy is as much about growth at the top line [revenue] or about evolution of our propulsion systems and our offerings…[as it is] about continuing to optimize and be the lowest cost producer as best we can.

One of your internal goals is to bring together your business segments to derive efficiencies by the end of 2018. Are you on track with this goal?

The first thing we did at the start of 2017, we now have Presidents running the businesses … and that's made a massive impact on the quality of the data and the speed of decision making. The second issue is that we wanted to try and get the New Flyer parts and the motor coach parts businesses together as one….by the end 2018, not only do we want the management teams together as one group, which we are there today, but by the end of 2018, and in fact, likely in the third quarter, that the entire parts business will be on the same IT system, which then sets us up to look at overheads, the number of warehouses and those things from a cost perspective. The other part of that is the efficiency of freight, with so many warehouses you are moving parts around a lot, so we are right on track to be able to have that done by the end of this year.

Your EBITDA margins have been steadily increasing, where will they trend do given these initiatives?

Well, there are two components. When you think about our two reportable segments, one is, for lack of a better word, making stuff, the OEM side of our business and manufacturing, each of those businesses continues to have good progress on the improvement of the margins, again notwithstanding the volatility of sales price. Again, we don't give guidance about where the they will go in the future but we continue to have, we think, a very focused plan to continue to grow the margin dollars. On the parts side, in addition to us going after the cost base by bringing it all together, we've had pressure and our parts business has been under some headwinds on revenue … I always say to our investors, if our parts business is volatile, I'm not that worried because at the end of the day, if we make $300-million of EBITDA, if I make $70-million or $75 or $80 on parts business, that's wonderful, our real business is designing and building buses. The parts business is about satisfying a customer so that the next time he want to buy a bus, he's happy with the way we've supported [him] and we are at the front of the line.

What is your operating capacity?

The transit bus business has three different manufacturing systems…most of those facilities are on single shifts … So all that to say is that we are building transit buses with something like, were at 75 per cent to 80 per cent of our capacity before we've got to out and change buildings and grow buildings. The motor coach side is kind of in the same place. The motor coach has two different models built on two very different lines that we are in the process of trying to come up with a strategy of harmonizing those onto one production line so it has ultimately more capacity than it would have today. The ARBOC or cutaway business has lots of capacity, we are just two months into it, but we can double or triple that business before we've got to worry about facilities.

Do you envision that in 2018, you will need to invest in new manufacturing facilities for transit buses?

We've got no plans at this point in time, or no hard and fast plans, to go out and be building more facilities.

Let's talk about your electric business, what is your strategy even though it's probably going to evolve very slowly?

We think electrification is going to be evolutionary not revolutionary. It's not like we are going to see our industry go to all electric buses any time soon. There are still lots of issues. For example, there are no charging standards that are approved yet … by comparison Europeans now have electric standards for buses. The second issue is, that our view is, if we can work with our customers to have a common bus platform but be propulsion agnostic that allows them flexibility to migrate over time. So I use the example of New York City, they have diesel buses of ours, they have natural gas, they have hybrids and now they have all electric, all under the same Xcelsior program … There is also the reality of the funding environment. It's one thing to get special funding from the Feds or from the State to buy five or 10 electric buses but now when you start to think about that going mainstream, the amount of charging infrastructure whether it's at depots, on routes, and so forth is not trivial, [its] very expensive … Our view is that the economics will make sense not too far away in the future around electric buses.

How are the U.S. state and municipal budgets right now?

The general economic health in the U.S., which is 90 per cent of our business, continues to be very robust and strong … When we go back to those transit agencies and ask them about their fleet replacement plans and their budgets and so forth, we continue to see a fairly nice healthy, albeit slow, growth of the fleet replacement and the fleet.

Since 90 per cent of your revenue is in U.S. dollars, do you have a currency hedging strategy in place?

Well, the New Flyer business is effectively naturally hedged. In the motor coach case, there's a slightly more Canadian dollar cost base and so for that we use a number of instruments for hedging, but it's not a massive part. We're largely naturally hedged as a company.

Of your 32 facilities you don't seem to have a large presence on the west coast?

No, and some of that is just history and evolution of the business. Both New Flyer and MCI ironically were founded in Winnipeg … so today on the west coast what we do is service, completion of buses and we sell some parts, we don't have any manufacturing in California or on the west coast.

Is that region a void where you want to expand to?

It could be but at the end of the day, it's really to us about facility optimization. There are some contracts that we bid on that want State content but for the most part they use Federal funds, which means you can't differentiate about where it's made and which State. So we'll build a bus in Alabama and we'll drive it to Los Angeles just like my competitor will build a bus in Riverside, California and drive it to New York City. Freight and delivery as a percentage of the total cost is relatively small so to us. It's been very much about optimizing our facilities and getting really good at what we build and where we build as opposed to worrying about local delivery or local capability. Having said that, we've put service or we've put completion centers where we felt they made sense.

In terms of optimizing your facilities, a key objective of yours, how far along are you on your internal plans ?

I will give you an example. In Winnipeg, we used to have two production lines so with two lines you have twice the inventory located on the production line, you have redundant manufacturing, engineers, overheads and so forth. In New Flyer's case in Winnipeg we harmonized those onto one line and we built mezzanines so that people are working on top of the bus and underneath the bus at the same time at half the footprint, which means we were able to cut the takt time in half, which means we have more process efficiency. That's a good example of the New Flyer side of the business that's fairly mature at the efficiency. The other thing that we've been doing is picking off certain parts to make ourselves so I'll just give you an example. Imagine the rear door of a bus, so we buy or make our own fiberglass … You eliminate all kinds of handling and damage and scrap. MCI is a couple of years behind and some of that is what I described before, a business that went through a lot of turbulence not a lot of investment in the physical facilities or the IT systems so kind of half way through the journey on MCI of really optimizing that portion of the business. The ARBOC facility is still in its infancy. As I said before is making six or seven buses a week, it's really not mature in terms of the production line but we're already in there working with them.

Sound like a lot of roadway then. Driver-less buses do you see that as a reality in the future?

In the future, yes … It's going to come but it's not tomorrow ... We think we're going to be later adopters not early adopters.

Over the years, you have steadily increased your dividend returning capital to investors. What are your thoughts on a share buyback program?

Our view on the share buyback is that we've never really talked about it until now. Is it a tool that we want to have in our tool box ? We haven't yet come down to a decision of if we want to do that our not. We feel that the best use of our capital now continues to be putting it back into strategic acquisitions and the investment to optimize our business and improve cash flow and EBITDA.

Is that something you will be discussing at upcoming board meetings?

It is absolutely on every board meeting agenda.

What are you key priorities in 2018?

First and foremost, we are really focused on people … We use this expression, "A pursuit for being an employer of choice."….The second issue is we're dead set focused on shareholder return so you balance that employee focus with a reasonable return on invested capital. We pay a dividend so we feel is there a nice little yield story there for the business ... At the same time to prove that we can reinvest and deliver growth so that return on invested capital is the way that I get paid, for example, from a long-term perspective and that we are trying to align everything we do with that.

The priorities in the short-term obviously continuing to execute on the integration of our parts business into one is a big priority for 2018. The investment in MCI [Motor Coach Industries International Inc.], to bring the facilities and the systems and the product development stuff up to standard, and there has been a lot of new product development there and getting that to market is another key priority. Then this issue about really trying to understand where's our next leg of growth.

Any closing remarks?

We're really proud of where we've come from. We've got a lot of history. We've pulled together some really blue-chip brands in the bus space. We think we've built a really neat brand from little 'ol Winnipeg here in terms of being able to do that and delivering on performance for our shareholders. So we are quite bullish and excited about where else we can go, and to have the financial flexibility and a solid board and a track record – it's pretty exciting.

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