Wajax Corp

TSX:WJX

Earnings Call Transcript 2022-Q1

[Operator]

Thank you for attending Wajax Corporation's 2022 First Quarter Financial Results Webcast. On today's webcast will be Mr. Iggy Domagalski, President and Chief Executive Officer; and Mr. Stuart Auld, Chief Financial Officer. 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 Iggy Domagalski.

[Ignacy Domagalski, executive]

Thank you very much. Good afternoon, and thank you for participating in our first quarter call. This afternoon, we'll be following a webcast, which includes a summary presentation of Wajax' Q1 2022 financial results. The presentation can be found on our website under Investor Relations and Events and Presentations. I will provide you with a general update and then turn it over to Stu for comments on backlog, inventory, cash and the balance sheet.

To begin, I'd like to draw your attention to the cautionary statements regarding forward-looking information on Slide 2, 3 and 4. Additionally, non-GAAP and additional GAAP measures are summarized on Slides 18 and 19 for your reference.

Turning to Slide 5. Revenue of $439.5 million was up $52.4 million or approximately 14% in the quarter. The increase in revenue resulted from higher industrial parts and ERS sales in Western and Eastern Canada and higher mining sales in Western Canada, including 1 large mining shovel delivery in the current quarter that was earlier than originally planned. EBIT of $26.4 million was up $4.2 million or approximately 19% in the quarter. There was no benefit in the first quarter this year from the Canadian Emergency Wage Subsidy, which last year had a positive effect on EBIT of $6.3 million. Excluding the effect of the wage subsidy in the first quarter last year, EBIT increased $10.5 million or approximately 66%. The improved EBIT resulted from higher volumes and margins and a higher proportion of industrial parts and ERS sales compared to equipment sales. These increases were offset partially by higher selling and administrative expenses and the prior year recovery of personnel expenses from the CEWS program without a similar recovery in the current year.

Selling and administrative expenses as a percent of revenue increased from 13.9% in the first quarter last year to 15.3% in the first quarter of 2022. This increase was due mainly to higher salary costs as the volume of business increased over the prior year, additional expenses related to Tundra and a prior year recovery of personnel expenses from the CEWS program without a similar recovery in the current year. Management remains committed to ongoing cost productivity.

Adjusted net earnings of $0.73 per share was up $0.14 or approximately 24% in the quarter, noting the adjustments recorded on this chart. At the end of Q1, the year-to-date TRIF rate of 1.42 increased 1%. Safety continues to be Wajax' #1 priority, and management is committed to continuously improving our safety programs to improve on this result. We would like to thank everyone on our team for their ongoing dedication to workplace safety.

As previously stated, the company did not recognize any reimbursement of compensation expense for the CEWS program in the quarter. We have included a description of last year's wage subsidy and the application of the amounts at the bottom of this slide for your convenience.

Turning to Slide 6. The revenue increase of 14% in the first quarter resulted from growth in Eastern and Western Canada. Central Canada sales of $76 million decreased 6% in the quarter, mainly due to lower construction and forestry equipment sales, offset partially by strength in industrial parts and power systems sales. Eastern Canada sales of $156 million increased 4% in the quarter due to higher bearing sales, driving higher industrial parts revenue. Western Canada sales of $207 million increased 33% in the quarter due primarily to ERS and industrial parts strength due to strong sales from Tundra and robust bearing sales as well as higher mining equipment sales, including 1 large mining shovel delivery and higher product support revenue in the mining and construction and forestry categories.

Please turn to Slide 7. An update on equipment and product support sales and year-over-year variances are shown on this page. Equipment sales of $117 million decreased 1% compared to last year, due primarily to lower construction and forestry sales, offset partially by higher mining sales in Western Canada and higher power system sales in all regions. OEM supply chain challenges have primarily affected equipment supply and construction, forestry, material handling and power systems, and those challenges are expected to continue into the second quarter of 2022. Product support sales of $125 million increased 16% due to strength in mining and construction and forestry revenue in Western Canada.

Please turn to Slide 8. An update on industrial parts and ERS sales and year-over-year variances are shown on this page. Industrial parts sales of approximately $129 million increased $25 million or 24%, due mainly to strong sales from Tundra and organic strength in bearing sales in all regions, but primarily in Western and Eastern Canada. ERS sales of $60 million increased $10 million or 21% due to strength in Western Canada. The higher ERS revenue in Western Canada was driven primarily by the acquisition of Tundra in 2021 and higher parts and service revenue in the Fort McMurray region.

Turning to Slide 9. The slide summarizes sales at a category level for the quarter and year-to-date for our company's overall groupings of heavy equipment and industrial parts and services. In the first quarter, heavy equipment grouping increased $17 million or 7%, driven by higher sales in mining and power systems, offset by lower sales in construction and forestry. Total growth in industrial parts and services categories of approximately $36 million or 23% was driven by increases in both industrial parts and ERS.

I will now turn the call over to Stu.

[Stuart Auld, executive]

Thanks, Iggy. Please turn to Slide 10 for my comments on backlog. Our backlog increased $115.8 million or 27% sequentially from the previous quarter and increased $263.6 million or 95% on a year-over-year basis. The sequential increase was due to higher orders in most categories, most notably the construction and forestry category and the ERS and industrial parts categories. The year-over-year increase was due primarily to higher orders in most categories, most notably, construction and forestry, material handling, power systems, ERS and industrial parts categories. Overall, backlog reflects continued momentum in heavy equipment and industrial parts and services business.

Please turn to Slide 11 for an update on our current inventory levels. Inventory increased $20.4 million compared to Q4 2021 due primarily to higher equipment inventory in the construction and forestry category and higher mining rental equipment and parts inventory, offset partially by lower mining equipment inventory. Inventory increased $30.4 million compared to Q1 2021 due primarily to higher work in process and parts inventory driven by increased sales volumes and offset partially by lower equipment inventory. We continue to work with major suppliers with a focus on construction, forestry, material handling and power systems equipment to help secure additional inventory to meet customer demand in 2022.

Please turn to Slide 12, where I'll provide an update on cash flow and leverage. Cash flow from operating activities in the current quarter of $19.4 million decreased $16.6 million from Q4 2021, mainly due to a decrease in cash generated from changes in noncash operating, working capital, in particular, higher AR and contract assets. Our leverage -- our Q1 leverage ratio decreased compared to Q4 from 1.29x to 1.24x due to a lower debt level in the current period and a higher trailing 12 months EBITDA. The corporation's leverage ratio is currently below the target range of 1.5x to 2x at the end of Q1 due to the strength in trailing 12-month pro forma adjusted EBITDA, combined with a reduction in debt levels on account of significant cash generated from operating activities. Our available credit capacity at the end of Q1 was $341.4 million, which is sufficient to meet short-term normal course working capital and maintenance capital requirements and certain strategic investments.

Please turn to Slide 13, where I'll provide an update on financial position. We continue to focus on working capital efficiency, which is a key component in managing our overall leverage targets. The improvement in inventory turns from Q1 is due to higher trailing 12-month average sales and lower average inventory level. Further opportunities to sell redundant real estate as well as sale and leaseback opportunities have been identified and are being pursued in 2022. Proceeds from any real estate sales will be used primarily to repay debt. The earnings impact from any sale and leaseback transactions is not expected to be material as any gains are expected to be approximately offset by the incremental lease costs over the term of the lease. Finally, the Board has approved our second quarter 2022 dividend of $0.25 per share payable on July 5, 2022, to shareholders of record on June 15, 2022.

Please turn to Slide 14. And at this point, I will now turn it back to Iggy.

[Ignacy Domagalski, executive]

Thanks very much, Stu. Our 2022 outlook appears on Slide 14. And rather than reading the outlook verbatim, I have a few important points here. Generally, in Q1, we were very pleased with our performance in terms of sales and gross profits and earnings. We were happy with our mix, which was 43% for our industrial parts and services category grouping and 57% in our heavy equipment grouping. And in that heavy equipment category, we're very pleased with how the Hitachi transition is going so far, which is effective March 1 of this year.

As we move forward and further into 2022, we continue to see sound fundamentals in many of our key markets, strengthened by improving commodity prices and increased capital spending by our customers. Those favorable market conditions still remain counterbalanced by the unpredictable nature of the COVID-19 pandemic and the related supply chain issues, which we expect will be a factor throughout the year ahead, particularly in our heavy equipment business. We continue to manage these challenges through frequent dialogue with key customers and key suppliers, preordering new equipment and utilizing repairs and rebuilds to extend the service life of our customers' equipment. Labor issues and inflation continue to be factors that we also continue to manage on a daily basis.

Our improved balance sheet and a record quarter end backlog of $540 million continue to show momentum in the business. And to maintain that momentum and to increase shareholder value, we plan to continue our focus on our following key priorities: investing in our people and their safety; continuing to develop and deliver exceptional customer experiences; organically growing our business, while also building our acquisition pipeline; supporting that close relationship with Hitachi; prudently managing our balance sheet; deploying our ERP and remote diagnostic systems; and continuing to build sustainability into our business.

Thank you very much. I'd now like to turn it back to the operator for any questions.

[Operator]

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

[Michael Doumet, analyst]

The first question I had, the industrial parts and the ERS business, that's been growing at a solid pace for the last several quarters now, Iggy. Any way you can help us break down the drivers exactly by, I guess, end market, share growth, company initiatives. Just really trying to get a sense for the overall sustainability of the growth rate.

[Ignacy Domagalski, executive]

Thanks, Michael. That's a great question. We have had solid results over the past few quarters. But really going back about 5 years, it's -- we've had good results in this business. Our cumulative annual growth rate in our industrial parts and services business for 5 years is about 13%, which we're very proud of. And there is no one specific thing that is driving the success in this business. We have great suppliers. We continue to invest in our key accounts program. We continue to add new suppliers where it makes sense. And because of the nature of our industrial parts business, we're able to substitute certain products where one of our manufacturers is not able to meet a delivery. So, whereas some of our competitors may be experiencing supply chain issues, which we are as well, but we're able to find those products from different suppliers, and that's been quite positive for us here during these times of supply chain challenges.

[Michael Doumet, analyst]

That's great. On the 13% that you just quoted, would you know offhand how much of that would be organic versus M&A?

[Ignacy Domagalski, executive]

Hard to tell, Michael. I have to get back to you on that one.

[Michael Doumet, analyst]

Okay. No, fair. And I guess moving over to product support. You moved from a somewhat soft Q4 to a record Q1. I'm assuming mining played a pretty big role there. I guess same question as last. Do you think this is sort of a fair base level as we think about 2022? Just again a question on sustainability and drivers.

[Stuart Auld, executive]

I think -- Michael, I think we had the same question in Q4 when they were down, and they've started to come back, especially from the impacts of Fort Mac in Q1. So believe they're sustainable now. But obviously, we rely a lot on what happens in Western Canada for this.

[Michael Doumet, analyst]

Perfect. Okay. I'll sneak in one more here. Again, it's kind of the Q4-Q1 contrast question. I think the SG&A Q4 had a couple of one-timers, I think up to $4 million to $5 million. Your Q1 SG&A is a little bit higher in comparison there. I'm just trying to get a sense for what drove some of the increases and whether we should see a step up in Q2 versus the regular seasonality.

[Ignacy Domagalski, executive]

Thanks for the question, Michael. I mean we're constantly working hard to control our expenses. And -- but at the same time, we've needed to continue to hire to build the capability to deliver the results that we did deliver in Q1. So it's a balance. In 2022, you can continue to see SG&A in that 14.5% to 15.5% range.

[Operator]

Your next question comes from Devin Dodge with BMO.

[Devin Dodge, analyst]

Look, just a quick question, maybe starting with your inventory position. You kind of touched on this earlier, where you have some maybe flexibility that others don't have. But can you give us a sense for where your inventory sits currently compared to where you'd want it to just given the demand environment that you're seeing right now?

[Stuart Auld, executive]

Well, I think, in general, Stuart. From the industrial parts side, we feel pretty good about the inventory level. But just given some of the issues in the market, we're looking at opportunities to beef that up a little, but not a ton. In terms of the equipment side, inventory is at a decent level, we could take more, but it's also dependent upon us getting inventory from our suppliers. So we feel pretty good about Hitachi right now. We've exited most of the Deere legacy equipment, which we think is great. The Hitachi stuff is starting to come in, more at a trickle to start, but we hope that, that will beef up as we go through the year and then obviously beef up to help us support the beginning of next year.

Tigercat, we feel pretty good, could always have more of that, and the same with Hyster. So don't feel too bad, but we're working, obviously, with our suppliers as we can to see what else we can get to meet or exceed demand.

[Devin Dodge, analyst]

Okay. That's good color. Maybe, Iggy, a question for you. Just -- you've been at -- in the CEO seat for a little bit now. Can you give any early thoughts on your, say, your vision for Wajax? What do you think the business looks like 3 to 5 years from now? Are there sectors or regions that you like to add scale? And are there maybe other parts of the portfolio that don't align with that long-term goal?

[Ignacy Domagalski, executive]

Devin, that's a great question. Thanks for that. I like the strategy that Wajax had before I got here, which was to put acquisition capital into the industrial parts and services business. And so that's an exciting business for us. As mentioned, been growing at 13% for the last 5 years, and we plan to continue those great growth rates. So we'd like to continue to invest in that business, both in growing the organic business and through acquisition. And there's a lot of room in that business to grow. We estimate that's a $10 billion market across the country, so we're continuing to do that. And then when we look at our heavy equipment business, I think the most exciting story there is this Hitachi story. For the last 20 years, we were dealing with a joint venture that essentially did not want Wajax to win. And now we're dealing directly with the Hitachi factory. It's a wonderful relationship, and we're expecting to see benefits in every possible way that you can experience with a great partner who wants you to succeed.

So in both sides of our business, I think we have really, really great potential to grow the business profitably. A couple of areas that we're really starting to dig into a little bit is digitalization. And so we have a Director of Technology Digitalization, who's really focusing on how do we deliver digital solutions to our customers. It's still in its infancy, but it's an area that we're starting to put some resources into. And we also recently appointed a Director of Environmental Innovation. And their job is to really figure out how we can help our customers solve their carbon problems. So both of those areas are areas that the company we'd like to grow, and we're just putting the initial pieces in place to start down those journeys.

[Devin Dodge, analyst]

Okay. And maybe just one quick follow-up. Hitachi, obviously, the JV with Deere is kind of -- is over now. Is there a role to play for Wajax there? Or are you likely to sit that one out?

[Ignacy Domagalski, executive]

Devin, apologies. You cut out halfway through your question. Could you please repeat?

[Devin Dodge, analyst]

Sorry. Just asking about Hitachi. They have to set up their own distribution network, I think, in the U.S. Is there a role for Wajax to play?

[Stuart Auld, executive]

Yes. We are -- it's Stuart. We are playing a role just in terms of helping them set things up, determine what parts that they need to stock. Going forward, are there other opportunities? I mean we're going to -- we've talked about the U.S., but we're going to continue to focus right now on Canada. But we see lots of opportunity, as Iggy said, with Hitachi relationship going forward.

[Operator]

Your next question comes from Michael Tupholme with TD Securities.

[Michael Tupholme, analyst]

You talked about supply chain challenges or issues in your release, and it's come up a couple of times on the call today. I'm just wondering if you can comment on what you've seen in terms of any changes since we last chatted last quarter over the last couple of months in terms of the supply chain picture? Have things improved? Have they worsened? Have they stayed the same?

[Ignacy Domagalski, executive]

Mike, it's Iggy here. Thanks for the question. Overall, I would say they're unchanged. Certain suppliers have started to figure it out a little bit better. Other ones have gotten a little bit worse. And I think it just depends on which area of the business they're in. But overall, the general picture has not changed. When you do look at our backlog, record high $540 million, we do expect most of that to still deliver in 2022, which is good news. But a lot of new orders that we're taking are getting pushed out into 2023, which was to be expected.

[Michael Tupholme, analyst]

Okay. And on that point actually, I was going to ask you just -- the duration of the backlog as it stands now or the period over which you expected to deliver it, how does that compare to what Wajax would have historically seen? Is it -- has it become extended in any way?

[Ignacy Domagalski, executive]

That's a good question, too, Mike. Generally, it's a little bit longer. Our backlog would have delivered in a shorter period of time in the past. And that just has to do with most of our major suppliers. I mean some of our suppliers are quoting 1-year deliveries, and that's not normal.

[Michael Tupholme, analyst]

Okay. Regionally looking at Central Canada, that was the one region where revenues were down on a year-over-year basis, and I think that was also the case last quarter. What have you seen in terms of backlog trends in Central Canada? And can you comment on what sort of visibility you have into that region seeing an improvement in sales on a year-over-year basis?

[Ignacy Domagalski, executive]

Thanks, Mike. Without getting into the specifics of the backlog by region, we typically don't disclose that. But I can tell you a little bit about Ontario. We believe that, that is one of our biggest opportunities in this company. When we compare our market share in Ontario versus regions -- versus east and west, we're lower. And we recently put some new management into that group, new management to the region, but has lived in the region and has been with the company for a long time. We have a ton of faith in that management, and we're really excited to see them start to deliver some great results in a region that for the last little while for Wajax has underperformed.

[Michael Tupholme, analyst]

Okay. That's helpful. And then lastly -- and I apologize if you were asked about this earlier. I might have missed it. But the gross margin performance in the quarter was quite strong, and I understand that there was probably -- some of that was a function of mix. But how should we think about the sustainability of the gross margins you did this quarter and the rest of the year?

[Stuart Auld, executive]

Yes. So the -- so you're right. A good part of it was mix, given the industrial piece. We are seeing some strengthening, as we said, in equipment. But I think you'll see the margins kind of moderate to something in the 20 -- 20%, 20.1%, 20.2% somewhere in that range as we get through the year, especially as we deliver probably more equipment in the last 3 quarters of the year, because that will be -- as we start to kind of balance out Hitachi deliveries.

[Operator]

Your next question comes from Bryan Fast with Raymond James.

[Bryan Fast, analyst]

I was just hoping to get some more color on the M&A pipeline. Just maybe some insight into the scale of the targets that you're seeing and if geographically there are areas where you might be seeing more opportunities.

[Ignacy Domagalski, executive]

Bryan, thanks for the question. As we mentioned on our last call, we've allocated a full-time resource to corporate development and essentially just focusing on acquisitions. He's got nearly 30 years in the industry doing this type of work. And we're really starting to build out that pipeline. In terms of geography, it's everywhere. We're really going to our business and asking the folks on the ground about what are the best opportunities, and we're getting that feedback from them and with that building our pipeline. So geographically, everywhere.

In terms of size, we have a lot of tuck-ins in the pipeline, and we feel pretty good about closing some of those in the not-that-distant future. Anything of scale, we have a few of those in the pipeline, but those will just take longer. And COVID has had an impact on those businesses as well. So figuring out what a normalized earnings going forward is a little bit more of a challenge. So those will take a little bit longer. We certainly would like to do tender-size acquisitions and are looking for those. But in the meantime, we'll continue to do the tuck-ins to keep our team sharp on doing acquisitions and integrating them.

[Bryan Fast, analyst]

That's very helpful. And I know you provided a little bit of commentary there, but maybe some more details. Just regarding the aligned relationship with Hitachi, could you just talk about some of the early benefits that you have experienced?

[Ignacy Domagalski, executive]

Thanks for that, Bryan. As I mentioned, it's nice to have a partner that wants you to win. And so that means a few things. It means immediate better customer service. It means preferred access to inventory, whether that's spare parts inventory or new machines. It overall means just better terms in our entire business relationship. And so those are some of the early wins that we're seeing.

And another big win is the fact that Hitachi had promised us a certain amount of volume in 2022. And as of right now, it looks like they'll be able to deliver all of that to us in order for us to be able to meet all our plans, and many of our other manufacturers have not been able to do that, but Hitachi is really stepping up to the plate and really helping us meet our targets.

[Bryan Fast, analyst]

Yes. It's good to see.

[Operator]

We have a following question from Michael Tupholme.

[Michael Tupholme, analyst]

In terms of the large mining shovel deliveries for this year, so there was 1 in the quarter. And then is there 1 more to go? And when is that?

[Stuart Auld, executive]

Large mining shovel in Q1, we thought it was going to convert in Q3. So it was a little earlier, and we've got 2 of the large ones that will be in the second half of this year.

[Michael Tupholme, analyst]

And sorry, are those consistent in size with what you did in the first quarter? Is this the...

[Stuart Auld, executive]

No, it was 5,600 in Q1, and there are 8,000s in the second half of the year. And both those 8,000s are in our backlog. So they will be delivered.

[Operator]

Thank you. There are no further questions at this time. You may proceed.

[Ignacy Domagalski, executive]

Thanks, everyone. Have a wonderful day.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.