Wajax Corp

TSX:WJX

Earnings Call Transcript 2020-Q2

[Operator]

Thank you for attending Wajax Q2 2020 Financial Results Webcast. On today's webcast will be Mr. Mark Foote, Wajax 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 Mr. Mark Foote. Please go ahead, sir.

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

Thank you and good afternoon, everyone, and thanks for joining us on our second quarter call today. This afternoon, we'll be following a webcast, which includes a summary presentation of Wajax' second quarter financial results. Presentation can be found on our website under Investor Relations, events and presentations. I'll provide you with a general update and then will turn the call over to Stu for comments on backlog, inventory, cash and the balance sheet.And to begin with, I'd like to draw your attention to our cautionary statement regarding forward-looking information on Slide 2. Additionally, non-GAAP and additional GAAP measures are summarized on Slide 16 through 24 for your reference.So if you'll turn to Slide 3. Wajax has consistently adhered to 4 objectives in response to the pandemic: first, to protect the health, safety and well-being of our employees; second, to continue to provide strong service to our customers; third, to protect the financial health of the company; and finally, positioning ourselves to refocus on growing the company as conditions improve. Our decisions in the second quarter and going forward will be made according to these objectives, and a summary of our actions is included in the MD&A and news release issued on August 6, 2020.On behalf of the management team and the Board of Directors, I would like to thank our employees for their dedication, commitment and flexibility during this difficult period. The entire team continued to do an excellent job in the second quarter, including adhering to enhanced safety protocols and demonstrating their commitment to serving our customers every single day. The team's efforts resulted in improved customer service scores in the quarter, and it was instrumental in the sequential reductions in inventory and leverage and generating positive cash flow. If you turn Slide 4. Revenue of $356.9 million was down 13% in the quarter. Volumes in April and May were comparable, and both months were down significantly on a year-over-year basis. Volume in June was up year-over-year due to 2 large mining shovels totaling approximately $29 million that are being delivered earlier than planned. Excluding the mining shovels, June sales were down mid-single digits, which is an improvement from April and May. EBIT of $20 million was down 5% in the quarter. In addition to the revenue decline, actions taken to accelerate the reduction of aged and used equipment resulted in a decline in gross profit rate. Wajax received the benefit of the Canadian Emergency Wage Subsidy program, which we will address in just a moment.Adjusted net earnings of $0.48 was down 24% in the quarter. Higher year-over-year finance costs negatively affected net earnings due to lease liabilities primarily. And the year-to-date TRIF rate of 1. 26 is 11% better year-over-year. We are very proud of the team. I'm very, very proud that the team has reduced the number of injuries 14% and has implemented a wide range of enhanced safety protocols in order to improve safety during the pandemic which has benefited our team, our customers and our business partners. Turning to Slide 5. This slide provides information on 2 factors that affected results in the quarter, notably the Canadian Emergency Wage Subsidy and the gross profit rate. Wajax qualified for the wage subsidy for a portion of the second quarter. The amount received was $15.5 million, which was allocated to cost of sales and SG&A in proportion to related personnel costs that are allocated to those areas.Expected receipt of the subsidy was apparent early enough in the quarter to allow the company to minimize, to the extent possible, the negative effect of current market conditions on employees, including the avoidance of significant additional temporary and permanent layoffs and a partial recall of employees placed on layoff or reduced hours earlier in the quarter. Excluding the effect of the wage subsidy, gross profit rate of 14.9% declined 4.3% year-over-year. The primary factor in the decline, 3.4% specifically, related to an accelerated reduction in aged and used inventory and a higher mix of lower-margin equipment sales. We expect margin pressure to continue in 2020 albeit at a less significant rate than was experienced in the second quarter.Excluding the effect of the wage subsidy, the SG&A rate to sales of 13.6% declined 30 basis points year-over-year based on an $8.4 million reduction in related costs. Given the reduction in revenue, we are pleased to report an increase in cost productivity, which includes lower personnel and discretionary costs and voluntary salary and retainer reductions for management and the Board of Directors, respectively. Turning to Slide 6. Revenue declined in all regions. Reductions are due to lower customer activity related to COVID-19 and noting additional commentary in a moment on Western Canada. Dealing specifically with regional sales in the quarter, Central Canada sales of $74 million declined 10%. Positively affecting sales in Central Canada was growth in material handling and engineered repair services that partially offset reductions in other categories. Excluding the effect of mining equipment sales in other regions, Central Canada was our strongest sales region in June in terms of year-over-year performance.Eastern Canada sales of $152 million declined 10%. Positively affecting sales in Eastern Canada was mining, construction and ERS. And while ERS grew in the quarter, the implementation of physical distancing requirements in Wajax' main ERS shops in Québec curtailed production, limiting sales. Operational changes have allowed production to gradually increase while continuing to ensure employees are working safely.Western Canada sales of $131 million declined 17%. Positively affecting sales in Western Canada was the delivery of large mining shovel, with offset -- which offset the revenue decline in the mining categories’ product support volume albeit at significantly lower margin. Material handling and ERS had increased sales in the West in the quarter. Lower customer activities in the oil sands has reduced equipment utilization, negatively affecting product support. Utilization has begun to show signs of improvement, but the company expects year-over-year declines in product support in the oil sands to continue through the third quarter. Please turn to Slide 7. Sales by type of transaction is shown on this page. In addition to what is listed here, there are 2 additional points to consider. In product support, approximately 85% of the decline in sales relates to Western Canada. The vast majority of which is due to lower oil sands activity affecting mining and the engines and transmissions business and the parts and service category. In ERS, sales increases relate to the acquisition of NorthPoint in 2020. The company remains very pleased with the performance of recent acquisitions of Groupe Delom and NorthPoint and review -- and continues to review additional ERS acquisition opportunities for execution when market and balance sheet conditions are appropriate. Turning to Slide 8. This slide summarizes our sales at a category level for the quarter and year-to-date. Noting that market conditions due to COVID-19 are broadly affecting our business, sales contribution from our targeted growth categories in the quarter was comparable to last year given the acquisition of NorthPoint.Construction sales were -- construction sales trend was primarily -- was the construction category -- the construction category was the primary focus of our aged and used equipment disposals in the second quarter, which benefited revenue and contributed to inventory reduction, including owned used equipment and aged consignment stock.I'll turn the call over to Stu.

[Stuart H. Auld, Chief Financial Officer]

Thanks, Mark. Please turn to Slide 9 for my comments on backlog. Our Q2 backlog decreased $41 million or 18% sequentially from the previous quarter and decreased $105.7 million or 36% on a year-over-year basis. The sequential decrease was driven primarily by mining shovel deliveries in Alberta and Québec. The year-over-year decrease relates to lower orders in most categories, but most notably in mining power generation, material handling and forestry categories. Please turn to Slide 10 for an update on our current inventory levels. Inventory, including consignment decreased $51 million compared to Q1 2020 as a result of lower equipment inventory in the construction and forestry categories and lower parts inventory in the construction and industrial parts categories. Consignment inventory decreased $21.9 million from the previous quarter.Inventory, including consignment, decreased $78.8 million compared to Q2 2019 as a result of lower consignment inventory, which decreased $76.2 million compared to Q2 2019 and consists primarily of construction excavators. As stated previously, we are adjusting our incoming inventory orders based on market conditions and are focused on reducing inventory levels.Please turn to Slide 11, where I will provide an update on cash flow and leverage. Our cash flow from operating activities in the current quarter have increased $50.7 million from Q1 2020 due primarily to an increase in cash generated from changes in noncash operating working capital of $34.1 million, lower rental equipment additions and higher net earnings. Our Q2 leverage ratio decreased compared to Q1 from 3.04x to 2.82x as the lower debt level associated with the decrease in working capital was partially offset by the lower trailing 12-month pro forma adjusted EBITDA.Our available credit capacity at the end of Q2 was $174.8 million, which is sufficient to meet short-term normal course working capital and maintenance capital requirements and certain strategic initiatives. Please turn to Slide 12, where I'll provide an update on financial position. We continue to focus on working capital efficiency, which is a key component of managing our overall leverage targets. All actions aimed at lowering working capital are expected to increase RONA over time which will have the additional benefit of lowering our working capital sales ratio and increasing inventory turns. The decline in inventory turns from Q2 2019 and Q1 2020 are due to lower trailing 12-month average sales despite the strong declines in average inventory levels.As previously disclosed, we continue to evaluate ways to unlock cash from the business and as such, have completed a market value assessment of our own real estate holdings. Subsequent to the second quarter, we entered into a sale and leaseback transaction for one of our wholly owned properties for proceeds, gross of transaction costs of $5.4 million.Further opportunity to sell redundant real estate as well as sale and leaseback opportunities have been identified. Proceeds from any real estate sales will be used primarily for debt repayment. The earnings impact from any sale and leaseback transactions is not expected to be material as gains are expected to approximately offset by incremental lease costs over the term of the lease.Finally, the Board has approved our third quarter dividend of $0.25 per share payable on October 2, 2020, to shareholders of record on September 15, 2020. Please turn to Slide 13. And at this point, I'll hand the call back to Mark to provide a brief update on our 2020 financial outlook and concluding remarks.

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

Thanks, Stu. With respect to the outlook for the remainder of the year, current business conditions related primarily to COVID-19 concerns and secondarily, the weak resource markets in Western Canada continue to have a negative effect on the company's results during the second quarter.Volume declines in the first 2 months of the quarter improved in June, as we stated, and as customer activity began to increase. And revenue was positively affected by the early delivery of the 2 customers of the 2 mining shovels which the corporation had previously expected to deliver in the third quarter. While volumes have shown an improving trend, we continue to expect revenue to be lower year-over-year in the third quarter. In response to difficult market conditions and consistent with the corporation's plans to reduce inventory, we've accelerated plans to dispose of aged and used equipment inventory in the second quarter, which combined with a higher mix of lower-margin equipment sales, had a negative effect on gross profit rate. While we expect to continue to take actions to reduce inventory to conditions’ appropriate levels, we do not expect the same degree of margin decline in subsequent quarters when compared to the second quarter.Our focus is to manage the business according to the 4 objectives we stated earlier: protecting the health and safety of our employees, providing strong service to our customers, protecting the financial health of the company and positioning Wajax to execute its growth strategies as conditions improve. We expect to partially offset the effect of volume declines with cost reductions while managing customer service levels, working capital and capital spending accordingly. The corporation's current sources of liquidity are expected to be sufficient while preparing to return to growing the business and providing strong service to our customers as conditions improve.Operator, we'll now turn the call open for questions.

[Operator]

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

[Michael Doumet, Analyst]

I was just wondering if you guys could provide maybe a little bit more clarity on the revenue cadence through Q2. And Mark, you talked about an improvement in June, maybe exiting out the sale of the 2 mining shovels. Can you comment on your June sales and how they compare to last year? And whether that momentum has been sustained or maybe even improved in July and so far?

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

The June numbers, if you exit the mining shovels, were down mid-single digits, which includes kind of a non-comp contribution from NorthPoint. So if you looked on a pure apples-to-apples basis to last year, a bit less than 10% decline in June versus more than twice that amount in April and May on a percentage basis.

[Michael Doumet, Analyst]

Okay. That's perfect. And just in terms of early signs in July and whether you saw momentum?

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

Honestly, Michael, it's a bit noisy. Kind of the day-to-day businesses appear to be tracking reasonably close to what happened in June. There's a bunch of equipment deals which may or may not close in July, but July certainly wasn't like April and May. So it was a bit closer to June, but we haven't really completed the equipment sign-offs for the end of the month yet.

[Michael Doumet, Analyst]

Okay, great. Good color. And then maybe just turning to the actions to accelerate the disposal of aged and used equipment. Maybe if you could just elaborate on that. I mean, was the catalyst there simply the weakening macro backdrop? And any way you can quantify the disposal and how much is left to do?

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

Can you repeat the last statement you made, Michael? I got the most of the question, but you maybe drifted out just as you finished that question.

[Michael Doumet, Analyst]

No, for the second part, any way you can quantify the amount that you dispose and how much is left to do?

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

Well, I would say that I guess the reason we did it was reasonably simple. I think the -- we're carrying some excess coming into this year, given a pretty tough equipment market that was occurring late last year. And I think when things went south at the beginning of the second quarter, the end of March, we decided we really weren't willing to wait to start getting the inventory levels down. So I don't -- we certainly wouldn't have approached things the way we did had the market been more normal in March, but obviously, that wasn't the case.The exact amount of inventory that could be left, I think if you look at our forecast for the end of the year, we're down from where we are now and from where we ended last year, assuming that our sales forecasting hangs in there, which hopefully, it does. So we've got probably anywhere from $20 million to $40 million in inventory to burn through in all categories. Kind of the more painful pieces of construction are hopefully behind us now though.

[Michael Doumet, Analyst]

Got it. And then maybe if I could sneak one last one in. Maybe a tough question to answer. But just given the variables, including your estimation of the wage subsidy going forward, how should we think about SG&A and margin progression through the second half of the year as revenues ramp back up?

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

On the SG&A side of things, we have estimated what we think the CEWS benefit is to us in the second half of this year, recognizing that's completely dependent on what happens with our revenue. It's not nearly as material as it would have been in the second quarter. So there are additional cost reduction activity -- actions that will be necessary for us, that we're working our way through in the third quarter. So on a percentage of sales basis, generally within the range where we've typically operated, recognizing that there's some additional cost reduction activity we're going to end up needing to take based on our sales outlook for the second half of the year.As far as where the margin lands, we're -- as we said, we don't expect it to perform like it did in the second quarter because some of the actions we took there were some of the more significant equipment impacts, but it is not expected to be as strong as our margins typically would be.

[Operator]

Your next question comes from the line of Michael Tupholme of TD Securities.

[Michael Tupholme, Research Analyst]

Just maybe picking up on that last line of questioning regarding the CEWS impact in the quarter. I guess a bit of a theoretical question, but if you hadn't received that subsidy mark, do you think you would have been able to reduce the costs in the second quarter by a comparable amount and essentially arrived at the same type of results you delivered in the quarter?

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

I don't believe we would have taken cost reduction actions that would have gotten the full amount of the CEWS payment. But I think it's reasonably safe to assume that we would have taken cost reduction actions that would have been comparable to the majority of that payment. I don't -- we wouldn't have got all the way to the $15.5 million, but we would have been north of 50% of that number.

[Michael Tupholme, Research Analyst]

Okay. And is that -- sort of the inability to get all the way there, was that partly a function of just the timing and the speed with which you would have had to put those actions in place, and that's just tough to do, whereas if we look forward between whatever payments you do receive from the program, plus with your cost actions you think you can offset a lot of the downside that would come from the revenue declines?

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

I suspect we'll offset part of the effect of the revenue decline. I don't know if we'll offset all of it. And the -- I guess the reason we wouldn't have gotten to the full amount of the CEWS is a couple things. I mean, first of all, managing through the second quarter was partially a function of not being entirely certain about how to predict the 3 or 4 months afterwards, and it's a service-oriented business. So the minute you start releasing people it's going to negatively affect your service level. So we try to avoid that, if at all possible.Plus, if you think about it, the CEWS payment is for just compensating for staff costs that may go, in fact, beyond the second quarter. So I think getting into the back half of the year, we'll do what we need to do on the cost side of things in relation to a balance between where the revenue is going to be and where our customer service levels need to be and manage it as aggressively as we can.

[Michael Tupholme, Research Analyst]

Okay. That makes sense. Appreciate the detail earlier regarding the improvements in revenue in terms of the sequential progress through the quarter. Just a question around, was that fairly -- those improvements, were they fairly balanced and seen kind of across the broader business? Or were they more pronounced in certain areas than others?

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

Ontario and Atlantic Canada performed pretty well in the month of June, and they were, I'd say, relative to Québec and Western Canada, they performed a bit better in April and May albeit, they were also down considerably. So Ontario and Atlantic Canada were reasonably good, reasonable bright spots in -- as the quarter was closing.Québec has picked up steam, still down, but we had a lot of kind of we had lower mining activity in Québec, which can hurt our business quite a bit, which has caught itself back up to a reasonable degree. And the West, obviously, has got the most pressure on it. And that's broadly across a number of things.So Atlantic Canada, Ontario, reasonably good stories; Québec improving fairly quickly. And we were pretty bullish on Québec for the balance of the year, we think. And the West is under a fair amount of pressure. It started to ease up a bit, but I think we're expecting the west to continue to be a soft spot for us for the balance of the year. Wajax's primary exposure in the West from an EBIT standpoint is really what happens with activity in the oil sands. We can withstand sales reductions in a bunch of categories through cost reductions reasonably well. But we -- obviously, our activities in the oil sands are pretty important to the company's profitability, and we think that may remain under a bit of pressure for -- certainly for the third quarter anyway.

[Michael Tupholme, Research Analyst]

Okay. Just lastly, to follow up on some of the discussion earlier about the additional inventory disposals you hope to achieve. If we take those into account, plus any other variations or fluctuations from a working capital perspective, what is the right way to be thinking about changes in noncash working capital for the second half of the year?

[Stuart H. Auld, Chief Financial Officer]

The expectation with no numbers as we should be overall cash flow positive in the second half of the year.

[Michael Tupholme, Research Analyst]

And just to clarify there, are you talking about strictly from a working capital perspective, positive? Or are you talking about cash flow for the entire company from operation?

[Stuart H. Auld, Chief Financial Officer]

Entire company.

[Operator]

[Operator Instructions] Your next question comes from Devin Dodge of BMO Capital Markets.

[Devin Dodge, Analyst]

Look, your target range -- or your target leverage has been in that 1.5, 2x range. You've been above it for the last while, but you've been able to kind of manage through it even through the -- at least at this point, the downturn here. Just I guess maybe 2 parts to this. Is that still the right target range or do we need to recalibrate what we think is the right amount of leverage for Wajax? And part two would be, if it is still that 1.5 to 2.0x, how should we be thinking about the timing for when you could get back into that range?

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

Yes, we changed our disclosure on leverage, which we may or may not communicated very well as we closed last year because our debt obviously is carrying roughly $70 million in acquisition capital for Delom and for NorthPoint. Now the cash flow out of Delom has helped pay that down a wee bit. But without trying to reconcile it back, we -- our current debt levels include $70 million worth of acquisition capital. So it's inflated by that. And that is not necessarily a reflection of kind of our day-to-day capital needs. So when we changed our leverage narrative to towards the end of last year, we tried to separate for people that the 1.5 to 2x relates to our day-to-day working capital and kind of sustaining capital requirements and that we're prepared to run above that to the extent that there's a change in economic cycles or in fact, if there's acquisition capital that is reasonably new.So I think we're pretty comfortable that the 1.5 to 2x is, in fact, a pretty good range to be in from a normal course working capital requirements basis, but it's certainly not adequate when you're considering the acquisition capital that we spent. So we'll go back and kind of check that narrative a little bit. But 1.5 to 2x, we think, is a good range for normal course requirements. And we've just put into the debt stack the acquisition capital for Delom and NorthPoint.

[Devin Dodge, Analyst]

Okay. Okay. That's helpful. Maybe just switching gears, can you remind us how many mining shovels are in the backlog right now and when they're expected to be delivered? I'm just wondering if -- what you're seeing in terms of opportunities in the mining space right now. I mean clearly, gold miners are doing well. Just wondering if this is translating into any or many opportunities for Wajax.

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

Yes. I believe there's 2 large shovels left in backlog. One delivers in December of this year, assuming it hits its schedule, which it appears that it will. And there's one in there for next year, which was originally scheduled for this year that was pushed to 2021. They're both going to Western Canada.There are in inventory, I believe 6 or 7 shovels of a smaller nature, which there are some mining opportunities out there right now. So hopefully, we can move some of those shovels through. We've assumed none of those go through this year, but there are some opportunities starting to show up on the heavy equipment side for the mining business, and we're working as hard as we can to kind of capture that for ourselves.

[Devin Dodge, Analyst]

Okay. That's great. And maybe just one last one. The ERP system, can you give a -- just an update on where this project stands right now?

[Stuart H. Auld, Chief Financial Officer]

Yes. So we're sort of in a holding pattern right now, just continuing to refine it. The -- we were going to start the rollout earlier this year. The biggest issue is arguably travel and in person training. So we put it on hold at least for the balance of the year.

[Operator]

There are no further questions at this time. I'll turn the call back over to the presenter.

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

Okay. Well, that's it for us today. So thank you very much for joining the call, and we'll speak to you again in November for the third quarter.

[Operator]

And this concludes today's webcast. Thank you for participating. You may now disconnect.