Wajax Corp

TSX:WJX

Earnings Call Transcript 2020-Q3

[Operator]

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

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

Thank you, and good afternoon, everyone. Thanks for joining us on our third quarter call today. This afternoon, we'll be following a webcast including a summary presentation, which can be found on our website under Investor Relations, Events & Presentations. I'll provide you with a general update, and then I'll turn it over to Stu for some additional comments. And our cautionary statement regarding forward-looking information is on Slide 2. And additional non-GAAP -- I'm sorry, additionally, non-GAAP and additional GAAP measures are summarized on Slide 3, and additional information you can find in the appendix at the end of the presentation. So if you turn to Slide 4, Wajax has continued to consistently adhere to 4 objectives in response to current conditions: first, to protect the health and safety of our employees; second, to continue to provide strong service to our customers; third, to protect the financial health of the company; and fourth, positioning ourselves to refocus on growing the company as conditions improve. Our decisions in the third quarter and going forward will continue to be made according to these objectives, and a summary of our actions is included in the MD&A and the news release that was issued last night. On behalf of the management team and the Board of Directors, I want to thank our employees for their dedication, commitment and flexibility during this difficult period. In the quarter, the team's efforts resulted in consistently strong customer service scores, excellent workplace safety results, and their efforts contributed to year-over-year improvements in cash flow from operations due to ongoing efforts to reduce inventory and to manage costs. If you turn to Slide 5, revenue of $340.6 million was down 7% in the quarter. Revenue in July was weak on a year-over-year basis, while still down, improved a bit in August and was higher on a year-over-year basis in September. We'll have further revenue commentary in just a moment. EBIT of $14.3 million was down 8% in the quarter. The revenue decline and the effect of restructuring costs was partially offset by lower SG&A and other factors. We will address the restructuring and the application of the Canadian Emergency Wage Subsidy just shortly. Adjusted net earnings of $0.50 was down 4% in the quarter. Adjusted earnings reflect the exclusion of the after-tax costs of $5.6 million in restructuring, a $1.2 million gain on property sale, and a $1 million noncash gain on mark to market of derivative instruments. Year-to-date TRIF rate of 0.99 is 32% better than last year. We're very proud that the team has continued to reduce the number of injuries and has implemented a wide range of enhanced safety protocols in order to improve safety during the pandemic, which has benefited our employees, our customers and our business partners. If we turn to Slide 6, this slide shows an adjusted earnings bridge, which provides us an opportunity to discuss the restructuring that was completed in the quarter. The corporation made the difficult decision to reduce the size of the workforce by approximately 8% or 243 employees. The associated annual compensation costs of the employees released is $19.3 million, and a major portion of which will not be incurred in 2020 due to the majority of these employees -- excuse me, being on temporary layoff in the second and third quarters. While the immediate primary driver of the workforce reduction is volume related, the corporation believes that a material portion of these savings will be structurally maintained as volumes improve. Reducing the workforce is a regrettable action, and the company has endeavored to balance customer service, anticipated volumes and costs in order to minimize the effect to the extent possible on our employees. Recognizing that, the company is pleased that approximately 300 employees or 34% of the staff that was originally placed on reduced hours or temporary layoff in the second quarter have now returned to full-time hours. Turning to Slide 7, this slide provides information on the application of the Canadian Emergency Wage Subsidy in the quarter. Wajax received $5.4 million on a pretax basis, which was allocated to cost of sales and SG&A in proportion to the related personnel costs associated with those areas. Excluding the effect of the wage subsidy, gross profit margin of 18% declined 1% year-over-year and improved sequentially 3.1% when compared to the second quarter. As expected, margin pressure related to aged inventory disposable was not as significant a factor in the third quarter. Excluding the effect of the wage subsidy, the SG&A rate to sales of 13.1% declined 40 basis points year-over-year. And excluding the effect of the subsidy and the gain on sale, SG&A reduced by $3.4 million or 7% versus last year, in line with the change in revenue. Turning to Slide 8, dealing specifically with regional sales in the quarter and keeping comments at a pretty high level, Central Canada sales of $74 million increased 3%. We continue to be confident in an improved long-term position in the Ontario market and saw evidence of that in the third quarter. September sales were particularly strong. Eastern Canada sales of $137 million declined 10%. Lower equipment sales and shortfalls in ERS and industrial parts contributed to the decline. Similar to Ontario, Eastern Canada sales strengthened in September. Western Canada sales of $130 million declined 9%. Revenue pressure in the mining and engines and transmissions categories continued in the west, due in part to oil -- lower oil sands volumes. And while the trends in September did improve slightly, total volumes in the west were not as positive as the gains seen in Central and Eastern Canada. Indicators on oil sands activity are more positive looking forward, recognizing those effects are yet to be seen in our results. If you turn to Slide 9, sales by type of transaction is shown on this page. And in addition to what's listed here, 2 additional points to consider: first, in product support, approximately 81% of the decline in sales relates to Western Canada. The majority of which is due to lower oil sands activity affecting the mining and engines and certain transmissions parts and service sales. And in ERS, sales increases relate to the acquisition of NorthPoint in January 2020. The company remains very pleased with the performance of the recent acquisitions of both Groupe Delom and NorthPoint and continues to review additional ERS acquisition opportunities for execution when market and balance sheet conditions are appropriate. If you turn to Slide 10, this slide summarizes our sales at a category level for the quarter and year-to-date. Noting that market conditions are broadly affecting our business, sales contribution from our targeted growth categories in the quarter increased 7.5% based on flat sales in construction and gains in material handling and Engineered Repair Services. I'll turn the call over to Stu.

[Stuart H. Auld, Chief Financial Officer]

Thanks, Mark. Please turn to Slide 11 for my comments on backlog. Our Q3 backlog decreased $18.5 million or 10% sequentially from the previous quarter and decreased $115.7 million or 40% on a year-over-year basis. The sequential decrease was driven primarily by lower orders in most categories, but most notably in the construction, material handling and ERS categories. The year-over-year decrease relates to lower orders in all categories except construction, but most notably lower orders in mining, power generation and material handling categories.Please turn to Slide 12 for an update on our current inventory levels. Inventory, including consignment, decreased $39.2 million compared to Q2 2020 as a result of lower equipment inventory in the construction, power generation and mining categories. Consignment inventory decreased $15.5 million from the previous quarter. Inventory, including consignment, decreased $116 million compared to Q3 2019 as a result of lower equipment inventory in the construction, forestry, power generation and material handling categories and lower parts inventory in the industrial parts and ERS categories, offset partially by higher mining equipment inventory. As previously stated, we are adjusting our incoming inventory orders based on market conditions and are focused on reducing equipment levels.Please turn to Slide 13, where I will provide an update on cash flow and leverage. Cash flow from operating activities in the current quarter have decreased $8.5 million from Q2 2020, due primarily to lower net earnings and higher finance costs paid on the debts and rental equipment additions. Our Q3 leverage ratio decreased compared to Q2 from 2.82x to 2.59x as the lower debt level was partially offset by a lower trailing 12-month pro forma adjusted EBITDA. And our available credit capacity at the end of Q3 was $181.8 million, which is sufficient to meet short-term normal course, working capital and maintenance capital requirements and certain strategic investments.Please turn to Slide 14, 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. 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 Q3 2019 is due to lower trailing 12-month average sales and higher 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. In the third quarter, we entered into a sale and leaseback transaction for one of our own properties for proceeds, net of transaction costs, of $5.2 million. Further opportunities 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 transaction 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 fourth quarter dividend of $0.25 per share payable on January 5, 2021, to shareholders of record on December 15, 2020. At this point, I'll hand the call back to Mark to provide a brief update on our 2020 financial outlook and his concluding remarks.

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

Thanks, Stuart. Current business conditions related primarily to COVID-19 and secondarily to weak resource markets in Western Canada have continued to have a negative effect on the corporation's results during the third quarter of 2020. Volume trends in comparison to last year, as we stated earlier, improved as the quarter progressed. While volumes have recently shown an improving trend, Wajax continues to expect revenue to be lower year-over-year in the fourth quarter. As such, the corporation made the difficult decision in the third quarter to reduce the workforce by approximately 8% when compared to January 1, 2020. In response to difficult market conditions and consistent with the corporation's plans, owned and consignment inventory continued to decline in the third quarter, while margins improved sequentially from the second quarter when accelerated disposal of aged inventory temporarily reduced margins. The corporation's focus is to manage the business according to its 4 key objectives: protecting the health and safety of employees, providing strong service to customers, protecting the financial health of the corporation, and positioning the company to execute its growth strategy as conditions improve. The company expects to partially offset the effect of volume declines with cost reductions while managing customer service levels, working capital and capital spend accordingly. The corporation's current sources of liquidity are expected to be sufficient while preparing to return to growing the business as conditions improve. And with that, I think we'll open it up for questions.

[Operator]

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

[Michael Doumet, Analyst]

I was wondering if you could provide additional information as it relates to the restructuring initiative. Where exactly the headcounts were reduced just in terms of regions or categories? And as a follow-up, Mark, you discussed that most of the cost reductions were volume related. So how should we think about the potential structural improvement in the SG&A rate going forward?

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

Yes. On the first part of the question, Michael, the -- probably about 70% of the reductions came from non-ERS businesses and about 30% came from ERS businesses. As it relates to kind of the base business reductions, they were -- they were spread in pretty much across all regions, with the most of the effect being felt in Western Canada, specifically the Prairies. In the ERS side of things, some volume reductions that have really come from a number of social distancing issues, we have to contend with. And some of the bigger shops that we have in Eastern Canada gave us a requirement to remove some of the staff there. I think as it relates to looking forward, I think it's probably safe to assume that about 1/3 of those annualized costs are structurally maintainable as volumes improve. It could be a bit higher than that, but that's probably a reasonably conservative estimate.

[Michael Doumet, Analyst]

And then just turning it to the inventories and the free cash flow generation in the last several months. Obviously, lots of progress there. Should we expect Q4 cash flow from inventories to be typical of regular seasonality? I guess this is probably the first year, at least to me, where equipment companies are thinking about managing their inventories down through the downturn and then up for the recovery in the same 12-month period. So just how are you thinking about inventory restocking as the macro recovers from here?

[Stuart H. Auld, Chief Financial Officer]

So at this point at least to the end of the year, we're still working with our vendors to manage those inventories slightly down for the balance of the year and not really have to start placing significant orders until early next year. And then we would expect a positive cash flow in the fourth quarter.

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

Michael, if I could just add one thing to what Stuart said, which was accurate, the equipment inventory levels in Wajax really have only been an issue in construction. Outside of that, the equipment inventory level has been actually quite good. So while it's been an issue for us for this year because of demand, to Stu's point, the likelihood is we'll be getting the point where orders are going to have to be placed for probably the second quarter of next year. Or we're going to -- even with modest sales expectations, likely to run short. So we're getting into a pretty good shape. And a lot of the corrections that have occurred this year set us up, we think, for a pretty positive next year.

[Michael Doumet, Analyst]

Got you. So Mark, fair to say that the construction inventory will be at normal levels at some point early next year?

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

Yes. I mean I think if you look at the inventory chart that Stuart had in the presentation, the targeted growth categories, which construction is the biggest contributor to, are running at inventory levels that pretty consistent with a couple of years ago now. So we still have some consignment inventory to work through, although that consignment has come down quite a bit. So I'd say that to Stu's point earlier, likely by the end of this year, we're at -- we're certainly at run rate construction levels. And hopefully as demand picks up, we'll need to increase the orders a bit more than we have already.

[Michael Doumet, Analyst]

Got you. And then maybe one more before I pass it on, I mean I'd like to sort of get your take on Q4 sales trends. I mean you indicated on one hand that you were up in September, but do you expect sales to be down in the fourth quarter. Just help us reconcile the 2, please.

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

Yes. The sales volumes on a month-to-month basis in the third quarter were -- it'd be difficult to spot a trend there. Opening volumes in the fourth quarter are not bad. I think we're trying to be reasonably conservative with how we think about the fourth quarter right now. We've got one large shovel to deliver in December, but that's comp-ed to last year. So our biggest issue right now, I think, is watching what happens particularly in the oil sands in the fourth quarter, but the volume there is pretty important to us. But out of the gate in the fourth quarter, the volumes are not too bad.

[Operator]

[Operator Instructions] Your next question comes from Bryan Fast with Raymond James.

[Bryan Fast, Research Analyst]

Just looking for more color on the margin compression in parts and services for the quarter.

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

Okay. Call it, 80% of the sales reduction is Western Canada. Most of that's in the oil sands. That's our most profitable parts and service business. And really the primary area of margin compression is product support, and a bunch of that is the labor side of things. Now mix is hurting us from an overall parts and service business because as I said, the oil sands business is the largest contributor to our parts and service profitability, but we saw actually reasonably strong margins in equipment in the quarter. Good margins in ERS. We saw a wee bit of a decline in industrial parts, but that's primarily because of the shift from -- in regions and some weakness in the west. And we did see some compression in parts and labor margins particularly driven by the west, but the labor margins were probably the bigger issue.

[Bryan Fast, Research Analyst]

Okay. And then just looking at the forestry segment, with revenue down 10% year-over-year, we're just seeing record profits from lumber companies and forestry companies heading into year-end. Do you expect a bit of a lag effect in activity levels and maybe a pickup in 4Q for that sector?

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

We're expecting actually a reasonably strong year in the forestry business. We are yet to book some -- we have to finish those sales in the fourth quarter, but we are expecting to have a reasonably good fourth quarter in the forestry business.

[Operator]

Your next question comes from Michael Tupholme with TD Securities.

[Michael Tupholme, Research Analyst]

Mark, can you just talk a little bit more about your thoughts on the outlook for product support? You've mentioned a couple of times that that's been one of the hardest hit areas and critically important to your Western Canadian business. How do you see that trending as we move forward here through the fourth quarter and into next year?

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

I think we're cautiously optimistic that next year and perhaps towards the end of this year is a bit better than what we experienced so far this year primarily because we think the equipment activity levels will improve. We got about 30% of the fleet that we service is parked. And I think as curtailments would be expected to come off later this year and some of our large customers see some production increases, then we're generally believing that the trends will improve. So we're optimistic that, that trend does not continue into 2021. And we're hopeful that it's a bit better by the end of this year. That's on the kind of heavy equipment side of things. The engines and transmissions business, that may be structurally a bit longer to recover, but it's not as big a factor as the hydraulic shovels and some of the heavier parts and service stuff we have with our oil sands mining customers.

[Michael Tupholme, Research Analyst]

Okay. And then just as we think about the fourth quarter and your comment that you do still expect sales to be lower year-over-year, if we look across the various products categories, I mean you just spoke to product support. But as far as some of the other areas, would you expect sort of a similar distribution in terms of what's contributing to the declines? Or is there anything that you see sort of coming back more quickly, or frankly for that matter, falling off a little bit in the fourth quarter as we think about the other categories?

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

I would say that in kind of a distribution by sales type, I think product support is going to continue to be a bigger issue for us than some of the other lines are. We may see a bit of an improvement in summer ERS volumes. But I'd say the product support, at least for the fourth quarter of this year, we're expecting it to be -- continue to be a bit of a drag on our results.

[Michael Tupholme, Research Analyst]

Okay. And then just in terms of the CEWS benefit looking forward, is that -- do you again expect to realize some benefit from that program in the fourth quarter? And if so, is there any way to help us think about how to frame that?

[Stuart H. Auld, Chief Financial Officer]

If we do, it will be a lot less than what we saw in either Q2 or Q3. Just you have to wait until the month happens to do the calculation. So we expect there'll be some benefit, but it's going to be much lower than either of the last quarters.

[Operator]

There are no further questions queued up at this time. I'll turn the call back over to Mark Foote.

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

Okay. Well, thanks very much for your time today. We appreciate that. And we look forward to talking to you again at the end of the fourth quarter. Thank you.

[Operator]

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