Wajax Corporation

Good morning, everyone, and thank you for participating in our third quarter results call. This afternoon, we will be following a webcast, which includes a summary presentation of Wajax's Q3 2019 financial results.

The presentation can be found on our Web site under Investor Relations, Events & Presentations. To begin, I would like to draw your attention to our cautionary statement regarding forward-looking information on slide two.

Additionally, non-GAAP and additional GAAP measures are summarized on slides 13 through 23 for your reference. Please turn to slide three, and at this point I’ll turn the call over to Mark.

Thanks, Trevor. I'll provide some highlights on our third quarter before turning it over to Stu for commentary on backlog inventory and the balance sheet.

Looking at slide three, revenue declined approximately 1% in third quarter. The result was below our expectations and was up against a tough comparable from last year's Q3, when consolidated revenue was up 23%.

This year's strong sales in Eastern Canada and an improving trend in Ontario did not fully offset a decline in the west. Sales momentum in Western Canada decelerated as the quarter progressed, and was particularly weak year-over-year in September.

I will provide additional comments on regional performance in just a moment. EBIT improved 5% in Q3; SG&A was $4.7 million lower year-over-year in the third quarter, resulting in a cost of sales ratio of 13.6%.

The gross margin rate of 19% was unchanged compared to last year, and includes a $1.2 million cost associated with engineering project losses, which is equal to approximately 30 basis points in gross profit or $0.04 a share. These costs close out two projects where overruns are not believed to be recoverable from subcontractors and manufacturers, and we chose to complete these projects in the third quarter at our cost to ensure we served the needs of two large customers.

Adjusted EPS of $0.52 in Q3 was up 8% to last year. We'll have further comments on adjusted earnings in just a moment.

And finally, safety performance continued to be very strong in the third quarter as indicated by a TRIF rate of 1.01 and a year-to-date TRIF of 0.85. Our most important day-to-day responsibility is workplace safety, and we thank the entire Wajax team who continue to do an excellent job.

Turning to slide four, Central Canada sales of $71 million increased 1% in Q3, which is an improvement in trend from the first-half which was negatively affected by the loss of a road building line. Excluding the road building issue, sales in Central Canada were up 4% in Q3, and are up 3% year-to-date.

The Ontario market remains a very significant focus for Wajax, and our efforts to grow the business to volumes more comparable to our Eastern and Western Canada regions, continues. Eastern Canada sales of $152 million were up 27% in the third quarter, continuing a very positive trend.

Sales momentum was driven by the non-comp revenue from Delom and by ongoing strength in a broad range of categories including construction, forestry, and industrial parts. Our increasing scale in Eastern Canada and the opportunities we have in Ontario continue to provide offsets until Western Canada market conditions improve.

Western Canada sales of $142 million were down 20% in the third quarter. And as previously noted, they decelerated in the quarter, and were weakest in September.

Lower new equipment sales are the primary issue in the West, resulting from prior year mining sales which did not repeat this year and weaker market conditions, most specifically in construction. We believe that weather conditions were also a factor for our heavy equipment customers.

Our Western Canada market share in construction excavators and forestry equipment improved in the third quarter, which helped to offset the negative effect of some of these market conditions. Turning to slide five, equipment sales of $109 million were down 19% in the third quarter, driven primarily by Western Canada per the pervious comments relating to both mining and construction.

In mining, we have an excellent equipment backlog that will improve that trend going forward. And in construction, while we expect conditions to remain challenging, we continue to have market share growth opportunities as evidenced by the share growth we experienced in the third quarter and year-to-date.

Industrial parts sales of $90.7 million were up 2.4% in third quarter. Strength in Eastern Canada continued to offset weakness in the West, and the Canada sales were comparable year-over-year.

Product support sales of $117.1 million were essentially flat in the quarter. Strength in Eastern Canada offset weakness in the west and sales declined in central for construction product support declined due in part to the whole building alignment [technical difficulty].

Turning to slide six, provide some additional commentary on market conditions affecting certain categories in the quarter and year-to-date. But to avoid repetition, won’t go over earlier comments made, but feel free to ask any questions if you have later in the call.

Using the construction class excavator unit market as a proxy for overall conditions, Q3’s market was down 14%. Western Canada market declined 24% with less significant declines in Central and Eastern Canada.

We continue to see a reasonable pipeline in construction and porting [ph] activity and ample inventory on the ground, and we are working to continue to build on market share gains we have made this year and to improve our product support service levels. Our manufacturing orders on additional inventory began being adjusted in the second quarter, April specifically, reflecting changing market conditions and a focus on the reduction of existing [technical difficulty].

The equipment margin in production improved [technical difficulty. In forestry, we saw results in all regions and solid market share across all equipment classes.

We continue to work to offset weakness in the BC market with opportunities in Central and Eastern Canada. And finally, we remain bullish on mining-related businesses including equipment, industrial parts, and our ERS sales to mining customers.

This perspective relates to our oil sands and conventional mining customers. Mining new equipment backlog increased again in the third quarter providing additional visibility to future sales, and Wajax continues to invest in additional resources and inventory to support demand for our mining customers.

Please turn to slide seven. Adjusted net earnings of $10.3 million or $0.52 per share increased 8% in the third quarter.

Improved cost efficiency and a constant gross profit rate offset higher finance cost to deliver earnings growth of slightly lower revenue, focused on working capital improvements to lower finance costs and ongoing cost and margin management in what appears to be a tightening market condition [technical difficulty]. And included in our adjusted earnings in the third quarter was a pretax structuring provision of $3.9 million related to planned management realignment.

The changes are expected to result in annualized pretax SG&A savings of approximately $5 million, of which $500,000 is expected to occur this year. The operations effect of these changes improves local market accountability to our customers, strengthens the regional alignment of our sales and product support teams, and integrates the loan and our legacy ERS business into national platform.

Please turn to slide eight, and I will turn the call over to Stuart.

Thanks, Mark. Our Q3 backlog decreased $8.6 million or 3% sequentially from the previous quarter, and increased $47.7 million or 20% on a year-over-year basis.

The sequential decrease relates to lower forestry, power generation, and construction orders offset partially by higher mining order. The year-over-year increase relates to higher mining and marine orders, offset by a lower material handling and power generation order.

Although we experienced a 19% decline in the equipment revenue than compared to the Q3 2018, our equipment backlog is $47 million or 28% higher than it was the same time last year. Level of backlog is supportive of achieving our short and medium term sales goals and provides better visibility as we navigate market uncertainty through Q4 which Mark will speak to momentarily.

Please turn to slide nine for an update on our current inventory levels. Inventory including consignment decreased $3.1 million compared to Q2 2019 and increased a $109.3 million compared to Q3 2018 and is primarily higher across our targeted growth categories.

Consignment inventory decreased $22 million from the previous quarter. As previously stated, we expected Q2 2019 to represent the higher water mark as it related to inventory.

That said, levels did not recede as much as we anticipated primarily as a result of lower than planned sales volume. As stated previously in this call, we began adjusting our inventory orders based on market conditions and are focused on reducing equipment level.

We continue to expect that inventory levels will decrease over Q4 which we will anticipate will have a positive impact on working capital, cash flow, and leverage. Please turn to Slide 10 where I will provide an update on financial position [technical difficulty].

Our Q3 leverage ratio increased compared to Q2 from 2.71x to 2.81x, primarily is a function of high debt levels associated with the increase in working capital partially offset by a higher trailing 12 month adjusted EBITDA. We continue to focus on working capital efficiency which is a key component in managing our overall leverage targets.

And we expect the ratio to improve further over the balance of the year. All actions aimed at lowering working capital are expected to increase [indiscernible] over time which will have the additional benefit of lowering our working capital to sales ratio increasing inventory [technical difficulty].

Additionally, we continue evaluate ways to unlock cash from the business. And as such have completed a market value assessment of our owned real estate holdings.

Opportunities to sell redundant real estate as well as selling lease back opportunities have been identified. Proceeds from any real estate sales will be used primarily for debt repayment.

The earnings impact from the sale and lease back transactions is noted expected to be material as any gains are expected to approximately offset by the incremental lease cost over the term [technical difficulty]. Finally, the board has approved our fourth quarter dividend of $0.25 per share payable on January 3, 2020 to shareholders of record on December 16, 2019.

We remain confident in the sustainability of our dividend at this level and across the business cycle. Please turn to slide 11, and at this point, I'll hand the call back to Mark to provide a brief update on our 2019 financial outlook and concluding remarks.

Thanks, Stuart. Market conditions -- and looking at slide 11, market conditions declined in the third quarter, most significantly in Western Canada, resulting in a deterioration of revenue momentum as the quarter progressed, and us falling below the expectations we had for the quarter.

Although recognizing the possible effect of these conditions, Wajax has not changed its operational plans and continues to expect 2019 full-year net earnings to increase over 2018 based on consolidated revenue improvements and the full-year effect of the acquisition of Delom. Continue to focus very closely on margin rates, costs, and inventory management while we pursue our growth plans.

And leverage is expected to remain within acceptable boundaries, and we believe the corporation maintains sufficient financial flexibility to execute its 2019 plan. And with that, we'll open it up for questions.

Hey, good afternoon, guys. So, Mark, you commented on construction in Canada being weakest in September.

I'm just wondering based on what you're seeing in October, would you qualify that impact as being maybe mostly weather related in September or should we expect that trend to continue through Q4?

We've had that conversation a lot internally, Michael. I think it's safe to say we think the weather had an impact on sales in both August and September, and we have seen October trends improve from what we were experiencing in September.

Okay. And then based on your prior comments, I also think that you were hoping for a bounce back in spend in mining in Q4 with the delivery of I think a shovel or two.

Can you remind us what that contribution could look like for Q4?

Yes, I think we'd previously disclosed we had one large shovel delivering in the fourth quarter, and that being the EX8000, so call that between $15 million and $20 million depending on the final [technical difficulty].

Okay. And then just turning to inventories, obviously ended a little bit higher than presumably you would have liked.

[Technical difficulty] in which categories maybe -- which categories do you think you had the most inventory versus I guess expectations, and maybe could you quantify what you would qualify as excess inventories as at Q3?

If you -- so I assume your question is sequentially as compared to Q2?

Yes, and the other question too is like in terms of how much inventory you're carrying versus what you would like to be carrying now, and maybe quantifying that excess inventory in terms of how much would it take to normalize basically?

The inventory we're carrying that's in excess of what we had anticipated, and I just want to stress that the quality of the inventory is excellent. So excess doesn’t mean a problem for inventory, it just means more than we were expecting to carry.

Most of that -- well, off of it is in equipment, and the majority of that is in construction. There's a little bit in material handling, but the majority is in construction.

And I would say that we're probably heavy, call it roughly between $20 million and $40 million, and would have -- that we would have been carrying inventory, so we're expecting to see some degree of correction in the fourth quarter, but the quality of the inventory is excellent and we've been through it very carefully. And we've managed the inbound side of it starting quite a while ago, and with around a fair amount of work we've managed to preserve the margin.

So we do think the inventory is going to wind itself down a bit, and we do not see a margin dilution [technical difficulty].

Okay, that's helpful. Thanks, Mark.

Hey, guys. Just a quick question around some of the weakness in Western Canada, do you feel that it's stabilizing over there?

And was there any difference between private versus publicly-funded construction activity?

I don’t know, Derek, if we know the answer to your second quarter because the quarter was a bit difficult to read in Western Canada because it bounced around pretty aggressively. We weren't expected to see the sales line in September that we saw.

BC forestry from an equipment standpoint that has got some real challenges associated with just generally a pretty weak market. And construction activity in the Prairies and BC, as we said was just less than we expect.

So we have seen some degree of improvement and trend in October. So that's positive, but I can't really tell you what was public versus private.

I'm not sure I know that.

Okay, no, that's fair enough. Yes.

Are you finding that the overall competitive factors are pressures increasing in Western Canada due to the softening in demand versus Eastern Canada, where perhaps the strength and demand might provide a better kind of competitive dynamic there, or is it still a pretty competitive business all around?

Yes, I don't -- I think it's pretty competitive regardless of where we are, if margins are a proxy for a change in the level of competition, our margins were actually stronger on construction equipment in the West and they were the same period last year.

Okay. And you are reiterating your outlook, anything behind that, that gives you that confidence that you should be able to reach your stated guidance there.

And do you feel that you're coming close to being sufficiently right sized relative to the end market or as end markets are kind of softening further, you might need to take even more further right sizing initiative.

Did you mean right-sizing in the sense of cost, Derek?

Yes.

We're pretty efficient today. I think the SG&A to sales ratios is fairly good.

You saw that we made some additional management changes which simplified the organization that had been planned for a little bit. So we didn't - we executed in third quarter, so that will take a bit of cost out of the business $5 million I think we reported on an annualized basis.

The market conditions right now are - they're a bit difficult to read. So, some of our markets like industrial that continues to plow along at a reasonably decent clip our ERS business is strong, material handling, etc, etc.

So the things that aren't really affected by Western Canada construction, even our resource businesses are doing reasonably well. So I think we're going into next year with probably a little bit of conservatism with respect to our original plans, we feel still feel pretty good about our 2021 guidance that we've previously provided.

So, we're still very dedicated heading that. But we've taken some actions with respect to margin and cost contingency plans, which we feel we may have to employ if market conditions don't improve from where they're at.

But right now we're cautiously optimistic that next year will be reasonably good, and that will fill our guidance for the fourth quarter.

Okay. Thanks, Michael.

I'll turn it over.

Thanks, Mark. Can you shed a little bit more light on the engineering project losses the $1.2 million?

Did I understand you indicate that those projects are now done and if that is the case, does that mean there should be no further risk associated with those projects in terms of potential additional losses?

Yes, those projects are complete, Michael. And we've accounted for essentially everything that's associated with them.

So I mean, there's always some degree Western engineering projects, but it would be unusual for Wajax to take a loss like that, but we thought it was in the best interest of some pretty big customers. So we did so in the third quarter and they're closed.

Okay. It's sounds like it's a - you view it as sort of a one off like it's not indicative of it's not a function of characteristics associated these projects in general.

And you know, even though these are done, we should be worried about the prospect of these kinds of things happening more frequently. It's that all fair to say.

Fair to say.

Okay. Just in terms of the - you address the large mining shovel delivery for the fourth quarter, but can you help us just remind on 2020 the timing of any orders and deliveries for large mining orders in 2020?

I would have to get back to you Michael. I think that's moving around a little bit.

But I believe there are three large shovels in next year's plan. And potentially one more than that, but we're still working on a couple of things.

But I believe we've got three large shovels and backlog right now, the third of which entered in the third quarter, and if you wouldn't mind us getting back to you with the exact dollar value. I suspect the numbers around $50 million to $55 million for all three.

If that's inaccurate, we'll get back to you with the number, but I think you can probably walk around without a decent answer.

Sure, I was also just interested in timing, but if you don't have that we can take that offline as well.

So working with a couple of customers honored it's in the year, but we just want to make sure we get the timing correct.

Okay. In terms of in terms of Delom acquisition you are now, as we look through the fourth quarter of 2019, you are going to be, you have lapped the quarter, you made the acquisition, or you will be in the fourth quarter.

So just wondering if you can talk a little bit about how that business has been performing organically because I guess that's going to be more important as we look at the 2020. And then I guess related to that, as I recall, 2020 is the year that maybe you expect to see some more synergies coming out of that business.

So any further thoughts on the synergy front for Delom as we look to next year?

Well, I guess two things. First, is we're really pleased with the performance of the business, we based our return on the essentially the same that we worked with when we purchased the company and that's, pretty consistent with where we're at.

The combination of that loan business and our legacy or infrastructure is underway right now. So the combination of management teams et cetera and really leverage of the sales team.

So we feel no different about what the potential of that business is and it's likely to carry ERS and industrial are likely to carry a larger proportion of the growth requirements in how we think about next year. If for no other reason, just to mitigate the risk of the equipment markets aren't as strong as we had hoped.

So, still going to push hard on all the categories we've talked about in construction, material handling, et cetera. But we plan to push the industrial and the ERS business is a bit harder than we may have pushed them this year.

They're pretty balance sheet friendly businesses. They're accretive to margin, and they're good day-to-day business.

So we're feeling pretty good about where we're at right now and what's coming for next year.

Okay. And then just lastly, when I look at your outlook commentary, you essentially reiterated your expectation to deliver year-over-year earnings growth this year.

Now recognize you'd not provided specific rate of growth guidance previously. I'm just trying to understand is the outlook unchanged or from the perspective of whatever that rate of growth you do expect to deliver or in view of the software market conditions you saw in Western Canada third quarter are you, would you expect to deliver a lesser rate of growth even though recognize you never given us a number but is that rate of growth somehow tempered a little bit by what you've seen in the third quarter in Western Canada or any other factors?

Probably best to say that we don't believe that the sales shortfall we experienced in third quarter is fully recoverable. So internally, our expectation of growth would be less, but we feel comfortable with the ability to show an improvement year-over-year.

Okay, and you weren't, that would have flowed through to your earnings expectations. You weren't able to offset that through better cost management.

So in fact, the sales shortfall or the sales coming in less than you'd expected, would potentially weigh on what you would, what you will do relative to what you thought you could do previously?

Yes.

Okay, that’s all I have. Thank you.

Thanks. So I just wanted to get started with maybe some of the real estate transactions you kind of spoke about, do you have a sense or a target for the expected proceeds from any real estate sales or you only expect transactions?

Yes, at this point, it's not going to be an insignificant amount. But we haven't finalized the plans and will be in a position to update probably much later in the year.

Okay, so maybe something like with Q4 results, or is it there?

Yes.

Okay. I guess you talked about inventory.

I just wanted to make sure that maybe just carried over to some of the consignment inventory you have, just wondering how are you feeling about that, just given the weaker demand for construction equipment that we saw in Q3, I was trying to get a sense of this inventory is beginning to age out a bit.

I wouldn't say there's I mean, we are beginning to make deposits on consignment inventory, that's been the case for the last number of months. So with that's part of our cash planning right now, there's nothing about the inventory.

It's very current models, there is nothing about it that poses some risk about our ability to sell it or something like that. So, consignment inventory for us is really essentially prioritize-based on receipt dates.

Obviously respecting what the customer is looking for. But we try to prioritize the consignment inventory with the earliest receipt goes out the door first to reduce the deposits on the inventory, but we have started make the deposits, the orders have been constrained because we've got a fair amount of gear on the ground.

And we're very confident walk through in a pretty orderly fashion.

Okay, definitely that makes sense. But can you provide us like how does that process work?

Like, what level of deposit do you machine as you know, that consignment period has expired like how quickly does that ramp-up where you have to pay the full amount?

We have to the ninth month, we begin to make deposits on the inventory and it works on a declining balance, so it never really gets fully paid, but it works on a declining balance over the course of time. It's unusual for us to have inventory on the books for longer than 12.

It’s happened but it’s unusual. So our focus is on essentially taking inventory and prioritizing it based on where we’re going to have the part with cash before.

Okay. And I apologize if this is in the notes, I might have missed it, but I think it disclosed the level of deposits that you put down for the consignment inventory?

Yes, we have the financial statements and deposits on it.

Okay.

About 23 million bucks, it's in the financial statements.

Okay. Okay.

Maybe one last question, SG&A expenses were a fair bit lower in Q3 than in the prior quarters on a on dollar basis. Just how do you see these costs playing out in Q4, and maybe into 2020?

Should we expect something closer to the $56 million in the first-half, or maybe the $49 million that we saw in Q3?

I would think about it as a percentage of sales basis, because it'll go up and down in accordance with sales because a lot of our costs on sales commission side and things like that are variables. So it's probably the walking around number we've given people is the range 14.5 to 15.5 around 14% is probably a good.

Okay. Thank you.

Hi, guys, when I look back at these restructuring charges, Mark, there's been almost 27 million of them going back to 2014, I think in every year except one, which we've been asked to normalize for -- there was a question about are you done with this? But let me ask it a different way.

What is taking so long and cost so much to get what you want out of this business?

Well, it's a good question Ben. I think there's been essentially three tranches of effort.

And I can tell you that further restructuring absence, some significant market change that we're not really anticipating is not really planned right now. The biggest tranch or change we did was in 2016, when we eliminated the three prior segments.

And then, we had two additional changes to make. One was in finance, which we are essentially through right now, because we had to consolidate three independent finance organizations.

And when we reorganized the company in 2016, for a whole bunch of pretty good operational reasons, we kept the sales and product support teams separate under different leadership structures. And what we did with this particular change was we harmonize those, which was part of the plan originally, just didn't want to do it too early.

So we could have probably taken one big restructuring charge in 2016 and tried to run the whole change through the system faster than we did, but I think the risk associated with that, to the business and customers et cetera would have been to high. So I think we're generally feeling pretty comfortable with this as I never say final but, the last plan change that we're making.

And we feel the savings are definitely very good to us, but the simplicity of our company effective the end of these changes is orders of magnitude better and more efficient than it was three years ago.

Right. And there was a pretty significant reduction in your G&A.

Is that this quarter was that part of this is pulling through but there's, I mean, because there's multiple moving parts is also IFRS, which means some of the expensive below the line. I wonder if you can just help sort that out of that correct.

We will say that the restructuring provision we took in the quarter didn't really result in a ton of SG&A improvement.

No, Ben, sorry. Sorry to interrupt, Mark, but I'm thinking about sort of past restructuring it's been incurred.

I'm sorry, ask your question again. There I misunderstood.

Sorry. No, I'm just thinking like, because it's been a long process.

There's been lots of other, as you've pointed out lots of other restructuring that's happened over the last few years. So there's some of this is pulling through, they must be in the G&A already, yes.

And all the costs that we said we would say we have. Now we may have reinvested that more salespeople and more technicians, but the cost, we said the cost reductions we forecasted in 2016 have come through the finance cost reductions to come through and I'm certain that these cost reductions will come through also.

So, it's dropped the business to call it a stable run rate of maybe about 14 points, and that is a bit better than it were would have been historically.

Okay. Thank you.

Well, thank you very much for your time today, and we look forward to bring you up-to-date on the business with a fourth quarter call. Okay, have a good day.