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Edited Transcript of CVL.TO earnings conference call or presentation 9-Aug-19 3:00pm GMT

Q2 2019 Cervus Equipment Corp Earnings Call

CALGARY Sep 2, 2019 (Thomson StreetEvents) -- Edited Transcript of Cervus Equipment Corp earnings conference call or presentation Friday, August 9, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Adam Lowther

Cervus Equipment Corporation - CFO

* Angela S. Lekatsas

Cervus Equipment Corporation - President, CEO & Director

* Calvin Lorne Johnson

Cervus Equipment Corporation - VP of Operations - Agriculture Canada

* Fred Hnatiw

Cervus Equipment Corporation - VP of Operations, Transportation & Industrial

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Conference Call Participants

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* Jacob Jonathan Bout

CIBC Capital Markets, Research Division - MD of Institutional Equity Research

* Sakshi Kanda

TD Securities Equity Research - Associate

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Presentation

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Operator [1]

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Good morning, and welcome to Cervus Equipment's Second Quarter 2019 Results Conference Call. (Operator Instructions) I will now turn the call over to Cervus' Chief Financial Officer, Mr. Adam Lowther. Please go ahead, Mr. Lowther.

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Adam Lowther, Cervus Equipment Corporation - CFO [2]

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Thank you, operator, and good morning, everyone. Thank you for joining us today to discuss the results of Cervus Equipment for the second quarter of 2019. On the call with me is Angela Lekatsas, Cervus' President and Chief Executive Officer. Also joining us is Cal Johnson, Vice President of Agriculture Canada Operations; and Fred Hnatiw, Vice President of Transportation and Industrial Operations, who will be available for the question-and-answer portion of the call.

This call is being webcast and a replay will be available on Cervus' website. In addition, we are providing a presentation to accompany today's prepared remarks. You may access the presentation now by going to the investor portion of Cervus' website at www.cervusequipment.com.

The presentation is available with the webcast information in the middle of the page.

Before we continue, I'd like to advise listeners that this presentation may contain forward-looking statements and information that is subject to certain risks, uncertainties and assumptions. For a complete discussion of the factors, risks and uncertainties that may lead to actual results or events differing materially from those expected, refer to our press release and MD&A from yesterday, which is available on our website.

Please note that during today's call, we'll discuss non-IFRS financial measures, including results on an adjusted basis. We believe these adjusted financial measures can facilitate a more complete analysis and greater transparency into Cervus' ongoing financial performance, particularly, when comparing the results from period to period. We've included reconciliations of these non-IFRS financial measures to their most directly comparable IFRS financial measures in our MD&A.

Additional information regarding the quarter can be found in our press release and related financial information.

I will provide an overview of our financial results. After which, Angela will provide some comments on operating results and outlook before we open the line to questions.

Turning to Slide 3. I'll walk through the components of the quarter-over-quarter change. Overall, Cervus reported adjusted income before income tax of $2.2 million, a decrease of $11.4 million compared to the second quarter of 2018, which is seen in comparing the 2 gray bars on the chart.

This result was primarily due to the performance of our Agriculture segment, reflecting the headwinds currently facing Western Canadian producers. The largest component of this decrease was the $12.2 million or 44% reduction in gross profit generated from equipment sales compared to the prior quarter related to a 26% decrease in equipment revenue. Reduced equipment sales in our Agriculture segment comprised majority of the decrease, while tapering of truck sales in our Transportation sector relative to the strong sales of 2018 was the secondary factor.

Despite reduced equipment sales, the third buyer shows the impact of a 4% overall increase in product support revenue, which contributed $1.2 million increase in gross profit from product support.

Moving over to SG&A. SG&A decreased by $1.3 million in the quarter, primarily due to reduced sales commissions tied to lower equipment revenue. This was partly offset by increased SG&A expenses from the inclusion of the Red Deer agriculture dealership we acquired in the fourth quarter of 2018.

Finally, increased net finance cost of $1.6 million was primarily due to the adoption of IFRS 16, as allocating floor plan borrowing between credit facilities held financing costs relatively flat quarter-to-quarter.

Turning to Slide 4 and the balance sheet. Inventory remains the company's principal asset. Total inventory was $390 million at June 30, 2019, an increase of $32.6 million from June 30, 2018. Inventory in our Agriculture segment increased $54.1 million compared to the prior year, which was partially offset by a $21 million decrease in the Transportation segment. The net increase in inventory has been funded through increases in our floor plan facilities and our syndicated debt, as we manage our borrowing allocation in order to obtain the most effective source of financing.

Our net long-term debt to total capital ratio increased to 25% in the quarter compared to 14% at June 30, 2018, primarily due to using our lending syndicate to finance inventory. This ratio is consistent with our view that financial flexibility is maintained with a net long-term debt to total capital ratio remaining below 35%.

At June 30, 2019, the company had the ability to floor plan an additional $37 million of existing inventory through committed floor plan facilities and had $48 million available under our syndicated credit facility. The quarterly dividend of $0.11 per share was declared to shareholders in the quarter, a 10% increase from the dividend declared in June 30, 2018.

The company also repurchased $3.1 million of shares in the second quarter and $3.8 million of shares year-to-date. I will now turn the call over to Angela for some commentary and closing remarks. Angela?

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Angela S. Lekatsas, Cervus Equipment Corporation - President, CEO & Director [3]

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Thank you, Adam, and good morning, everyone. Before I comment on the quarter, I would like to acknowledge that this is my first quarter end as CEO of Cervus. For those of you who are on the call that I haven't met or talked to in my first 90 days, I look forward to meeting you in the future or talking to you on today's call. I have invited the heads of our business segments to be on this call to provide color and respond to questions on the specific industries in which we operate. Let's move now to a discussion on our company operations and strategies going forward.

Slide 5 demonstrates the magnitude of the perfect storm that has been created for Western Canadian Agriculture equipment dealers as Cervus adjusted income before tax in our Agricultural segment fell $11.7 million quarter-over-quarter, while the combined profitability of our Transportation and Industrial segments produced consistent results.

Today, Agriculture is our largest segment and the significant headwinds facing Western Canadian agriculture is driving producers to adjust equipment purchasing decisions. In response to Canadian realized net farm income declining 45% in the 2018 crop year, compounded by increased input costs, reduced commodity prices, trade disputes with China and dry weather conditions in parts of our Western Canadian region. Producers have responded with caution. As a result, our Agriculture equipment sales decreased 30% in the quarter and 22% in the first half of the year.

As our producers are adjusting to these market conditions, so are we. Following several years of increased focus on new equipment sales by dealer, aided by low interest rates and strong Canadian farm profitability, Western Canadian producers generally hold late-model equipment and are well-positioned to defer additional purchases. Dealers, including Cervus, have entered this market of reduced equipment demand, holding high levels of used equipment taken on trade, following elevated new equipment sales in 2018 and 2017.

Consequently, Cervus has experienced reduced equipment margins in the first half of 2019 and expects continued pressure on equipment margins across the industry until new and used equipment levels stabilize.

In the short term, we will be focused on strengthening our balance sheet and increasing our inventory turns. We anticipate continued support of our customers through this challenging market with increasing parts, service, rental and other solutions that will keep producers' equipment working well as they defer purchases this year.

This is our opportunity to strengthen our base by providing best-in-class uptime, through the harvest window while building on the continued strength and stability of our product support business.

Challenging times tend to highlight the opportunities for improvement in any business. Although, the macroeconomic factors presently impacting Canadian agriculture are largely out of our control, I see a road map for structural change and opportunities for strengthening our base.

First, Cervus tends to reduce -- intends to reduce our used inventory level. As illustrated on Slide 6, our used inventory turns of the last 2 years have regressed to levels experienced in 2015, but they remained comparatively strong to our industry peers, which aids us in the work ahead. To progress towards a sustainable used equipment turn of 2x or higher, we'll require a near-term reduction in new sales to limit incremental used equipment taken on trade. This reduction will impact our new equipment gross profit compared to 2018, but we view this strategy as necessary to strengthen our balance sheet and implement strong sales practices that balance profitability and financial strengths into the future.

Second, product support is the foundational pillar of our business across market cycles and continues to hold opportunities for growth as shown on Slide 7. While overall equipment sales decreased 26% in the quarter, product support gross profit dollars increased across all our operating segments, including Agriculture. Of note, although our Transportation segment generated 31% of Cervus' overall revenue, it contributed 41% of the overall product support gross margin dollars in the quarter. Looking forward, we are committed to accelerating efficiencies and offerings within product support and prioritizing growth in this area.

Third, the quarter illustrates the value of diversification across industries and geographies. Our expansion into Transportation, Australia and the retention of our Industrial segment is purposeful and delivered profitability in the quarter. Because our dealership share many fundamental attributes, we view exposure to multiple industries and geographies as a competitive advantage. The actions taken to stabilize our Transportation segment in 2017 has generated sustained profitability through 2018 and 2019, while our Industrial segment continues to deliver the highest exposure to product support as a percentage of overall segment revenue. We believe the foundation has been laid to build on organic and acquisitive growth opportunities in business-to-business dealerships across industries and geographies.

In closing, the current macroeconomic headwinds being experienced in Western Canadian agriculture today demands we focus on controlling our controllables through market cycle. This includes examining our cost structure, strengthening our balance sheet, focusing on profitability and continued investment in product support opportunities.

In our view, the long-term outlook for Canadian agriculture remains positive as consumer demands for food, at home and abroad, is robust and expected to continue.

Our producers are resilient and have experienced 15 years of continuous quality crop yields. We continue to view agriculture as an exciting and dynamic industry driven by passion of our farmers.

In November, we will be hosting an Investor Day in Toronto, at which time we look forward to sharing our 5-year strategy with you. Operator, we are now ready for the question-and-answer portion of our call.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Jacob Bout with CIBC.

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Jacob Jonathan Bout, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [2]

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So the conditions that you're seeing in the second quarter on both Transportation and Ag, is your expectation that, that continues into the second half of the year? And how are you feeling about 2020?

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Angela S. Lekatsas, Cervus Equipment Corporation - President, CEO & Director [3]

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I'll maybe turn it over to Fred to talk a little bit about how we're seeing Transportation in the second half, and then we'll pass it over to Cal and will talk about Agriculture in the second half. I think, they have different perspectives on what the second half looks like. Fred, do you want to start with Transportation?

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Fred Hnatiw, Cervus Equipment Corporation - VP of Operations, Transportation & Industrial [4]

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Thanks, Angela. Our sales in the first half on the Transportation side of the business were off primarily due to Peterbilt factory delays and we're coming off of high sales in 2018. The factory delays have now been, for the most part, resolved and we're expecting '20 and the remaining part of 2019 to be similar to the second half of 2018. Looking into 2020, we expect the market to be flat to the remainder of 2019, but still very robust.

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Jacob Jonathan Bout, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [5]

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And how are the newer dealerships performing, like Barrie, Stoney Creek, Windsor?

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Fred Hnatiw, Cervus Equipment Corporation - VP of Operations, Transportation & Industrial [6]

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Overall, the performance of the new branches within our Ontario operations are performing above expectations and extremely well.

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Jacob Jonathan Bout, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [7]

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Do you expect it to -- if you're saying flat here, basically you're not going to see a lot of growth there? Or...

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Fred Hnatiw, Cervus Equipment Corporation - VP of Operations, Transportation & Industrial [8]

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Although the market may be flat, we see opportunity for us to continue to grow market share in the Ontario marketplace.

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Angela S. Lekatsas, Cervus Equipment Corporation - President, CEO & Director [9]

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And, Cal, do you want to talk about the second half of -- for Agriculture?

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Calvin Lorne Johnson, Cervus Equipment Corporation - VP of Operations - Agriculture Canada [10]

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Sure. Yes, I will. It is Cal Johnson speaking. For the Agriculture side of our business, as we mentioned earlier, our focus right now is on reducing used inventory and also on supporting our customers through product support. And from a product support perspective, we continue to see that being consistent through the back half of the year. And from a used inventory perspective, we know that we've got to work through that and we would anticipate that we would've worked through the majority of our used inventory by the end of Q2 in 2020.

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Jacob Jonathan Bout, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [11]

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And as far as new equipment sales being down as much as they were in the quarter, is that kind of -- expect similar now for the remainder part of the year?

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Calvin Lorne Johnson, Cervus Equipment Corporation - VP of Operations - Agriculture Canada [12]

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I think, it -- yes, the situation that all dealers are in, relative to the industry, would indicate that, correct.

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Angela S. Lekatsas, Cervus Equipment Corporation - President, CEO & Director [13]

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And then, Jacob, just to your question on what do we see 2020 looking like. If we work through our used inventory, as Cal indicated, by the end of Q2, we would actually expect to start seeing some improvement in new sales in the earlier part of 2020 and that back half of 2020 looking more normal. Of course, that's all predicated upon what we see happening with the whole canola issue in China.

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Jacob Jonathan Bout, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [14]

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Last question here. Just, Angela, what's your view on M&A and given market conditions, assume that does create some opportunities?

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Angela S. Lekatsas, Cervus Equipment Corporation - President, CEO & Director [15]

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Absolutely. I see the bottom of the cycle is really an opportunity to be a consolidator and an acquirer. And that is one of the reasons we are focused on building our dry powder and improving our balance sheet. Cervus continues to kick the tires of potential acquisition opportunities right now with an appetite towards growing our product support business. We would pull the trigger on an accretive target, but that's based on improving our balance sheet strength and our dry powder.

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Jacob Jonathan Bout, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [16]

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Would you be looking at Transportation or the Ag side?

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Angela S. Lekatsas, Cervus Equipment Corporation - President, CEO & Director [17]

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I think we would look at both, but I think Transportation has more opportunity for increasing product support as a higher percentage of Transportation's revenue comes from the product support side of the business.

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Operator [18]

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Your next question comes from Sakshi Kanda with TD Securities.

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Sakshi Kanda, TD Securities Equity Research - Associate [19]

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I'll be asking on behalf of Cherilyn Radbourne. And congratulations on your first quarter as CEO, Angela.

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Angela S. Lekatsas, Cervus Equipment Corporation - President, CEO & Director [20]

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Thank you very much.

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Sakshi Kanda, TD Securities Equity Research - Associate [21]

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Yes. So we were just a bit surprised to see that within the Ag segment, parts revenue was flat, while service revenue was up 12%. Would you be able to elaborate a bit on what was driving this?

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Angela S. Lekatsas, Cervus Equipment Corporation - President, CEO & Director [22]

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Sure. I'll turn that over to Cal, who'll talk about parts in Agriculture.

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Calvin Lorne Johnson, Cervus Equipment Corporation - VP of Operations - Agriculture Canada [23]

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Yes, exactly. So, first of all, from a service perspective, that -- it's a result of a very intentional strategy of working through with our customers to ensure their equipment is ready for uptime and ready for the field. If they're not purchasing new equipment, they have to repair the equipment that they have in place. From a parts perspective, I think there's been a little bit of a delay in the business this year. The crop is 2 to 3 weeks maybe behind of where it is and we will be seeing Q3 be strong in the parts area.

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Sakshi Kanda, TD Securities Equity Research - Associate [24]

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Okay. That's great. And then in your MD&A, Angela, you mentioned that the outlook for Ag remains stable in Australia and New Zealand. We were just curious as to whether earnings were up year-over-year in your Australian segment this quarter and what impact, if any, global trade tensions have had on the parts business -- on that part of your business?

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Angela S. Lekatsas, Cervus Equipment Corporation - President, CEO & Director [25]

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Sure. So I'll maybe just make some overriding comments and then turn it over to Adam to talk about specifics. But we see that there has definitely been improvement in Australia, been very pleased with the operations there. New Zealand is -- has not been as great from that perspective, but it is a smaller country and more difficult to get the size and scale of economies. But very pleased with Australia. Adam, did you want to add some specifics around those?

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Adam Lowther, Cervus Equipment Corporation - CFO [26]

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Sure. So the Australia, New Zealand kind of cog, if you will, or group was better this quarter over last year's quarter by about $300,000, so that's on a net income before tax basis.

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Sakshi Kanda, TD Securities Equity Research - Associate [27]

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Okay. That's super helpful. And then last one for me. You commented in your message about strength in the diversification of your industry segments. Do you see greater opportunities to achieve synergies amongst the various verticals in which you operate?

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Angela S. Lekatsas, Cervus Equipment Corporation - President, CEO & Director [28]

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Absolutely. We see organic growth as an opportunity to achieve synergies from that perspective as well as from actually growing the offerings that we provide, such as storage solutions and rentals.

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Operator [29]

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(Operator Instructions) Ms. Lekatsas and Mr. Lowther, there are no further questions at this time.

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Adam Lowther, Cervus Equipment Corporation - CFO [30]

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Thank you for joining us this morning. Angela, myself and the Cervus leadership team look forward to speaking with you again following the release of our third quarter.

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Operator [31]

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Ladies and gentlemen, the speaker line has disconnected. Please stand by.

Ladies and gentlemen, we will now disconnect the conference call and webcast. Thank you for participating in today's conference.