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Edited Transcript of RME.TO earnings conference call or presentation 30-Oct-19 3:00pm GMT

Q3 2019 Rocky Mountain Dealerships Inc Earnings Call

Calgary Nov 15, 2019 (Thomson StreetEvents) -- Edited Transcript of Rocky Mountain Dealerships Inc earnings conference call or presentation Wednesday, October 30, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Garrett Andrew Wyatt Ganden

Rocky Mountain Dealerships Inc. - CEO, President & Director

* James Randall Wood

Rocky Mountain Dealerships Inc. - Chief Sales & Operations Officer

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Conference Call Participants

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* Cherilyn Radbourne

TD Securities Equity Research - Analyst

* Greg R. Colman

National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst

* Jacob Jonathan Bout

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

* Kyle Brock

RBC Capital Markets, Research Division - Associate

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to Rocky Mountain Dealerships' 2019 Second (sic) [Third] Quarter Financial Results Conference Call. (Operator Instructions) Please note that this call is being recorded today, October 30, 2019, at 9 a.m. Mountain Time.

I would now like to turn the meeting over to your host for today's call, Garrett Ganden, President and Chief Executive Officer of Rocky Mountain Dealerships. Please go ahead, Mr. Ganden.

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [2]

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Thank you, Chris, and thank you to everyone for participating in our call today. Just as a clarification, it's the third quarter 2019 call versus the second quarter, just so there was no confusion. Sitting with me today is our Chief Sales and Operations Officer, Jim Wood.

Please note that while talking about our results and answering questions, we may make forward-looking statements. These statements are subject to known and unknown risks, and future results may differ materially. We will also be discussing non-IFRS financial measures in today's call, including adjusted diluted earnings per share, adjusted EBITDA and operating SG&A. For more information about these topics, please review the sections of RME's management discussion and analysis for this quarter entitled caution regarding forward-looking information and statements, risks and uncertainties and non-IFRS measures. Listeners should also review the Risk Factors section of our most recent Annual Information Form. These documents can be found on our website as well as the SEDAR website.

Dollar amounts discussed in today's call are expressed in Canadian dollars and are generally rounded. There was little change in the political and macroeconomic uncertainty, which has persisted throughout the year and continued to weigh on the industry sales in the third quarter of 2019. RME demonstrated a resilience -- resiliency to the unusual, and in our view, temporary market conditions affecting our industry. Our focus was on reducing the inventories and strengthening the balance sheet, which defensively positions RME against an uncertain macroeconomic outlook.

Our team responded admirably in a highly competitive and uncertain industry environment by getting deals done, moving equipment and generating cash, while also maintaining our position in the market. We reduced inventories by approximately $62 million from our second quarter 2019 levels, the second-largest inventory decrease in our history. We also continue to make positive progress on the higher-margin product support side of the business, with a $2.3 million increase in revenues year-over-year.

The cool and wet conditions experienced throughout much of our territory significantly impacted harvest progress in September. The charts above illustrate harvest progression for each of the provinces at the end of the quarter relative to historical averages. The chart on the left of your screen shows the harvest progression in 2019 in red compared with the historical average by province. At quarter-end, Alberta harvest was 20% behind the 5-year average at only 34% complete. Saskatchewan was 28% behind and only 47% complete and Manitoba fared a little bit better and was only 9% behind their 3-year average and 67% complete.

This slide is the same data as we were just looking at on the last slide, but updated as at last week, October 22. Again, the chart on the left of your screen shows how the harvest has progressed as of last week, the red bars, compared with the historical average by province. In the third week of October, Alberta harvest was only 8% behind the 5-year average and 74% complete. Saskatchewan was 10% behind and 83% complete. Manitoba fell behind a little bit and is now 11% behind and 77% complete for the week into -- compared to 2018 -- into the 5-year average, sorry, to the average. What we don't know yet is what impact this early cool and wet weather may have on crop yields and quality.

For the third quarter of 2019, gross profit margin was 15% versus 15.5% in the third quarter of 2018. Adjusted EBITDA was $4.5 million compared with $12.2 million for the same period in 2018. Walking through the waterfall chart on your screen, this adjusted EBITDA change was due to the following. It's an $8 million decrease in gross profit on lower sales volumes, a $1.4 million decrease in gross profit on sales price variance. It is worth noting that given our aggressive focus on inventory reduction, the price-sales variance on used equipment was greater than what is reflected, but was offset by gains in other categories; a $3 million increase in gross profit on sales mix; a $2.2 million decrease in OEM incentives on lower sales volumes; a $1.9 million decrease in operating SG&A, reflects reduced sales commissions as well as other operating cost reductions, as discussed on our last quarterly conference call.

Finally, there was a $1 million increase in short-term finance costs associated with RME's floor plan facilities. Persistent and broad macroeconomic and political uncertainty, combined with the early arrival of cool and wet weather continued to weigh on and temper customer demand for equipment, leading to the decrease in sales. However, momentum in our parts and service business in the first half of 2019 continued to positively contribute to revenues in the third quarter. The agricultural equipment deliveries reported by the Association of Equipment Manufacturers for all of Canada continued its downward trend in the third quarter of 2019. Specifically, the September 2019 report indicated year-to-date equipment sales declined in major product categories, including 4-wheel drive tractors, down 32.9%; self-propelled combines down 27.7% for year-to-date 2019 compared to the same period in 2018.

Looking more closely at the graphic. I would point out the total units delivered year-to-date on a trailing 12-month basis in 2019 are now at levels not seen in Canada since 2004. As I mentioned earlier in the call, new and used equipment inventories were significantly reduced quarter-over-quarter to approximately $504 million, which is illustrated on the graph on the left-hand side of the slide. Again, this is a strong achievement against this significant macroeconomic backdrop our teams faced in the quarter. This was the largest quarterly inventory reduction RME has had since 2003 and the second-largest decrease in our history. New equipment inventory was approximately $145 million, representing a decrease of approximately $21 million or 12.5% compared to the second quarter '19. Used equipment inventory was approximately $360 million, representing a decrease of approximately $35 million, or 8.9% down compared to the second quarter 2019. We were also able to apply essentially all of the proceeds from the inventory reduction towards improving our balance sheet position, marked by a $56 million reduction in financial leverage quarter-over-quarter.

Operator, we are now ready to open up the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Kyle Brock with RBC Capital Markets.

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Kyle Brock, RBC Capital Markets, Research Division - Associate [2]

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This is Kyle on behalf of Derek. The reduction in operating cost was a bright spot during the quarter. I was wondering if you could talk a bit about where the savings are coming from? And what we can expect to see going forward?

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [3]

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So it was really a combination of things. Some of this we talked about last quarter that we were looking at, what we would say, some tougher conditions. And we had downsized some variable costs, most of which, quite honestly, unfortunately, was around staff levels that we had in locations as well as in head office. So that was a big chunk of it. Some of the other piece is, quite honestly, managing expenses through, what we would call, a very tough time. The expense reductions that we've seen in Q3, we would expect to see in Q4 as well as it would continue on. It's not a -- it wasn't a temporary reductions, we actually made it so that it was really more of a permanent drop.

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Kyle Brock, RBC Capital Markets, Research Division - Associate [4]

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Okay. Great. And with respect to the used inventory being down $35 million sequentially, are you now more comfortable with your current used levels or you -- or is destocking still a priority there?

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [5]

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The best time to be able to drop inventory is in season. And Q3 is, obviously, in season when you're going through the harvest period. So we wanted to make sure that we had a fairly big impact in Q3. We are going to continue to monitor and control our inventories like we have before, but it's obviously going to be very, very top-of-mind as we continue through it. So it's not going to be an aggressive reduction of inventory as we move forward. It's going to be prudence as we work through and try and understand when that market actually returns to a normalcy.

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Operator [6]

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Your next question comes from Jacob Bout with CIBC.

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

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I wanted to talk a bit about the macro environment for the Canadian farmer. And, obviously, third quarter was pretty tough. Maybe just starting off with the snow that you had and then, I guess, there's been a window here that the farmers have actually been able to get back out. What does that mean? I mean farmers who are more optimistic than they were, say, a month ago? Or -- and then when does this start to improve the macro environment? Is this a mid-2020, or is this a -- or we early part of a 3- to 5-year cycle?

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [8]

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Well, I think, the answer to that is, it's been a tough harvest like you had just mentioned. It's been hard on basically the entire industry. It still stems back to earlier in the spring when we started the -- geopolitical issues that started to arise as a result of China's tariffs, continue to have the India tariff. So from a sentiment perspective, the farmers are happier about the fact that they're getting their crops off. But I think general consensus, I would say, is everybody is looking forward to having 2019 behind us and looking forward to a spring where, hopefully, we've got some good moisture levels based on the rain and snow that we've had thus far. It would appear that we're going to have some decent moisture levels as we start into the spring. So I think when you look at when does it turn? Part of it is going to be when we're going to get the solutions on the geopolitical, the macro issues. Other than that, it's probably going to be latter part of Q2 in 2020, and that's going to assume growing conditions are good and we get a positive sentiment growing within the customer base in the farming community.

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Jacob Jonathan Bout, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [9]

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I also wanted to talk about the used equipment, inventory side of things. So a couple of things. So I can appreciate that things actually improved from second quarter. When you actually take a look year-on-year, I mean, your inventory levels are actually up. And there's -- I'm assuming there's going to be some seasonality component as well. And then I did want to ask about the floor plan payables as well. Also notice there, while the non -- for the interest-bearing whereas the noninterest-bearing was actually the reverse [stand] what's going on?

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [10]

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Okay. It's a few different (inaudible) I'm going to try and break that into pieces, Jacob, if that's all right. Yes, you're right. Inventory is higher this year over last year. We're down from the quarter. We did hit a high point in inventory in Q2. That was a combination of some higher presales that existed -- higher new sales that existed last year. And working our way through that also, you've got to remember the tough harvest we had last year with that early snowfall that happened kind of that early part of September. So we're working our way through that. I think the important piece for us is managing what the new equipment sales are as we continue to move forward. Because, as you know, every new equipment sale creates a used inventory piece. So we're going to continue to work through those levels and making sure that we're managing that as much as we can, right?

If you actually look at the inventory levels we have, from a units perspective, for the most part, we're actually pretty consistent with where we were last year. There are certain products that may be a little bit higher. There's other products that were a little bit lower. But overall, the mix is actually pretty darn good. So we've just been really focusing on trying to get those turns back up, right? So that's the first piece, Jacob. The secondary piece on the floor plan perspective?

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

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Yes. Interest-bearing versus the noninterest, yes.

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [12]

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Yes. So what ends up happening on that is as you do your inventory sales for new product, there are programs that the manufacturers put into place to be able to give you periods of interest free. Most of those end up depending upon season of use. So as you get into Q3, which would be season of use, for example, for harvest equipment, those would become interest-bearing. And that's why interest-bearing would've come up in Q3. Q4, as we go through our normal cycle, although expected to be lower new sales similar to what's going on in the marketplace already. Q4, the 0% piece will actually start to come up a bit again. So it's basically the cyclicality of the business.

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Jacob Jonathan Bout, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [13]

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Okay. But I was actually doing the comparison of Q3 in 2018 versus Q3 2019 (inaudible)

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [14]

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Yes. But that's basically where it comes down from, like, it's just a matter of the timing piece. Our expectation, and this is probably how I have to explain it is, our expectation is continue to be a 1/3, 1/3, 1/3, with some quarterly bumps into it, right? And the 1/3, 1/3, 1/3 is interest-bearing versus -- noninterest-bearing versus hedged.

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Jacob Jonathan Bout, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [15]

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Okay. So it's got to be very competitive out there right now on the used equipment side. That's going to impact margins, especially as we move into fourth quarter (inaudible) going to be a lot of competition for us trying to move product. What are you doing to help continue in the reduction of the...

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James Randall Wood, Rocky Mountain Dealerships Inc. - Chief Sales & Operations Officer [16]

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Yes. Jacob, its Jim here. I would say that our biggest advantage is we're predominantly Case IH and New Holland. And we are the largest Case IH dealer in Western Canada, so we don't have a lot of in-line competition for our used product. The competitive nature, yes, for sure, this is always a very competitive business, especially with manufacturers trying to drive market share. And that's why you saw such a big decline in our used equipment with some pressure on margins as we took the opportunity within this harvest to try and reduce our used and definitely be ultra-competitive. And we saw some good results. And with Q4 on the way, like Garrett says, we anticipate lower new sales based on the market as well. So we'll continue (inaudible) on our late-model and used equipment, which is the majority of our inventory.

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Jacob Jonathan Bout, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [17]

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Is the OEM helping you out at all on us?

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [18]

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Yes. They've been helpful.

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James Randall Wood, Rocky Mountain Dealerships Inc. - Chief Sales & Operations Officer [19]

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They could always be more helpful. But we do -- they definitely try and help in certain situations, but a lot of their programming is geared towards new so.

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Operator [20]

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Your next question is from Greg Colman with National Bank Financial.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [21]

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I wanted to talk a little bit about the balance sheet and the dividend. We've already seen a couple of amendments to covenant so far in 2019. Pretty limited outlook for Q4 into 2020, understanding it's a fluid situation. But how should we be thinking about the dividend as it relates to covenant compliance? I mean you kind of gave some good legalese in the prepared remarks, but what should we be thinking about that as a real risk in the short term? Or are we fairly comfortable with it? And we're seeing a trough in terms of covenant compliance here.

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [22]

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So here's the way we're looking at it, right? The Board, the management team, we're all committed to returning money to shareholders. It's something that we've done over the long term since our inception of being public, right? And we believe that the balance sheet that we have is available to weather these unusual temporary market conditions like we are seeing right now. That being said, the normal (inaudible) Greg. Dividends, share buybacks, they're all paid out of earnings, right? And if market conditions continue to be negative for an extended period of time, that may impact what we've got. Our banks have been very supportive as they understand that what's been going on in the industry and have continued to be. We continue to be in constant dialogue with them, keeping them up-to-date with the ebbs and flows of what's going on in the industry. So that's the noncommittal answer, Greg.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [23]

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No, no. Fair enough. And I mean I know it is a fluid situation. Maybe you could help us understand a little bit more the dialogue that goes back and forth of the banks, I mean if there's several scenarios in the near term where further relaxation is required, which are not at all outside the realm of possible. Is that the sort of thing where you would -- your learning syndicate would need to see a cut in payments to equity holders in order to see further covenant relaxation? Or is that not part of the discussion?

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [24]

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That has not been part of any discussion at this stage.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [25]

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Okay. And can you talk to us a little bit about a reinitiation or an acceleration of the NCIB? I know you haven't made any market purchases since, I think, March. I don't know if that's because it's expired? Or you've just kind of held off, but -- sorry, go ahead.

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [26]

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I was just going to say, the renewal is actually in November.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [27]

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The (inaudible) renewal?

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [28]

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Yes.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [29]

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I'm just trying to determine, is it likely that the NCIB will be restarted, we'll open market purchases and cancellation of shares, given how low the share price is right now? Is it likely to happen? And also, is it able to happen given the covenant situation?

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [30]

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Our plan is to renew the NCIB. The share buybacks are a portion of any type of shareholder return that we will do. And it's going to depend greatly on what the market conditions are. My -- what I would say is, if you look over the last 6 months, as we've gone through some of these tough market conditions, we haven't bought any shares back. I think we would need to see a market turn in some level of normalcy before we would actively pursue.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [31]

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That's fair enough. Okay. I appreciate that. And I know that's difficult to make those calls, but just wanted to have a discussion. Switching over a bit to inventory, great work on that -- on the inventory numbers there. I want to talk about sort of the current inventories on the books, and if you could just give us a bit of a history lesson as to the risk of any potential book value write-downs. I don't think we've -- I can't see any in my time covering you, but can you just remind us what the risk is of any asset impairment there on your book value in the past just for trough cycles?

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [32]

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So what we do, and we do this on a quarterly basis in the peaks or in the valleys. We go through and look at the inventory. This is a bit of an accountant answer, but the -- we make sure that it's basically lower of cost or net realizable value. If there's something that we have to take a charge on, we take it in the quarter that it's identified that it's needed. So we have been continuing to do that. There's pretty consistent write-downs over the last quarters and years. And evidence of that, it shows up in the -- I think it's the inventory note within the financial statements.

At this stage in the game and everything that we've seen like we were aggressive in our pricing on our -- to move that used. We were selling it for profit still, right? So it wasn't at the point where we were losing money on every sale. We were making less margin than we had been in the past. And assuming market conditions stay in this level, we're going to continue to price it in a way where we're going to get our share. And we're going to continue to make sure that we value the inventory appropriately at the end of every quarter as best of the information we have. So I get that, that doesn't outright answer your question, Greg, but I think the most important thing to leave you with thinking on it is, at the end of the day, we go through that on a quarter-by-quarter basis. As the market changes, we have been modifying ours as well to try, and what do you want to call it, mitigate any surprises.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [33]

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Fair enough. And then just lastly for me, like this is probably looking out a little bit further past, you've mentioned Q2 as something we're kind of -- should keep an eye out for as getting through into next year and a little bit of the weather nonsense behind us. But can you talk to us about the potential rebound effect in future years after you've seen periods of substantial same-store sales growth retrenchment? Is there -- the periods of massively retrenchment equipment sales tend to be followed by greater-than-historic rebound once the sentiment back? Or is it basically just lost revenue and then you get back to, sort of, the mean as opposed to shooting to the upside?

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [34]

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Well, as bad as this answer is going to be, the answer is going to be sometimes. You've seen it both ways, it depends on honestly how the customers and how the farmers are feeling their sentiment. What do they see from a commodity price perspective? What do they see as their access to market to be able to move those products? Good strong growing conditions have a tendency to increase buying. Tough growing conditions have a tendency to decrease buying. And I think that's a bigger impact overall than tough this year, great next year. That's the way I've always seen it and looked at it, Greg.

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Operator [35]

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Your next question is from Cherilyn Radbourne with TD Securities.

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Cherilyn Radbourne, TD Securities Equity Research - Analyst [36]

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Maybe I'll start by asking if you could just comment on what you're hearing anecdotally in terms of crop yield and crop quality as it gets brought off.

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James Randall Wood, Rocky Mountain Dealerships Inc. - Chief Sales & Operations Officer [37]

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It's so regionally different, Cheril. I would say, the quality is not there compared to the years. I think it was there at the beginning of harvest just with snow and rain, and it's been tough all. Manitoba's had tons of moisture, Saskatchewan's had snow, Northern Alberta's had snow. So when you can't take it off dry, they are challenged with less quality, which affects the price they get. As far as the yields go, it's just been all over the map. Like I know in Northern Alberta, North of Edmonton, a lot of their crop was drowned out from just torrential rains they had all season. And so I don't -- I wouldn't say it's been a great from a yield perspective or even a quality, a great harvest. I think it started out that way, but -- because like Garrett said, we did have some nice needed moisture. It sets us up good for next year, but it's definitely going to be a challenge this year.

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Cherilyn Radbourne, TD Securities Equity Research - Analyst [38]

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Okay. And then maybe a few questions just, sort of, related to cash flow. I just want to be clear, do you expect to make further progress on inventory reduction in Q4?

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [39]

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So normally, in Q4, we have an inventory increase, right? That's when a lot of the presales happen, the inventory, the annual flips, if you will, for the customer. So historically, we have an increase in Q4. So our expectation is to have a reduced increase this year compared to where we were in the previous years.

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Cherilyn Radbourne, TD Securities Equity Research - Analyst [40]

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And you'll accomplish that basically by carefully controlling new equipment sales effectively?

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [41]

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And expecting continuation of prudent used sales.

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Cherilyn Radbourne, TD Securities Equity Research - Analyst [42]

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Okay. And then just from a CapEx standpoint, how much do you have left to spend on the Kindersley facility.

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [43]

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We actually moved into it last week.

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Cherilyn Radbourne, TD Securities Equity Research - Analyst [44]

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Okay. So we should see CapEx come down a fair bit in the -- in Q4. Is that fair?

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [45]

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Yes. Q4 and through 2020.

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Cherilyn Radbourne, TD Securities Equity Research - Analyst [46]

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Okay. And just remind us, sort of, maintenance CapEx as we think about 2020?

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [47]

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Historically, it's been somewhere between the $6.5 million and the $8 million. So for argument sake, let's put it at $7 million.

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Cherilyn Radbourne, TD Securities Equity Research - Analyst [48]

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Okay. And then in your prepared remarks -- excuse me, I didn't hear any update on the CFO search. Just anything to tell us there?

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [49]

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Honestly, continuing on the search. We just want to make sure that we've got the right fit. We've got some, well, I would say, some really interesting candidates. And we're just wanting to make sure that we're doing the measure 3 times cut once scenario. So we're continuing to work towards a finale on that.

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Operator [50]

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Ladies and gentlemen, that does conclude the Q&A period. I'll now turn it back to over to Garrett Ganden for any closing remarks.

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Garrett Andrew Wyatt Ganden, Rocky Mountain Dealerships Inc. - CEO, President & Director [51]

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Thanks, Chris and everyone, and have a great day.

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Operator [52]

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This does conclude today's conference call. Thank you for you participation, and you may now disconnect.