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Edited Transcript of SQP.TO earnings conference call or presentation 31-Oct-19 2:00pm GMT

Q3 2019 Strongco Corp Earnings Call

MISSISSAUGA Nov 15, 2019 (Thomson StreetEvents) -- Edited Transcript of Strongco Corp earnings conference call or presentation Thursday, October 31, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* J. David Wood

Strongco Corporation - VP, CFO & Corporate Secretary

* Oliver Nachevski

Strongco Corporation - VP & COO

* Robert Jonathan Beutel

Strongco Corporation - Executive Chairman

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Conference Call Participants

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* Ben Cherniavsky

Raymond James Ltd., Research Division - MD & Head of Industrial Research

* Chen Rivlin;Rubicon Partners;Portfolio Manager

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Presentation

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Operator [1]

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Thank you for standing by. This is the conference operator. Welcome to the Strongco Corporation Third Quarter 2019 Conference Call.

(Operator Instructions) The conference is being recorded. (Operator Instructions)

I would now like to turn the conference over to Robert Beutel, Executive Chairman. Please go ahead.

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Robert Jonathan Beutel, Strongco Corporation - Executive Chairman [2]

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Thank you, Jenny. Good morning, everyone, and thank you for joining us to discuss our third quarter results for the period ended September 30, 2019. With me is David Wood, our Chief Financial Officer and Corporate Secretary. Also joining us today is Oliver Nachevski, Vice President and Chief Operating Officer.

Before we get started, I'd like to remind you that our discussion may contain forward-looking statements. This information, by its nature, is subject to risks and uncertainties that may cause actual events or results to differ materially. For more details, please see our news release issued yesterday and our MD&A and financial statements available on SEDAR and on our website at strongco.com.

I'll begin today with a brief overview of the quarter. David will then provide more details on the financials and our key markets. And following David's remarks, Oliver will discuss operations as we look ahead to the balance of 2019 and beyond. At the end of the presentation, we'll be pleased to take your questions.

In the third quarter, Strongco achieved solid performance in the wake of softer markets for heavy equipment. While lower equipment sales led to a 1% decrease in overall revenues during the period, notable upturns in product support, sales and equipment rentals relative to a lower proportion of equipment sales resulted in stronger gross margin in the period.

Gross profit was up 5% from the same period last year. And when combined with lower expenses due in part to the streamlining actions that began in 2016, led the company to significantly improved operating profit.

The slow start to the summer construction season, combined with the current preference among customers for rental product, has given way to a proportionate rise in inventory levels, which ended the third quarter at $202.7 million, up from $165 million at the same time last year. Correspondingly, associated equipment financing or interest expenses were higher for the period while pretax earnings increased substantially when compared to 2018.

As part of our ongoing efforts to judiciously manage inventory levels, Strongco has curtailed the purchase of incoming products for the balance of this year and anticipates the proportions of the equipment -- portions of the equipment, excuse me, on rent will convert to sales in the coming quarters as customers push to complete projects prior to the onset of winter weather.

While we cannot control the market uncertainties that come our way, we continue to benefit from the strategic restructuring initiatives of the past few years, which has better positioned us for improved stability, enhanced profit and value creation over the long term.

With that, I'll turn the call over to David Wood to review the financial highlights of the quarter. Thank you, Dave.

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J. David Wood, Strongco Corporation - VP, CFO & Corporate Secretary [3]

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Thanks, Robert. As we announced in the last 2 quarters, our results reflect the impact of the adoption of the new leasing standard, IFRS 16, effective January 1 of this year. Under IFRS 16, all leases, including our property leases, which had previously been treated as operating leases, are now recorded on the balance sheet as assets and lease liability. And the lease rental expense has been eliminated and replaced with charges for depreciation and interest.

Total revenue for the quarter was down slightly to $98 million from $99 million last year. For the 9 months, it was $303 million, down from $310 million in the prior year. The small year-over-year decline was the result of lower sales of equipment due to weaker markets and lower demand for new equipment, but this was offset by stronger rental revenue and product support sales.

The markets for heavy equipment that Strongco serves were estimated to be down 7% year-over-year in the quarter. While Strongco sales were affected by the lower demand, our sales were down less than the market, reflecting an improved market share in the quarter.

To break down our equipment sales performance by region, lower equipment revenues in Ontario and Alberta for the 3-month period were partially offset by higher sales in Québec. For the 9 months, equipment sales in Alberta were up 5% year-to-date due to stronger sales of articulated trucks as well as telescoping truck-mounted cranes and articulating cranes in the first half of the year.

In Ontario, sales of smaller cranes and heavy lift trucks were steady in the first 9 months of the year, while sales of larger hydraulic cranes and material handling equipment were lower. While equipment sales in Québec picked up in the third quarter, year-to-date sales in the province were lower due to continued weak demand.

Turning to the rental category. Year-over-year rental revenues were up 38% for the 3 months and 14% for the 9-month period across all regions of the country due to increased demand for rental equipment primarily in Alberta and Ontario as the general air of caution has led to a preference amongst customers to rent as opposed to purchase new equipment.

Product support revenues were up year-over-year by 2.8% for the 3 months due to increased service and parts activity in Eastern Canada and were up 3.6% for the 9-month period due to higher demand in Ontario and Eastern Canada. Product support revenues in Western Canada were lower for both the 3- and 9-month periods due to the heavy rains in the province, which delayed construction activity and also as a result of a pullback on infrastructure projects following the provincial election.

Fortunately, while revenues were slightly down, gross profit for the 3-month period increased to $19 million, up from $18.1 million in 2018. And for the 9-month period, gross profit was $55.9 million, up from $55.3 million in the prior year.

As a percentage of revenues, gross margins also improved in the third quarter to 19.4% from 18.3% last year. And year-to-date, gross margins rose to 18.4% from 17.8% in the first 9 months of last year. For both the 3- and 9-month periods, higher rental and product support revenues contributed to the year-over-year increase in gross profit and gross margins despite the lower equipment sales.

Operating expenses declined in the quarter to $13.6 million, down from $14.7 million in 2018. For the 9-month period, operating expenses were $42.5 million, down from $46.1 million in the same period of 2018. The reduction was the direct result of the restructuring and cost reduction activities taken over the last several years to streamline our business relative to the markets.

Lower operating expenses, combined with higher gross profit, resulted in a substantially improved operating income of $5.6 million for the quarter compared to only $3.4 million in the same period last year. And for the 9-month period, operating income was $14.4 million, up from $9.4 million in the prior year. EBITDA was up significantly for both the quarter and the 9 months at $13.3 million and $33.9 million, respectively, with significant improvement as a percentage of revenues.

Interest expense in the quarter rose to $3.5 million, up from $2.4 million a year ago, and for the 9-month period, increased to $10.5 million, up from $6.4 million a year ago. The increase was mainly due to the impact of IFRS 16 but also due to a higher level of interest-bearing notes combined with higher interest rates.

Net profit for the quarter was $2.1 million compared to a loss of $2.4 million in the same period in 2018. And for the 9-month period, net profit was $4 million compared to a loss of $600,000 in the same period last year.

As Robert mentioned, equipment inventory at the end of September rose to $202.6 million, up from $167.5 million at the beginning of the year and $165 million at the same time last year primarily due to a higher amount of equipment on rent but also to support our anticipated sales in the fourth quarter and into 2020.

At the end of September, Strongco had $73.4 million of equipment on rent consisting both of short-term rentals and RPO contracts, and that was up from $52.8 million at the beginning of the year and $56.4 million at the same time last year. Correspondingly, notes payable were up at the quarter end to $176 million compared to $141 million at December and $145.5 million in September of last year.

Now turning to our key markets. Improved demand for heavy equipment is palpable. However, an air of caution remains, particularly in Alberta and Ontario, resulting in a customer reluctance to commit to purchase and a preference to rent, a trend that we anticipate to continue for the balance of 2019 and into 2020.

As economic conditions in Alberta slowly improve, we are seeing higher construction activity and demand compared to prior year levels. However, the market for new equipment was estimated to be down more than 20% at the end of September as customers have shown a tendency towards used and rentals. This hesitancy to commit to purchase is also evident on Ontario, resulting in customers' increased reliance -- an increased reliance on rentals to meet their equipment needs.

In Québec, demand for heavy equipment was lower in the first half of the year. And while markets showed some improvement in the third quarter, with no plans for significant government infrastructure spending on the horizon, construction activity in the province and demand for equipment is expected to remain soft for the balance of the year.

Overall demand for heavy equipment in the Atlantic region is expected to remain soft, dampened by the lack of new government infrastructure spending and a slow housing market.

Looking forward, we are not anticipating markets to improve in 2020 and expect demand for new equipment may be flat to slightly down across the country. However, we remain confident from the actions that we've taken to restructure the business and reduce costs. We are better positioned to generate sustained profitability as markets fluctuate.

With that, I will turn the call over to Oliver Nachevski, Strongco's Vice President and Chief Operating Officer. Oliver?

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Oliver Nachevski, Strongco Corporation - VP & COO [4]

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Thank you, David. As Robert and David indicated, the first half of 2019 got off to a slow start with market conditions resulting in weaker demand and the associated activity, a situation that only began to ease up in the middle of Q2.

Looking at total units sold in the regions in which Strongco operates, markets across Canada were down 7% in the quarter. In spite of these challenges, I am pleased to report that Strongco held its own in a difficult environment with an overall market share increase of 8% in the same period.

Our rental business has been stronger throughout 2019. And with increasing construction activity, product support revenues have also improved. Strongco's market share in articulated haulers continues to grow in the third quarter with a few multiunit sales in Ontario and conversions from rental in Alberta.

The fourth quarter of this year began with renewed optimism across the business. With quoting activity underway, customers are closing out purchases for product on rent and they've closed their books for the year. And yet -- and the usual winter snow removal contracting is in full swing.

One notable win in the third quarter was the sale of 5 Volvo L110s to the city of Moncton, New Brunswick delivered this month for its upcoming snow removal operations, and we're currently refreshing the city of Ottawa's rental fleet for the addition of 9 new Volvo L90s as an extension to their existing snow contract.

We also continue to make headways with the Case product in Ontario, most notably the delivery of 8 721G loaders and 7 580SN tractor loader backhoes in Q4 to a major municipality in the province for similar work. While the crane business has been experiencing softer demand of late, particularly in Western Canada, we expect to see an uptick in sales in the fourth quarter, primarily in Québec, where our backlog is forming. Similarly, Central Canada is seeing a strengthening market for hydraulic cranes and heavy forklifts year-to-date, although the forecast is for softer demand in the region through the balance of 2019.

Amidst any market conditions, Strongco is a much stronger company today than it was just a few years ago. Even in the current environment, our brand is strong, which leads to healthy morale across our organization. We're enhancing our sales organization in regions where markets dictate. And beginning next month, we'll have a new sales manager in the province of Québec to meet current demand. We will also continue to target dedicated sales representatives for specialized brand and sectors in other regions of the country with the goal of generating additional revenues from Strongco's business streams.

Despite the lingering market uncertainties, we are pleased with Strongco's sales performance in a difficult year, and we will continue to build on our success to date in keeping with our goal to strengthen and position the business for improved profitability over the long term.

With that, I would ask the operator to open up the lines, and Robert, David and I will be pleased to answer your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Kevin Rivlin (sic) [Chen Rivlin] of Rubicon Partners.

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Chen Rivlin;Rubicon Partners;Portfolio Manager, [2]

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First of all, a great job on the -- managing the cash flows again. I guess my question is this -- is the same as the one I had last quarter. It's about the inventory -- the equipment inventory. So if I understand it correctly, it's at $22 million, about $22 million or 20% higher than it was the same time last year. But -- and if you're looking at the sales this quarter, the sales were down this quarter, 7% in -- for the market. And I think for you guys, it was just down 6%.

Previously, when I asked the question of why are we having higher inventory when the sales are down, you guys were saying that you're looking for higher sales in the second half of the year, and there was another -- a large crane order that you expected in the fourth quarter. And then there were a few comments on this call, they also alluded to that. Are you guys still expecting -- why are you so optimistic when it comes to the rest of the year? Or is it just way too optimistic on the inventory, which has just overshot?

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Oliver Nachevski, Strongco Corporation - VP & COO [3]

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Chen, it's Oliver over here. Thanks for the question. The inventory was not necessarily overshot. Some of the inventory that's on the book at the end of the quarter is slated to be flushed through the sales revenue stream through the balance of the year. Some of those bigger orders of inventory that came in were delayed in certain situations. But our optimism is as a result of the activity that we're seeing in our quoting.

What we generally see in April and May in terms of quoting activity this year has started real late into August and September. And the amount of equipment that's on rent and on rental option for purchase is where our optimism lies. We have a strong backlog, but we think a lot of this inventory will flow through off the book in Q4.

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J. David Wood, Strongco Corporation - VP, CFO & Corporate Secretary [4]

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And this is Dave, Chen. We've also -- as Robert mentioned in his speech, we shut the paths off. We're not ordering more inventory. We are -- so we're not going to see a lot more incoming inventory in the balance of the year. What we're going to see is the inventory we have starting to flow through.

That front large crane sale that we spoke about, it's still on the books for Q4. So we're expecting that to bring down our crane inventories as well. But we have optimism that there is still demand out there. And with our RPOs, customers will look to convert before the end of the year. We will see a reduction in our inventory by the end of the year.

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Chen Rivlin;Rubicon Partners;Portfolio Manager, [5]

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So I was referring just to the equipment inventory, not the one -- I think you guys have a different line for the RPO inventory and for the rental fleet inventory. So I was just referring to that equipment inventory that I presume is just related to just direct sales. Am I wrong in that? Or does that inventory -- does that line also includes some RPOs?

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Robert Jonathan Beutel, Strongco Corporation - Executive Chairman [6]

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Let me just try. From a macro level, as we reported on the balance sheet -- it's Robert, by the way. Our inventory is all in that one box. And so what you're seeing there is, yes, we do have the inventories that I remarked about, David remarked about, is the total inventory is up at $202 million, just shy of $203 million, at the end of the quarter.

You will notice, of course, that our rental -- we talked about the total of our RPO and our rental business is up by 50% of that increase. And the other 50%, that is -- it's roughly $20 million more on the rental side that we have in place now. And we have $20 million more roughly on the other side available in our system. And so we only have the one category of inventory, and that includes everything.

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Chen Rivlin;Rubicon Partners;Portfolio Manager, [7]

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Okay. I mean -- I guess I'm referring to the $20 million that you said on the other inventory. Is that something that you guys expect to see? If you compare that year-over-year, at the end of the year, do you expect it to be down? Do you expect it to be approximately the same level?

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Robert Jonathan Beutel, Strongco Corporation - Executive Chairman [8]

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We expect that the total inventory -- we don't break out in our public disclosure necessarily which fits -- which is in each bucket, but we do on a retrospective basis. We don't do it on a prospective basis. But total inventories are expected to decline, and that will come from a couple of sources.

As Oliver mentioned, it will come in part from sales of stuff that is now sitting on the lot, and it will also come from customers who had a rental purchase option, opting to take it down and purchase it by year-end. Is there any more, Oliver?

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Oliver Nachevski, Strongco Corporation - VP & COO [9]

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No, that's essentially what it is. We had to load up for the season. And like I said, some of the product was delayed, and we weren't able to retail it in time for the end of the third quarter. And it's kind of stretched us out into Q4, but we expect a significant decrease before the end of Q4. And just like David mentioned, we have next to nothing on incoming inventory for the balance of the year. So we'll end up in a decent spot. I don't believe it will be as low as last year's, but it should be close to where we finished 2018 with Canada.

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J. David Wood, Strongco Corporation - VP, CFO & Corporate Secretary [10]

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So just to clarify, I mean your comments are well taken. We had certainly, earlier in the year, hoped that this year would look a little bit more like last year. It has been a bit slower. And so some of it is a timing issue, some of it is a market issue. But also, from our perspective, we feel that the products we have are not exotic in that sense and that there is a constant market for them. So again, we're addressing these issues in many ways.

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Chen Rivlin;Rubicon Partners;Portfolio Manager, [11]

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Okay. Fair enough. And I guess the last one, again, on the inventory, that's -- on the age side, what do you expect to be -- like at the end of the year, what do you think will be, kind of, the -- maybe the demographic picture of the -- from an aging standpoint, how would that compare with last year?

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J. David Wood, Strongco Corporation - VP, CFO & Corporate Secretary [12]

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Our -- age of our inventory is much younger than we've seen in the -- for the last several years. We've taken action, as you know, over the past few years to delever the balance sheet and shed some of the noncore brands and aged products. So today, our inventory is much younger.

That's still the case now, and it's -- we're expecting it still to be the case at the end of the year. We don't -- we're not carrying a lot of aged inventory. And as Robert said, there's nothing exotic. It's really our core brands, all very salable product.

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Operator [13]

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The next question is from Ben Cherniavsky.

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Ben Cherniavsky, Raymond James Ltd., Research Division - MD & Head of Industrial Research [14]

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What was the -- yes, just trying to figure out what the impact of the crane sale was? Is that like -- when you talk about large crane, are you talking about a few million dollars for that?

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J. David Wood, Strongco Corporation - VP, CFO & Corporate Secretary [15]

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Yes, yes, a few million. Yes, it's a couple of large cranes. It'll be a few million dollars.

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Ben Cherniavsky, Raymond James Ltd., Research Division - MD & Head of Industrial Research [16]

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Yes, that's all I had. I was going to ask about the inventory. You guys covered that.

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J. David Wood, Strongco Corporation - VP, CFO & Corporate Secretary [17]

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Okay. Thanks.

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Operator [18]

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This concludes the question-and-answer session. I'd now like to turn the conference back over to Robert Beutel for any closing remarks.

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Robert Jonathan Beutel, Strongco Corporation - Executive Chairman [19]

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Thank you, everyone, for joining us this morning. I'm hopeful we've answered your questions. As always, we remain available. As you know, our year-end is December 31. So our year-end results are generally available, I guess, it's March, so it will be some time until you have the pleasure of listening to us on your telephone again. But please, if there are any questions, you can call us, and I wish you all the best. Thank you so much.

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Operator [20]

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This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.