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Edited Transcript of WJX.TO earnings conference call or presentation 7-May-19 5:00pm GMT

Q1 2019 Wajax Corp Earnings Call

MISSISSAUGA May 15, 2019 (Thomson StreetEvents) -- Edited Transcript of Wajax Corp earnings conference call or presentation Tuesday, May 7, 2019 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* A. Mark Foote

Wajax Corporation - President, CEO & Director

* Stuart H. Auld

Wajax Corporation - CFO & Senior VP of Finance

* Trevor Carson

Wajax Corporation - VP of Financial Planning & Risk Management & Treasurer

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Conference Call Participants

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* Derek Spronck

RBC Capital Markets, LLC, Research Division - Analyst

* Devin Dodge

BMO Capital Markets Equity Research - Analyst

* Michael Doumet

Scotiabank Global Banking and Markets, Research Division - Analyst

* Michael Tupholme

TD Securities Equity Research - Research Analyst

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Presentation

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Operator [1]

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Thank you for attending Wajax Corporation's 2019 First Quarter Results Webcast. On today's webcast will be Mark Foote, Wajax' President and Chief Executive Officer; Mr. Stuart Auld, Senior Vice President, Finance and Chief Financial Officer; and Mr. Trevor Carson, VP, Financial Planning and Risk Management. Please be advised that this webcast is being recorded. Please note that this webcast contains forward-looking statements. Actual results may differ from expected results.

I will now turn the call over to Trevor Carson.

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Trevor Carson, Wajax Corporation - VP of Financial Planning & Risk Management & Treasurer [2]

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Thank you, operator. Good afternoon, everyone, and thank you for participating in our first quarter results call. This afternoon, we will be following a webcast, which includes a summary presentation of Wajax' Q1 2019 financial results. The presentation can be found on our website under Investor Relations, Events & Presentations.

To begin, I would like to draw your attention to our cautionary statement regarding forward-looking information on Slide 2. Additionally, non-GAAP and additional GAAP measures are summarized on Slides 14 through 20 for your reference.

At this point, please turn to Slide 3, and I'll pass the call over to Mark.

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A. Mark Foote, Wajax Corporation - President, CEO & Director [3]

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Thanks, Trevor. I'll provide some highlights on our first quarter results and turn it over to Stuart for commentary on earnings, inventory and our balance sheet. We are pleased with revenue growth of 9% in the first quarter, which showed growth in all regions. These gains were achieved despite more difficult market conditions, particularly in Western Canada. On a comparable basis, the business grew approximately 4% with a further 5% related to Delom, which was acquired in the fourth quarter of 2018.

Our early experience with Delom has been excellent, and I'll provide further comments on our ERS business in just

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EBIT rose 6% and at a slower rate than sales due primarily to higher costs that reflected year-over-year increase in spend consistent with our budget.

Our expenses are higher due to the inclusion of Delom, which is noncomp to last year and due to higher personnel and other costs related to our organic growth plan and major projects, such as our ERP and customer support centers.

Higher gross margins contributed to the results, which included the sequential margin improvement when compared to the fourth quarter of [2018].

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Adjusted EPS declined 12% to $0.43 due primarily to higher finance costs, which reflect interest costs on higher debt and the effect of IFRS 16. The $0.43 result includes a negative impact of IFRS 16 of approximately [$0.02 per share].

On safety, we experienced 2 additional recordable incidents in the first quarter, which resulted in a slight increase of TRIF rate to 1.32. Our team continues to focus on 0 injuries, and we're working diligently with our new colleagues at Delom on the health and safety program. For our team members who are listening, thank you again for your efforts on workplace safety and for the excellent safety performance you've delivered in April, which was injury-free in the base business. I would also like to congratulate everyone on the Wajax team for achieving the Canadian Mental Health Association's National Workplace Excellence Award in 2019. And you worked very hard on the entire health and safety program to enhance the ability to protect our team and their family.

Turning to Slide 4. All regions saw growth in the first quarter. In Western Canada, revenue growth of 1% resulted from mining product support, which offset general weakness in the equipment market. Activity in the oil sands and mining has remained positive, and we're pleased with the progress on new mining equipment sales that have gone into backlog.

Momentum in Western Canada improved as the quarter progressed.

In Eastern Canada, growth of 25% continues to show momentum in our business. About half of the growth is due to ERS sales from the noncomp addition of Delom, and the balance was due to a range of categories, which showed solid organic growth. We're pleased that Wajax' total revenue continues to reflect a very strong base of business in

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In Central Canada, growth of 3%, while welcomed, continues to demonstrate the growth opportunities we're seeking from the key Ontario market. Our focus on the growth categories of Construction, Material Handling and ERS in Ontario continues, and we will see additional opportunities in categories such as industrial parts and

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Turning to Slide 5. Revenue growth was driven by product support, industrial parts and ERS volume, which offset sales decline in whole goods. New equipment sales weakness in the first quarter was focused first in the West and secondarily in Ontario. Generally, market conditions were less favorable when compared to the first quarter of last year, particularly in the West. And as stated previously, momentum in the West appeared to be improving in the latter stages of the quarter.

Industrial parts revenue continues to show steady growth -- steady momentum with a gain of 5% in a tough market, and product support benefited from oil sands and mining activity in the West.

Turning to Slide 6. A view of Wajax' growth by category shows that the majority of our growth continues to come from the aggregate volume of our targeted growth businesses. Material Handling and ERS saw strong growth with ERS positively impacted by Delom. ERS volumes, excluding Delom, increased approximately 10%. We continue to be very bullish on the ERS business given the increased strength of our offer by combining our legacy business with Delom and the regional opportunities with major customers that this business brings.

Construction was negatively affected by weaker year-over-year market conditions. As a point of reference, the Canadian market for production class excavators was down approximately 28% in the first quarter. Wajax total construction sales were down approximately 14% nationally with growth in our Hitachi Wheel Loader program helping to partially offset the effect of weaker market conditions and lower volumes related to the work in (inaudible)

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Of note, a customer feedback on the Hitachi loader program has been excellent.

The final comment on this slide relates to mining, both as a category and as an end market. Category strength related to mining equipment was solid in the first quarter due to the previously mentioned product support volume. In addition, we have -- we've seen current equipment sales -- we see current equipment sales trends strengthening in the late stages of this year and 2020 as additions to our backlog indicate. As an end market, mining represents additional growth opportunities beyond the related equipment of product support in areas such as industrial parts, ERS and Engines & Transmissions.

Before turning the call over, let me add some color to the announcement last night that Stu has become our new CFO. Stu and I have worked together for over 20 years, including a number of assignments before Wajax where Stu was my Senior Finance Officer at both Canadian Tire and Hudson's Bay Company. In addition, Stu is an accomplished General Manager, having been a Divisional President himself in both of those organizations. We're very fortunate to convince him to join us in 2014 and to assist us in the systems work that we've done, which evolved to include a significant role that he's been playing in improving our human resources [functions].

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Board and I are very pleased that he's agreed to take on the role as our CFO wherein he will also maintain his responsibility for information technology and be accountable for the implementation of our new

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Stuart H. Auld, Wajax Corporation - CFO & Senior VP of Finance [4]

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Thanks, Mark. Please turn to Slide 7 for my comments on earnings. In the first quarter of 2019, adjusted basic EPS declined to $0.43 from $0.49 for the same period in the prior year, representing a 12%

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Previously reported adjusted basic EPS for the first quarter of 2018 was $0.53. However, as disclosed in the corporation's audited consolidated financial statements for the year ended December 31, 2018, the correction of nonmaterial errors in prior periods was reported, impacting prior year comparative periods. Further details on these corrections can be found in our MD&A under Adjustments to Prior Period Comparative Financial [Statements]

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The earnings decrease relates primarily to higher selling and administrative expense, which were discussed by Mark, and higher finance costs, which were partially offset by higher gross margins, which came in at 19.5% versus 19.0%

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prior period. The increased interest costs include approximately $1.2 million due to IFRS 16, which will be addressed in more detail in a moment.

Overall, SG&A as a percentage of revenue increased 100 basis points to 15.2% from 14.2% in the prior year, which remains within our targeted range of 14.5% to (inaudible)

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The increase was primarily related to higher personnel costs to support our 2019 business plan and ongoing investments in our infrastructure related to the new ERP system and customer support centers.

As we've previously stated, we expect the earnings improvements will be weighted to the second half of the year as the cost base becomes more comparable on a year-over-year basis. Furthermore, earnings were negatively impacted by $0.02 due to the adoption of IFRS 16 as of January 1, 2019, which I will describe in further detail later in the [presentation].

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Please turn to Slide 8, which summarizes our backlog and historical trending. Our Q1 2019 backlog increased $49.9 million or 24% on a year-over-year basis and increased $48.3 million or 23% sequentially from the quarter -- previous quarter. The year-over-year increase relates primarily to higher mining equipment orders and higher ERS project work from Delom.

Quarter-over-quarter increase relates primarily to higher mining, material handling and forestry (inaudible)

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The additional mining equipment orders booked to backlog in the first quarter have a sales value of approximately $40 million and relate to delivery scheduled for 2020. We remain encouraged by the strength of our sales pipeline and in our plans for higher revenue this year relative to 2018.

Please turn to Slide 9 for an update on our current inventory levels. Inventory, including consignment, increased $122.7 million compared to Q1 2018 or $53 million compared to Q4 2018 and is higher across our targeted growth and core strength categories. Consignment inventory increased $26.7 million from Q4 and consist primarily of construction excavators ordered to meet our 2019 sales plan.

Based on our current sales pipeline and programs, we do not foresee material inventory risk despite the market conditions that prevailed in the first

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Net of consignments and additions from Delom, inventory increased by $23.9 million and includes $43.9 million, which is out in the field under the terms of our rental purchase program, of which we expect a high percentage to convert to sales this year.

Work in process also increased by $6.6 million to $24.5 million, largely related to mining and construction [projects]. We are comfortable with our current inventory levels, which align with our growth objectives for this year. We continue to expect the inventory levels will decrease over the second half of the year, which we anticipate will have a net positive impact on working capital, cash flow and (inaudible).

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Please turn to Slide 10 where I will provide an update on financial position and performance metrics. Our Q1 leverage ratio increased compared to Q4 from 2.45x to 2.89x primarily related to higher debt levels associated with higher working capital and was partially offset by higher trailing 12-month EBITDA.

Working capital has increased primarily due to higher receivables tied to higher sales and the previously discussed increase in (inaudible)

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We are continuing to focus on working capital efficiency, which is a key component in managing our overall leverage targets, and we expect the ratio to improve in the second half

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Our investment in inventory has increased our working capital to sales ratio on a trailing 12-month basis. But as I mentioned earlier, we expect this ratio to decline in concert with inventory levels in the second half

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As our financial performance continues to improve, we're seeing higher trailing 12-month adjusted EBIT, which increased $8.5 million or 15% compared to the previous year. But that hasn't translated into a higher RONA as our net assets have also increased by $100 million over the same

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Our long-term strategic plan calls for investment above historical levels and higher net assets. However, we are committed to increasing RONA over both the short and long term as we continue to focus on enhancing our EBIT margins and drawing down our inventory levels.

Finally, the Board has approved our second quarter dividend of $0.25 per share payable on July 3, 2019, to shareholders of record on June 14, 2019. We remain confident in the sustainability of our dividend at this level across the [business].

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Please turn to Slide 11 where I will provide an update and a more detailed description on how to interpret the impact of IFRS 16 leases on our Q1 financial statements. On this slide, we have presented both the balance sheet and the income statement before and after the adjustments related to the adoption of the new standard. For greater clarity, we have isolated the opening balance sheet adjustments on January 1, 2019, as well as the Q1 impact to our balance sheet in the

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With respect to the balance sheet on January 1, we increased both our right of used assets and liabilities by $81.2 million to reflect all property and hardware leases that were previously capitalized as operating leases. These changes did not have an impact on our opening equity balance.

From an income statement perspective, we observed a positive pickup of $733,000 selling and general and restrictive expenses as the new depreciation expense was lower than the previously observed rent payment. However, this pickup was more than offset by the

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which corresponds to the reduction in equity on the balance sheet. These changes also have a material impact on our adjusted EBITDA margins as a result of the reclassification of lease expenses.

Our reported EBITDA margin of 7.9% was approximately 130 basis points higher than would have been otherwise reported under the previous (inaudible).

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When considering our EBITDA margins on a like-for-like basis, we observed a 60 basis point increase over Q1 2018 due primarily to higher volume and gross margins, which was partially offset by higher SG&A (inaudible)

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Please turn to Slide 12. 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.

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A. Mark Foote, Wajax Corporation - President, CEO & Director [5]

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I wasn't planning to read the entire chart on Page 12, but I'll make 3 points. Market conditions were a bit noisy in the construction market, but we felt generally stable in most of the other areas that we trade into. So we're not calling any fundamental change from our original outlook about how we view market conditions for (inaudible) (technical difficulty)

As we mentioned earlier, we -- we've stuck with the strategic plan targets for ourselves for 2019, and as such, expect full year adjusted net earnings increase based on consolidated revenue improvements and the full year effect of the acquisition of Delom.

Got some very important projects in 2019, which have got the organization improving its infrastructure in both the ERP and customer support centers. Those 2 programs become operational, at least in pilot terms, roughly by the end of the second quarter and consume some expenses leading into that in the first quarter and will do so also in the second. And as such, the current view we have on the timing of revenue and expenditures suggest that the earnings improvements we're expecting for the full year will be weighted to the second half.

Okay. And I think with that, we'll turn it back to the operator for some question.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Michael Doumet from Scotiabank.

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Michael Doumet, Scotiabank Global Banking and Markets, Research Division - Analyst [2]

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So I'm trying to get a little bit of a better read on the market outlook for Western Canada. You're calling for decline in 2019, predicated on softness in a couple of markets, but not to the extent of what you saw in '15 and '16. It just feels like at this point, we're in much better shape than that sort of comparison to the last downturn. Any way you can narrow down the ranges? Just feels like -- I mean, should we be expecting moderate declines overall in Western Canada for the year?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [3]

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Yes. I think the primary effect that we're seeing right now is primarily in the construction market. So as I said, our mining and oil sands business is actually quite positive. The oil and gas business, it's an incidental volume to Wajax today. So even if there is a negative decline, it doesn't really affect us too much.

Forestry appears to be improving. The first quarter might have been a bit soft from a market standpoint, but our share was actually quite good in the first quarter. And it's really an observation about the general construction markets, which are an important part of our Western Canada business. And our national numbers for construction -- production class excavators were down 28% and I think in the West, we're down about -- there, the market was down about 33%. So we're not expecting to see the kinds of conditions we saw in the time frame you just referenced, '15 or '16, but there is some definitely equipment softness, particularly in construction. And while it did better as the quarter got closer to the end -- a bit cautious on just the general market conditions in construction in Alberta and B.C. in particular.

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Michael Doumet, Scotiabank Global Banking and Markets, Research Division - Analyst [4]

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Okay. Any way you can give us a sense there -- I mean you just talked about ending the quarter with a little bit more favorable trends on the numbers you just mentioned. Any way at all that we can see growth in Construction, maybe not for the year, but, call it, for the second half? Or is your expectation of -- relatively, I guess, a drag throughout the rest of the year for Construction?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [5]

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It's difficult to say right now, to be perfectly honest with you, Michael. I think it might be a bit optimistic to see growth in the Western Canada market in construction specifically. But if you look at our total Western Canada volume across all businesses, we were down in January. We were barely off last year's volumes in February, and we were ahead in March. So -- and that's all in. That's everything, including Construction. So I think we're still operating on the basis that construction markets may be a bit soft for excavators. Our wheel loader program's doing real well, so that's kind of a net new program for us in the West anyway, so that's a bit noncomp

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but generally speaking, the total volumes in the West definitely improved, and we were up year-over-year in March.

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Michael Doumet, Scotiabank Global Banking and Markets, Research Division - Analyst [6]

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Okay. Fair enough. And then on the gross margin, much improved sequentially. I'm assuming mix and Delom were accretive. Any way you can discuss how margins were trending by business line outside of those 2?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [7]

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If you're okay with it, I'll tell you how it's trending by sales type. Our new equipment margins, on a year-over-year basis, were pretty solid. Most of our increase in margin Q1 this year to Q1 last year was parts, so that was similar to the story, albeit less dramatic than (inaudible) margin improvement. I don't know if I can say that we saw any year-over-year fundamental shift at a category level, but our shift over to -- hard shift over to mining parts and service, the mix was also helpful in improving the gross margin year-over-year. And the sequential improvement was broad category of things, but most specifically, it was a much better parts margin than we saw in the fourth

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Michael Doumet, Scotiabank Global Banking and Markets, Research Division - Analyst [8]

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Okay. That's helpful. And maybe just one last question for Stuart. Saw on the inventory and working capital, your comments there for Q3 and Q4, is an outflow that's typically in line with the seasonal patterns. Should we interpret that expectation or that commentary as to see overall efficiency improvement in both working capital and in inventories throughout the year?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [9]

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Michael, can you repeat that? I think I just got a little lost there for a second.

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Michael Doumet, Scotiabank Global Banking and Markets, Research Division - Analyst [10]

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Yes. So for Q3 and Q4, I think Stuart commented on inventories declining, also working cap as being an outflow. But that's a typical -- that's typically in line with your seasonal patterns. So I guess the question is, are we expected to see efficiencies maybe as a working capital ratio or inventory turns on a year-over-year basis in the back half of the year?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [11]

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I suspect so, given that the revenue that we're expecting comes through in the second half of the year. But I suspect you would see that if the kinds of targets we have for revenue, we hit them.

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Operator [12]

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Your next question comes from the line of Devin Dodge from BMO Capital Markets.

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Devin Dodge, BMO Capital Markets Equity Research - Analyst [13]

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Just wanted to start with the level of consignment inventory, continues to push higher. I believe it's at the highest level, at least as far back as we went. Just wondering if the lower demand or the sluggish start in construction, how much that has played a role in pushing that higher.

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A. Mark Foote, Wajax Corporation - President, CEO & Director [14]

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It might have had a bit of an effect. We ordered inventory in the Construction business a bit more aggressively in the front half of this year than we might have done last year. Part of it just had to do with the lead times that we're seeing on some of our programs from the manufacturers, and that's specifically an excavator comment. So we would've loaded up a bit heavier in the front half of this year relatively speaking than the back half. So that's probably more self-induced and purposeful, and the market conditions might have affected [sales].

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Devin Dodge, BMO Capital Markets Equity Research - Analyst [15]

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Okay. I believe, you got a 9-month window for moving this equipment before payments need to start being made back to, I guess, Hitachi and John Deere. But just can you give us a sense for the average time this equipment's sitting on your lots and maybe how does that first -- how does that compare maybe to where it's been after Q1 in the last couple of years?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [16]

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Yes. Generally speaking, you're pretty close on the when it switches over to out of consignment. I think we tend to prioritize inventory movements so that it comes out of inventory before we get to that point. So I'm sorry, if you can just repeat the second part of your question. I'm not sure, if I really addressed it or not.

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Devin Dodge, BMO Capital Markets Equity Research - Analyst [17]

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I guess, how long has it been sitting on your average -- how long has it been sitting your lots versus maybe at the end of Q1 in like 2017, then 2018?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [18]

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I'll have to check the specifics and maybe get back to you after, but I don't -- as we sit here today, we're not staring at a significant amount of inventory that's about to age out and have to come out of the books or anything like that, nor are we sitting on something that's got any kind of margin risk attached to it if we had to clear it out. So our cycle time on the inventory is not fundamentally different than it's been. So hopefully that helps, but I think we can certainly check the exacts on Q1 over Q1 last year and get back to you on that.

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Devin Dodge, BMO Capital Markets Equity Research - Analyst [19]

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Okay. Maybe switching to SG&A costs. How should we be thinking about those through the balance of the year? Just wondering if the, I guess, $57 million in Q1, is that a good proxy for Q2 and maybe some moderation in the back half of the year? Just any color there would be helpful.

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A. Mark Foote, Wajax Corporation - President, CEO & Director [20]

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Probably the easiest way to think about it is think about the run rate in Q1 looking similar in Q2 and think about the back half of the year being more comparable to last year. None of these -- you just have to consider the Delom expenses as incremental and they're typically going to run about $2.5 million a quarter.

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Operator [21]

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Your next question comes from the line of Derek Spronck from RBC Capital Markets.

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Derek Spronck, RBC Capital Markets, LLC, Research Division - Analyst [22]

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Last quarter you mentioned that you're pretty aggressive on pricing around parts and service. You seem to have a nice pickup this quarter in those 2 segments. Maybe talk -- maybe if you could provide a little bit of color around where you landed on a pricing front in those segments and some of the underlying trends you're seeing?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [23]

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When we released the fourth quarter, I think we said that we had some -- at that time, we had released -- we already made a series of changes that adjusted some of the retail, so that effectively just played out in the first quarter of 2019. It hasn't affected sales in any material way when we look at the specifics on where the price has changed versus what the sales volumes have been. A little bit of noise in the Construction business just because of the market, so that's a bit tougher to tell. But generally speaking, it's a retail adjustment compared to where we were, I think as we said, kind of partway through the third quarter last year. So other than saying that there are some upward increases in the prices, it has not materially negatively affected the sales and that's effectively what we said in March and that's what we're reporting today.

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Derek Spronck, RBC Capital Markets, LLC, Research Division - Analyst [24]

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Okay. Great. I know you didn't mention it, but did weather play a factor at all in this quarter?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [25]

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Probably more than we had originally anticipated. And that -- yes, I think January, February weather might have had a bit more of an impact on the business than I think we were thinking at the time. If you think about that trend in sales in January, February and March, that would be supported. The market in Ontario and Quebec was also pretty soft from a construction standpoint. The current trend would suggest that's gotten a bit better. So yes, weather was a factor and probably more so than we originally (technical difficulty)

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Derek Spronck, RBC Capital Markets, LLC, Research Division - Analyst [26]

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Okay. That's great. In -- what's the underlying competitive dynamic right now in the marketplace? Is that roughly what you're expecting? Is it getting a little bit more competitive out there? Just looking for a little color.

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A. Mark Foote, Wajax Corporation - President, CEO & Director [27]

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It depends on which kind of business. I mean, they're always all pretty competitive, and everybody is going see the units in the market dropping off the same way we did, so typically that shows up as a more competitive environment than we were experiencing last year. Margins have held in reasonably well on the whole good side of the business in kind of the heavy equipment side. There's -- and again, it depends on which market you're talking about. The oil sands market has been really positive, particularly the equipment opportunities, which are currently in discussion are anticipated to be coming up shortly, so that's always an uber-competitive process. No real change in the kind of the general demand side of the business. I don't think in Material Handling or Industrial Parts, we've seen any kind of significant shift than where we've might have been last year. So it's a bit of a mixed bag, but it's likely turning out a little bit better than we had originally expected.

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Derek Spronck, RBC Capital Markets, LLC, Research Division - Analyst [28]

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Okay. That's great. And maybe just one more from myself. When you look at your current product portfolio, is there any more changes or paring back of the amount of equipment that you're providing right now? Are you comfortable with your current product portfolio?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [29]

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Yes and no. And we don't have any specific plans right now vis-à-vis changes with manufacturer relationships that type of thing. We're going through a process right now to kind of look at the capital allocation going to various businesses versus the return on profitability we're getting out of them. It doesn't necessarily suggest that we're planning a major change, but it may get the emphasis from one business to another. It doesn't affect our Construction or Material Handling business. Those ones we're very dedicated to and really happy with. So any changes we made there worked out pretty well for us. But in some of the other businesses, yes, there's some discussion going on right now just about the capital allocation. We got the potential to make more money in some categories if we shift either working capital investment or human resources investment. We're talking about that at the moment, but nothing specific to report at the moment right now.

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Operator [30]

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(Operator Instructions) Your next question comes from the line of Michael Tupholme from TD Securities.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [31]

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You called out the amount of costs in the quarter related to the customer support centers projects. I'm just wondering what, if any, expenses were incurred in Q1 in respect of the new ERS system. I didn't see those specifically called out.

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A. Mark Foote, Wajax Corporation - President, CEO & Director [32]

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Maybe I can ask Stuart if he knows what flowed through the P&L (technical difficulty). You meant the ERP system?

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Michael Tupholme, TD Securities Equity Research - Research Analyst [33]

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ERP, pardon me.

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A. Mark Foote, Wajax Corporation - President, CEO & Director [34]

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Nothing material I don't think. I think, well, look at it this way, there's project costs in the ERP, which are capitalized. You don't see going through P&L typically. There is a bunch of ancillary costs, which relate -- there's a ton of people attached to that project, so there's a whole bunch of payroll and travel and all sorts of different things like that. But you know what, if you said it's $1 million, that's probably a good walking around number as far as the SG&A impact of it. The CSC costs, when we adjust the earnings, you see the nonrecurring project costs that came out of the adjustment. The CSC costs are actually in the P&L though. They're more material than that, and they would probably be similar to $1 million that came through the P&L, which is ancillary costs year for ERP. And if you just take those as directional, right now, I don't have any specifics numbers right in front of me, but that's probably a pretty good proxy.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [35]

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So just to be clear, we're saying approximately $1 million for ERP and then also $1 million for CSC or was it $700,000 for CSC?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [36]

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The $700,000 in the CSC was -- you'll see that in the adjusted earnings report. In addition to that, in the P&L, there's a number of costs associated with the project, which are just run rate costs of setting it up. So they're legitimately part of the P&L. And again, this is not exact, but, I think for your purposes, the good way to think about it is, the expenses being up, net of the property disposal for last year, about $7 million year-over-year, think about it as a 1/3, 1/3, 1/3. A 1/3 of it's Delom, a 1/3 of it's the combination of CSC and ERP project costs, which are in the P&L. And a 1/3 of it is just the higher personnel costs associated with the fact that we are carrying more people in the first quarter of this year than we did last year, which between technicians and salespeople, we feel that it's necessary just to support the growth we're planning in the business. So think about it as a 1/3, 1/3, 1/3, you're not probably not that far off by doing it that way.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [37]

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Okay. And the 1/3 that relates to ERP and CSC, those are there again in Q2, but then after that, we should assume that those largely go away. Is that the right way to think about this?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [38]

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I don't know if I'd assume that they're going away. They're definitely there in Q2. ERP and CSC will change kind of composition of how it affects the P&L as you get in the second half of the year. But we're -- we would suggest that when you're thinking about the costs in the second half of the year, think about them as more comparable to last year's total SG&A with the addition of about $2.5 million a quarter for Delom.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [39]

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Okay. Just a question about the gross margins. So -- and I think you touched on this a little, but nice rebound relative to the fourth quarter, but also up year-over-year. Is this the sort of level we should think about over the remainder of the year? Or was the composition of mix this quarter such that we shouldn't really be reading too much into this quarter's level for the rest of the year?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [40]

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No. This quarter's GP rates are probably decent proxy for the full year. I think that's what we -- when we released the March results, we said that we were expecting 2019's margins to be generally equivalent, I think, to 2017 would be. But it's not unreasonable to take Q1's GP rates and think of that as a good proxy for (technical difficulty)

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Michael Tupholme, TD Securities Equity Research - Research Analyst [41]

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Okay. Just a couple of questions on Delom. So for starters, if I understood what you're saying, Mark, ERS was up 10% year-over-year ex Delom, which if I my understanding correctly, suggests about $19 million from Delom in terms of revenue in the quarter. Is that the right math?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [42]

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Yes.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [43]

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Okay. Can you just talk a little bit about Delom synergies. When you announced the acquisition, there seemed to be an expectation on your part that there was an opportunity for revenue synergies. I know it's only the first full quarter you've had the business, but are any of those beginning to contribute to thus far, or is that something we should look to down the line?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [44]

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I'd say it's probably safer to think about it down the line. There's a bunch of tactical revenue things that are showing up that are nice little surprises. But a few things about Delom, which are proving to be true. One is the admin synergies are happening a little bit faster than we originally expected. They're not material, but I think we expected maybe about $0.5 million in SG&A savings in the second year, which we're probably going to achieve this year. And the revenue synergies are generally pretty tactical right now. We remain really bullish on that business when you think about it from a (inaudible) (technical difficulty) standpoint though. By then, we'll have -- we will have adjusted how organized how the sales teams work, combining both the legacy ERS business and the Delom operation. And we're pretty bullish about where it goes after this year. But this year, I'd say pretty conservative on the expectations beyond the EPS that we previously disclosed.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [45]

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Okay. And the $0.5 million of savings that were originally expected in 2020 but maybe may come a little bit earlier. Is that an annual savings number, or is that the per quarter number?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [46]

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No. That's just an annual number. I mean, Delom, it's a small business, so it doesn't have a ton of admin to begin with. When we built the business case, included in that was a small administrative synergy, which we didn't really plan into it until 2020. That's expected to happen quite a bit faster.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [47]

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Okay. You provided a fair bit of commentary about the construction market, how it's evolved over the course of the first quarter. But it sounded like most of that commentary was in respect to Western Canada. But you also mentioned that you did see some weakness in Ontario. Just wondering if you can talk about how Ontario has evolved? Was there a similar dynamic where things improved as a quarter progressed? And secondly, how we think about Ontario construction for the balance of the year?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [48]

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Yes, between the Québec and Ontario markets, they're both the unit count basis, down about 20 points and the market's down about 20 points in the first quarter. One is down 22 and the other is down 20, so if you will let me go with 20 for both for a moment. We're pretty bullish on the Construction business in Québec. That's also where our loader program has been the most successful. So despite the fact that there may be a pinch on the market side, the wheel loader program has been really successful in the Québec market and the Atlantic provinces. So that's helping to offset any market weakness that we saw. The Ontario market for construction is a bit different. As you know, we parted company with a work-in program in the second half of last year, due to the (inaudible). And in construction market, the construction sales totals for Wajax and Ontario were negatively affected by the loss of work-in in the first quarter, which is a bigger factor for us and necessarily what happened in the excavator market. So most of the work in volume, about 2/3 of the annual volume comps out in the first half of this year. The second half of last year was a much smaller number. But the Ontario construction number being down is probably more a function of the loss of work-in and less a function of the excavator (technical difficulty)

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Michael Tupholme, TD Securities Equity Research - Research Analyst [49]

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Okay. Notwithstanding your comments about the market as a whole being down approximately 20% were it not for the loss of work-in, you would have done a lot better than that. Is that what you're saying?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [50]

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Yes. That's a good way to put it.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [51]

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Okay. And then, just lastly, on a question about the leverage. Just wondering how we should think about the leverage ratio evolving as we go through the year and if got a year-end target? I know, I guess, Stuart mentioned that you do expect decline in inventories in some favorable working capital trends, but on the leverage ratio, specifically, if you've got any commentary there?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [52]

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Yes. We have a target. We're not going to share it today, but we have a target. I think safe to say that we're expecting leverage to decline by the end of the year. I would expect it to stay not dissimilar from where it's at right now for a number of months yet, but we do expect improvements before the end of this year.

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Michael Tupholme, TD Securities Equity Research - Research Analyst [53]

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Okay. And your sort of formal target of 1.5 to 2x. Is that not something we should be very focused on now because of some of the dynamics including the Delom acquisition and, like, is that sort of a longer-term target to keep in mind as opposed to something we should be benchmarking against right now?

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A. Mark Foote, Wajax Corporation - President, CEO & Director [54]

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Yes, not to suggest 1.5 to 2x isn't important, but as you recall, when we established that, that was kind of a run rate target for the base business. It excluded considerations of acquisitions and that type of thing. So I would say that we're not uncomfortable with where our leverage is right now. We do expect it to improve. I don't know if it would go back -- I don't think it would go back inside that range before the end of this year. But if we run at 2x EBITDA plus the acquisition cost of Delom, we're not at all uncomfortable with that. If it was 3 years ago, we might have said we are because the whole financial flexibility of the company had on its dividends and other things is very different today than it used to be. The covenant structures are quite different now than they used to be. So I think we're not uncomfortable with the leverage where it's at. We expect it to improve. 1.5 to 2x is a good proxy for the base business sans an acquisition, and if you roll in the acquisition capital, we expect that leverage to be comfortably a bit higher than that, which is fine.

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Operator [55]

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

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A. Mark Foote, Wajax Corporation - President, CEO & Director [56]

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Okay, well. Thanks very much for your time today. We appreciate that, and we'll talk again in August with our second quarter results.

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Operator [57]

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