Wajax's (WJXFF) CEO Mark Foote on Q2 2016 Results - Earnings Call Transcript

| About: Wajax Corp. (WJXFF)

Wajax Corporation (OTC:WJXFF) Q2 2016 Results Earnings Conference Call August 5, 2016 2:30 PM ET

Executives

Mark Foote - President and CEO

John Hamilton - SVP, Finance and CFO

Brian Dyck - SVP, Wajax Equipment

Analysts

Michael Doumet - Scotiabank

Sara O'Brien - RBC Capital Markets

Bert Powell - BMO Capital Markets

Michael Tupholme - TD Securities

Ben Cherniavsky - Raymond James

Operator

Welcome and thank you for attending Wajax Corporation's 2016 Second Quarter Results Conference Call. On today's call will be Wajax's President and Chief Executive Officer, Mr. Mark Foote; as well as Mr. John Hamilton, Senior Vice President, Finance and Chief Financial Officer; Mr. Brian Dyck, Senior Vice President, Wajax Equipment, Mr. Steve Deck, Senior Vice President, Wajax Industrial Components and Mr. Michael Gross, Senior Vice President, Wajax Power Systems.

Please be advised that this call is being recorded. Please note that this conference call contains forward-looking statements. Actual future results may differ from the expected results.

I will now turn the call over to Mark Foote.

Mark Foote

Thanks very much and welcome to our second quarter call. I will make some introductory remarks and turn the call over to John for the details on the second quarter.

Second quarter segment earnings for the Equipment and Industrial Components segments exceeded our expectations. However, our results were Power Systems business were disappointing.

We're particularly encouraged by results in our Equipment segment where revenue and earnings exceeded amounts recorded last year, despite a more challenging Western Canada market and the business disruption caused by the of Fort McMurray wildfires.

In the Power Systems segment, lower selling and administrative costs couldn’t overcome the significant decline in revenue and margins, mainly attributable to Western Canada. Fort McMurray wildfires led to a temporary shutdown of the four locations we have in the second quarter, which resulted in any $8.3 million reduction in our year-over-year revenues.

Only a minor amount of property damage was experienced at the branches and they were all up and running in June. While these wildfires negatively affected -- impacted all three of her segments, we expect to recover most of the at least $1 million in estimated losses via proceeds from insurance coverage.

The reorganization that we announced in March of 2016 is proceeding on schedule. We're on track to complete it by the end of this year. We expect to realize savings in 2016 of between $6 million and $7 million, with the full $15 million in estimated cost, reduction is expected to be realized in 2017.

In addition we continue to reduce staffing levels in response to Western Canada market conditions, particular in the Power System segment and we're taking measures to improve margins there.

Consistent with last quarter, our outlook for 2016 is that market conditions will remain very challenging. We continue to expect that the revenue and margins will be under pressure due to difficult market conditions in the West and reductions in resource customer -- capital and operating expenditures.

During second half of the year, we will continue to expect that earnings will improve compared to the first half of 2016, excluding the restructuring charge we took in the first quarter, driven by cost reductions and margin improvements, particularly in the Power Systems.

With respect to our dividend, the quarterly dividend amount of $0.25 was maintained for the third quarter and the expectation of improved earnings -- on the expectation of improved earnings going forward, we will continue to consider the amount of the dividend quarterly taking into account the corporation's forecasted earnings, leverage, and other investment opportunities.

While conditions remain challenging, we're beginning to realize the potential for improved operational execution as we transition to a lower cost functional organization. As a result of these restructuring efforts, we have increased confidence in the enhanced earnings possibilities from the execution of our four points of growth strategy. And before I turn it over to John, just as a side note, we'll make a couple comments about John Hamilton's planned retirement in spring of next year at the conclusion of this call.

Okay John, cam I turn it over to you please?

John Hamilton

Thanks Mark. Second quarter 2016 consolidated revenue was $336.6 million; that was down just 1% versus last year. The Equipment Segment revenue increased 7% on the strength of higher mining equipment sales, whereas revenue in the Power Systems and Industrial Components segments declined 16% and 3% respectively. This was as a result of reduced activity in Western Canada energy sector.

Our consolidated earnings for the second quarter were $4.3 million or $0.22 per share compared $9 million or $0.52 a share in 2015. Year-over-year increase in the Equipment Segment earnings was more than offset by reductions in Power Systems and Industrial Components segment

As a result of lower volumes and margins which are only partially offset by lower selling and administrative costs.

As Mark mentioned, the Fort McMurray wildfires led to temporary shutdown of four of the corporation's branches in the second quarter, resulting in an $8.3 million reduction in revenues. Property and operating losses are estimated to be at least $1 million and the majority is expected to be recovered via insurance proceeds.

Consolidated backlog of $165.2 million at the end of June decreased $40.6 million compared to March. The decline was primarily related to the delivery of two large mining shovels in the equipment segment.

And turning to the individual segments starting with Equipment. Total revenue of $178 million in the quarter was up 7% compared to last year. Equipment sales increased $14.1 million, mainly as a result of increase in mining equipment sales.

Parts and service volumes were down $3 million to $57.7 million compared to last year, mainly as a result of the Fort McMurray wildfires and lower construction sector volumes. Quarterly segment earnings of $13.3 million or $1.6 million ahead of last year, on higher volumes and lower selling and administrative costs.

Turning to the power systems, revenue decreased 16% to $61.9 million. Equipment revenue decreased $6.8 million on lower off-highway sales to oil and gas and power generation customers. Parts and service sales decreased $5.2 million attributable to lower sales to customers in Western Canada partially due to the Fort McMurray wildfires.

Our segment earnings decreased $5.8 million to a loss position compared to the previous year as lower revenue and margins were only partially offset by lower selling and administrative costs.

And then in Industrial Components, revenue of $97.5 million was down 3% compared to 100.8 million posted last year. Bearings and power transmission parts and service revenue increased $2.2 million compared to last year due mostly to the Wilson acquisition completed in April.

However, fluid power and process equipment sales decreased $5.5 million due to reduced activity in the Western Canada energy sector. Earnings decreased $1.8 million to $3.6 million. Lower sales and margins were only partially offset by a $700,000 decrease in selling and administrative expenses. Lower margins included $900,000 of increased inventory obsolescence charges compared to last year.

And we finished the quarter with funded debt of $158.6 million now is up slightly compared to March. And then finally, the corporation declared $0.25 per share dividend for the third quarter of 2016, payable on October 4th, 2016.

So, operator, we’ll now open up the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions]

Your first question is from Michael Doumet from Scotiabank.

Michael Doumet

Hi, good afternoon gentlemen.

John Hamilton

Hi, Mike.

Michael Doumet

Hi, so just going back to similar discussions we had last quarter, I understand there was write-down, but could you help us better understand how Power System returned to profitability? You seem to be doing what you can internally adjust the cost base, but does there need to be a market improvement as well?

Mark Foote

I think Michael in absence of the market improvement of which would be helpful, but not something we expect. Really the focus in Power System is getting back to profitability is really on two points. The first is cost reduction, so we got a bunch cost of that would be coming out of the business in the second half of this year. It's the majority of this back half cost reductions on the reorganization actually effect what is up until the end of June was our Power Systems business.

So, that's going to be a bit of that -- it's going to be a bit of a help. The real focus for us right now in Power Systems is on the gross margin line in addition to the costs and focus there is primarily on the parts and service margins. That's really where the company is going to focus is trying to make sure that the pretty significant makeshift that we've experienced a way from very profitable off-highway types of businesses in Western Canada that were particularly around the oil and gas business and the oilsands business, that our service margins can improve that's through better labor proficiencies, and then our parts margins can improve through a number of different avenues that we have available to us.

So, I would say that in absence of revenue improvement which we don't expect, the focus is pretty confident in the cost reduction side of things and it's possible we can do a bit better than we'd originally anticipated. But the real focus is on the margin line and if we can make those two things work, then we believe we can return that business to at least breakeven and perhaps profitable despite current market conditions.

Michael Doumet

Okay. Thanks for those comments Mark. So, just so I understand, not necessarily an improvement overall in the revenue line, but mix in some markets will need to improve?

Mark Foote

I think -- yes, we're -- our expectations inside the company are for no revenue improvements in Power Systems and still focusing very much on working to it get back to breakeven standpoint through cost reductions and some gross margin improvements, particularly in the on-highway and power-gen businesses.

Michael Doumet

Okay. Thanks. And just shifting gears here, just a free cash flow, you pointed early in the year that you had excess inventories and you did a good job in selling that down in the quarter. Do you feel there's more room to reduce inventories at this point? And are you looking at other -- any other potential free cash flow levers that you could pull?

John Hamilton

Sure. We've done a pretty good job getting rid of some of the excess inventory that we had, but that we still do have some additional opportunities not only on the equipment side, but also on the part side. Then you're going to ask probably orders of magnitude. So, I would suggest that there's probably another $20 million at least that we could probably take out. I'm not suggesting that we would get that done by the end of the, but that's certainly our focus and we've got a bunch of folks in the organization focusing on getting that done.

Michael Doumet

Okay. Well, those are my two. Thanks a lot.

Operator

The next question is from Sara O'Brien from RBC Capital Markets

Sara O'Brien

Hi, good afternoon. Can you comment again on the free cash flow, just looking forward, I guess what's the trade-off between the inventory reduction and the margin? And are you seeing that negative margin impact -- having to liquidate any inventory just to get it off the books and generate free cash at this point?

John Hamilton

I think whatever negative margin impact we've had in the P&L, getting rid of excess inventory has had marginal effects on that at best.

Sara O'Brien

Okay. And same going forward you wouldn't expect to liquidate anything for the sake of cash flow at this point?

John Hamilton

Well, the when we say liquidation, we're trying it on an early basis to bring down our inventory. And so we wouldn't see in any one quarter, huge loss of inventory that would be taken out, it would be done gradually. So, you don't necessarily see a big effect on that in terms of your margins.

Sara O'Brien

Okay. I just wonder -- based on the leverage ratio that's 2.8, the dividend covenant at 3.25, is there any risk in your mindset the cash flow won't be enough to keep in those levels -- that comfort range?

John Hamilton

Well, I guess there's always a risk. I guess we kept it in our view forward is that we would still have adequate room based on our internal projections. So, but there's certainly always risk and obviously, the closer we get to that number, the higher the risk.

Sara O'Brien

Okay. And maybe Mark, can you comment on the reorganization internally and how that's going across with customers as well as your staff internally? How the buying has been?

Mark Foote

I think we're in pretty good shape, but we're -- any company going through a big change would be this early in the process. From a customer standpoint, we gotten a fair number of pretty positive comments about more unified selling position with the customer and a broader capability of serving. So, I think from a customer standpoint, we're in pretty good shape.

Internally, as I said, we're -- anybody in this type of transition would be -- it's pretty early. So, that has been excellent we had a national town hall involved probably 65%, 70% roughly of our entire team and that we pulled them for their understanding of our strategy and their support for our direction and it was actually quite high.

So, lots of work to be done. There's still a whole bunch of work to be done between now and end of the year and it's obviously a big change for us. It will keep on going. But so far so good, I guess the best answer I would have for you Sara.

Sara O'Brien

Okay. And as you expected end date of getting all this transition done is this year or is it going to 2017?

Mark Foote

No, it's -- I think like any company we're never really done in a binary sense, but everything we currently have plan we're very confident will be complete by the end of this year.

Sara O'Brien

Okay. And maybe switching back to the financials, just wondered if you can comment a little bit more on the margin in the Equipment group, very strong despite product support being down as a percentage of sales, was that all SG&A or were there some parts of margin that performed better than expected on the gross margin level?

John Hamilton

You're talking about gross margins or EBIT margins?

Sara O'Brien

Well, EBIT very strong, even product support as a percentage of total sales was lower.

John Hamilton

I think that the big impact on the EBIT dollars has to do with -- the year-over-year basis has to do with the SG&A expense that were reduced. So, that's the biggest portion, but our margins were relatively comparable. Gross margins I'm talking about.

Sara O'Brien

Okay. That's it for me. Thanks.

Operator

The next question is from Bert Powell from BMO.

Bert Powell

Thanks. Mark did you intend to say something about John before Q&A?

Mark Foote

I'll stop short of reading the email we read from you earlier.

Bert Powell

Okay.

Mark Foote

No, I was going to address that --

Bert Powell

Yes, please don't read that.

Mark Foote

Yes, I was going to address that at the end Bert if that's okay.

Bert Powell

Okay. Sorry, I thought -- okay, I'll leave.

Mark Foote

Was that your question?

Bert Powell

No, no, I have another question. I just -- I thought you were going to say something upfront. Never mind, never mind. Just Power Systems getting to breakeven, so what's with the timing in terms -- that you're thinking about?

Mark Foote

We're working hard to get it done by the second half of this year and it really does relate to margin improvements, cost reductions, and some improvement in our power generation performance. But we're working hard to get it done by the -- in the second half of this year. That's in the period we're in right now.

Bert Powell

Right. And but that's where the bulk of the focus is in terms of that the seven and 15, right, that's Powers System centric.

Mark Foote

Sorry Bert, I didn't hear you very well.

Bert Powell

So, the -- maybe I'll move my mike closer. The savings that you've talked about 6 to 7 this year, 15 next, the bulk of that is Powers Systems, correct?

Mark Foote

In the second half of this year -- roughly half of what's coming in second half of this year is related to Power Systems, roughly half.

Bert Powell

Okay. And then just timing for the large shovel deliveries in the second half of this year, what quarters those are likely to fall into?

Brian Dyck

Bert, it's Brian. The two shovel that we have to deliver this year will be Q4.

Bert Powell

Q4? Okay, thanks for that. And Brian just, while I have you, any -- Western Canada, any signs of any upticks or people working -- pent-up demand in terms of the deferrals on maintenance that has to happen? Just any sense of where your clients are in terms of utilization or -- for you guys your machine population health?

Brian Dyck

I think that's sort of a two-part question. The first answer would be in the equipment business, in the whole goods business and I don't know that that's bottomed-out yet in Western Canada. We didn’t see any signs of that in the second quarter.

But I think in product support or the parts and service business, I think that our comparables are getting a bit more easier to reach than I think the large variances in that probably easy in the second half.

Bert Powell

Okay, that's great. Thanks.

Operator

[Operator Instructions]

The next question is from Michael Tupholme from TD Securities.

Michael Tupholme

Thanks. In there in the MD&A, there's discussion about Equipment and Industrial Components earnings exceeding your expectations, what was the key driver in each of those segments that led to the performance versus your expectations?

John Hamilton

In Equipment business, it would be a combination of margin and we actually saved more in the SG&A base than we had anticipated and in Industrial Components, it would be primarily related to the SG&A base.

Michael Tupholme

So, with respect to the margin you mentioned, John, is that -- I mean is that just a function of mix or something in the quarter or is that a sustainable type of benefit and that you think you're going to continue to see?

John Hamilton

So, which business are you talking about?

Michael Tupholme

Well, I think when you answered the first part of the question, you said within Equipment, the performance versus your expectation was a combination of margin and SG&A, so I guess I with respect to the margin piece I'm assuming any gross margins?

John Hamilton

I think for Equipment I was saying was -- it was volume and SG&A.

Michael Tupholme

I'm sorry. Okay. So, the volume was better than you expected?

John Hamilton

Volume was little better than we expected and the SG&A was better than expected.

Michael Tupholme

Okay. So, with respect to volumes is that a function of some sort of a shift in the market conditions or is it just sort of pattern worked out well in the quarter?

John Hamilton

Yes, I wouldn't suggest it's a change in market pattern. Things -- I think more so worked out better. We had note -- we did have two shovels in there. We product support ex the issues in Fort McMurray just got worked out better -- little better than what we thought, but I wouldn't suggest that it's a pattern that on a go-forward basis, that I would say that's a new pattern.

Michael Tupholme

Okay. And the size of the shovel deliveries this quarter, was that about $35 million, is that right?

John Hamilton

Little less, it's about 30.

Michael Tupholme

Okay. And similar amount for Q4?

John Hamilton

Little higher in Q4 because there -- two of the larger shovels -- or the two large shovels we sell will be in Q4 and the ones we had in Q2 were one of the largest ones and the second largest one.

Michael Tupholme

Okay. The $1 million of lost profits and damages due the wildfires, John, is that a pretax or after-tax number?

John Hamilton

That's a pretax number.

Michael Tupholme

Okay. And most of that was in Equipment, I imagine?

John Hamilton

Yes, Equipment is the biggest brand. So, they would have the bulk of the amount. And again that loss included some minor property damage as well as wages that we had to pay as well as lost profitability. So, it's all part that.

Michael Tupholme

Okay. And have you thus far -- or do you expect to see any additional volume as a result of demand associated with any four McMurray rebuild related efforts?

Mark Foote

We don't have anything scheduled -- accessory builders, the machines are back operating or a lot of utilization is a lot better, but as I've said before the rebuild business in Fort McMurray can be lumpy at times. So, it will be just sort of at a normal run rate right now.

Michael Tupholme

Okay. All right. Thank you. I'll turn it over.

Operator

The next question is from Ben Cherniavsky from Raymond James.

Ben Cherniavsky

Hi, guys.

John Hamilton

Hi Ben.

Ben Cherniavsky

I can still say good morning from out here. First of all, John, I just want to pass on the congratulations or whatever is appropriate given the decision you made to retire and just recognize the contributions you made to Wajax for so many years. It's been a pleasure dealing with you as a CFO and I wish you well when you retire.

John Hamilton

Thank you, Ben.

Ben Cherniavsky

I'm sure we'll talk before then, but I know this is sort of the ceremonial moment.

John Hamilton

Well, thank you. I appreciate those comments.

Ben Cherniavsky

Just on questions further towards the shovels and the impact et cetera. First of all, can you maybe just talk or maybe Brian talk a little bit about the nature of those orders what -- like how competitive was it to win them, where are they going if you can't identify the customer, just generally are they replacement demand or is this new shovels for new application?

Brian Dyck

One of the shovels went into gold mine in Eastern Canada and one of them went up to Fort McMurray and they were both not replaced.

Ben Cherniavsky

And the two that are still in the backlog, that -- where are they headed?

Brian Dyck

Those two are going into oilsands.

Ben Cherniavsky

And so how competitive is it to win those kind of orders?

Brian Dyck

Brutal.

Ben Cherniavsky

I guess a double question. Well, like I appreciate your candor with that, but I mean you've -- clearly you've made some money on this, if I understand the mechanics of what you're saying with the margin, what you're suggesting is that even though the mix shifted to more whole good, the sheer volume of revenue related to these deliveries over your fixed cost base helped improve the margin, is that effectively the right way to think about it?

Brian Dyck

We made margin on the product, but honestly the success of those two shovels was the efficiencies of our service staff and the way that they put them together. So, even in light of the fires in Fort McMurray and the delays and the issues that we had putting them together, we probably -- in today's day and age, we did really well putting them together and I'd say that's where the margin came from.

Putting add-ons and actually doing the assemblies and things--

Ben Cherniavsky

Yes, the prep work.

Brian Dyck

That's what helped us out on those deals. The actual selling the pieces was tough.

Ben Cherniavsky

All right. Okay. Now, that's helpful. But -- and so as we think about going forward then with two more of these shovels for delivery, that's in your backlog I assume. With the backlog for mobile equipment, if I recall right, is still down quite a bit.

So, everything else -- because you would have those other two shovels that you did deliver, presumably in your backlog, previously--

Brian Dyck

Sorry.

Ben Cherniavsky

Sorry.

Brian Dyck

No, they came out of backlog, obviously.

Ben Cherniavsky

Yes. So, just I get the backlog adjusted for the mining then is still very, very depressed right now.

Brian Dyck

We've had some successes in other areas of our business that will go into backlog come in this quarter. But it -- you're correct we're not going to replace two EX8000 shovels, I wouldn’t imagine in the backlog in the second half.

Ben Cherniavsky

But then as I think about the implications for margins and mix et cetera like was that -- is the margin you achieved this quarter sustainable in the back half of the year for mobile equipment?

John Hamilton

Well, again, the margins, if you look at our EBIT percentage on a quarter-by-quarter basis over the last couple of years, you can see its -- it gets pretty lumpy, but it's still kind of hanging in there and I would think quite hard relative to the conditions we're in, I wouldn't suggest though that the margin that we would achieved in Q2 was something that you could use on a go-forward basis.

Ben Cherniavsky

Okay. Thanks very much guys.

Operator

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

Mark Foote

Okay. It's Mark speaking. I just want to -- part for scripted remarks for a second appropriately. Bert referred to it, Ben referred to it, and we -- I think on behalf of everybody on the phone who has come to know John, in most cases, pretty well over the last nearing 18 years in his time at Wajax, certainly on behalf of our entire team and our Board of Directors, we're pleased that John will get the chance to retire when he had planned to. But we're very, very sorry to see him go.

I think the thing that's -- it's special of John as he has been with Wajax through some pretty tough times and some pretty good times. And he has always been a balanced person and a real backbone for management team.

So, we will eventually be sorry to see John leave, but having said that, he's being good enough to give us such an advance notice that the transition from one state to the other is -- we think it will be pretty smooth. And we're very appreciative of John's continuing contribution through what's pretty challenging time for us.

So, from me personally, from our entire team, our Board of Directors, and I know from people on the phone, would congratulate a memorial end up, but we'll remind people that he is not going anywhere for a bit.

So, with that, thank you very much for your time today and we look forward to talking here at the end of the third quarter.

Operator

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

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