Rocky Mountain Dealerships' (RCKXF) CEO Garrett Ganden on Q3 2016 Results - Earnings Call Transcript

| About: Rocky Mountain (RCKXF)

Rocky Mountain Dealerships Inc. (OTCQX:RCKXF) Q3 2016 Earnings Conference Call November 9, 2016 11:00 AM ET

Executives

Garrett Ganden – President and Chief Executive Officer

David Ascott – Chief Financial Officer

Analysts

Jacob Bout – CIBC

Ben Cherniavsky – Raymond James

Sara O'Brien – RBC

Cherilyn Radbourne – TD Securities

Peter Prattas – AltaCorp Capital

John Chu – Laurentian Bank Securities

Operator

Good morning. My name is Stephanie and I will be your conference operator today. At this time, I would like to welcome everyone to the Rocky Mountain Dealerships Third Quarter Results Conference Call. All lines have been placed on mute to avoid any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]

Thank you. Garrett Ganden, President and Chief Executive Officer, you may begin your conference.

Garrett Ganden

Thank you, Stephanie. Good morning everyone and welcome to Rocky Mountain Dealerships conference call for the third quarter of 2016. My name is Garrett Ganden, President and Chief Executive Officer of Rocky. Also joining me on the call today is our Chief Financial Officer, David Ascott. By now everyone should have accessed to our third quarter earnings release for the period ended September 30, 2016 went out on Tuesday morning. If you did not receive the earnings release, it is available on the Rocky’s website at www.rockymtn.com. This call is being webcast and an archived recording will be available via the company's website as well.

I'm going to start today’s call with some prepared comments on the quarter followed by David’s review of our financial results. Once David is done, I will add some comments on operations and then we'll open up the lines to questions from the group. Before we begin, however, all participants should be cautioned that certain statements made in the conference call today will include forward-looking information. Comments that are not statements of historical fact including comments that may address future or expected activities, outcomes, results or developments are considered forward-looking statements by applicable law and as such involve risks and uncertainties.

Actual results could differ materially from the forward-looking statements made or implied today. For more information callers should access Rocky’s public disclosure documents including its most recent MD&A and annual information form all available on SEDAR.

Favorable crop conditions and positive grower sentiment, combined with our lower fixed-cost model, again allowed us to deliver improved year-over-year earnings, despite reduced equipment demand this quarter. While it is not uncommon for a portion of harvest to take place in the fourth quarter, late-season rains and some early snowfalls have resulted in a higher-than-average amount of harvesting activity to carry over into the fourth quarter this year. Despite these harvesting delays, early indications are that 2016 should produce a bumper crop, second only to the record-setting crops of 2013.

We continue to reap the benefits of the decisions made and strategies implemented over the past two years. Our ongoing focus on responsible inventory reduction has produced our lowest inventory levels since 2012. The resulting cash generation enabled us to continue to deleverage our balance sheet during the quarter, including a reduction of $41.7 million on our floor plan payables.

In response to economic conditions, we reduced the fixed cost structure throughout our business, including the previously-announced changes to our industrial equipment distribution model. We believe our current cost model is both sustainable long-term, as well as scalable to meet future demand. Combined with improvements made to our balance sheet, we feel well positioned to continue providing value to shareholders.

The Western Canadian agriculture market continues its track record of strength and stability. While commodity prices have fluctuated of late, crop receipts continue to be healthy and farmer balance sheets remain strong. We continue our efforts to position ourselves as a unique and compelling value proposition to customers and shareholders in our industry. We continue to make progress in this regard, as we seek to make Rocky the equipment dealer of choice throughout Western Canada. As always it is the people in Rocky, who drive our business and I thank them for their commitment to being the dependable partner of choice for our customers and our investors.

With that said, I'd like to turn the call over to David to review our financials in more detail.

David Ascott

Thank you, Garrett. Today, I will give an overview of our financial results and then I will provide some detail on our balance sheet position. Our summary of financial results for the third quarter of 2016 versus 2015 is as follows. Total revenues contracted by $33.3 million, or 13.0%, to $222.6 million. Gross profit decreased by $3.2 million, or 7.9%, to 16.6% of sales, up from 15.6% in the prior year. Inventory decreased by $49.2 million or 9.9% over Q2 2016 and $44.1 million or 9% over Q3 2015.

Operating SG&A declined by $3.7 million or 14.6% to 9.6% of sales down from 9.8% of sales. Adjusted diluted earnings per share of $0.37 up from $0.35 in Q3 2015. Our adjusted EBITDA increased by $0.5 million or 4.3% to $12.2 million. With regards to the amalgamation of our industrial distribution facilities located in Calgary and Red Deer into existing agriculture facilities located in those areas we recognize additional onetime costs of $1.3 million in the quarter comprised predominantly of increased accrued lease terminations costs.

In response to commercial real estate demand and other markets conditions we increased our estimate of these lease termination costs to include the full contractual liability on the facilities vacated. The decrease in sales for the quarter was driven primarily by a $31 million decrease in same store equipment sales.

As Garrett mentioned harvest has progressed more slowly in 2016 and in recent years. Rain and snow late in the harvest season has resulted in the carryover of a higher than average amount of harvesting activity into the fourth quarter especially in our northern regions. The timing of deliveries from our OEM’s also deferred delivery of certain units beyond the third quarter of 2016 contributing in small part to the decrease in new equipment sales during the third quarter of 2016.

Gross profit for the quarter decreased by $3.2 million or 7.9% primarily as a result of the decrease in new equipment sales. As a percentage of sales gross margin increased by 1% to 16.6% for the quarter due in large part to increased manufacture incentives recognized in the quarter and a shift in sales mix towards higher margin products for sales.

Operating SG&A during the three months ended September 30 2016, decreased to $21.4 million or 9.6% of sales from $25.1 million or 9.8% of sales. This reduction reflects the cost containment measures implemented through 2015 and 2016 to better align our resources deployed with current industry demand and the cost savings associated with the amalgamation of our distribution network.

Excluded from operating SG&A for the quarter are $1.4 million of asset impairment charges on redundant land, the aforementioned $1.3 million of expenses associated with the amalgamation of our industrial facilities and a $2.9 million gain on our derivatives financial instruments, as compared to a $4.1 million loss in Q3 last year.

The asset impairment charges were taken against our two vacant plots of land, which we've held for sale. These charges reflect our assessment of the market value of these properties in the current economic environment in Western Canada. The gain on our derivative financial instruments is primarily the result of recovery in the Company's share price and the associated impact on our total return swap positions.

For the quarter ended September 30 2016. We generated adjusted diluted earnings per share of $0.37 compared to $0.35 in Q3 2015. Moving to our balance sheet working capital as at September 30, 2016 was $142.5 million up from $138.5 million at Q2 2016.

Inventory was $445.6 million down $49.2 million during the quarter and down $44.1 million over this time last year. Within our inventory profile new agriculture equipment inventory decreased by $4.5 million and used agriculture equipment inventory decreased by $37.4 million during the quarter.

The decrease in used equipment during the quarter is representative of the cyclical demand for used equipment during the harvest season. Despite the softer overall demand industrial equipment inventory declined during the quarter. In response to current market conditions we continue to closely monitor our procurement of industrial equipment limiting new orders while focusing our sales efforts on existing inventory.

As Garrett mentioned earlier, the cash generation from the inventory reduction during the quarter allowed us to reduce our floor plan payable $41.7 million to $299.3 million as of September 30, 2016. As a percentage of equipment inventory floor plan payable is 74.7%, down 2.8% from December 31, 2015. As of September 30, 2016 the company was in compliance with all externally imposed capital requirements.

Now I would like to return the call back to Garrett to discuss our operations.

Garrett Ganden

Thanks David. Farmers across the Canadian Prairies have benefited from ample moisture and favorable growing conditions throughout most of the 2016 growing season. Despite relatively flat seeded and harvested acreage, Agriculture and Agri-Food Canada is calling for improved crop yields to boost overall production of principal field crops by 6.3% as

compared to last year, a level of production second only to 2013’s bumper crop.

As mentioned however, harvest progress is behind both last year and the five-year average in many regions, due to the rain and early snowfalls. Prices are both weak in canola although down in response to increased level of global supply and forecasted production showed modest improvements of late due in part to the uncertainties around the delay in harvesting and completion.

In the near term, agriculture commodity prices in Canada are expected to continue to be supported by the disparity between the Canadian and U.S. dollars, while sustaining cost reductions in fuel and fertilizer prices are providing input cost relief to farmers. On the industrial side of the business, Rocky’s success is largely correlated to investment in residential housing, as well as overall economic activity and spending in Alberta. The significant decline in the Alberta economy has tempered spending in all sectors and we continue to feel the effects on our industrial business.

As the industry had been persist, it is anticipated that overall infrastructure and residential housing investment may be for this can tail, which in turn is likely to negatively impact our industrial equipment sales. We remain committed to succeeding in the industrial market and management has made significant changes to restore our industrial delivery and results. With healthy commodity prices, diversified end markets and a strong team in place, we're excited about the value we can provide to shareholders.

Operator are now ready to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Jacob Bout with CIBC, please go ahead.

Jacob Bout

Good morning.

Garrett Ganden

Good morning Jacob.

Jacob Bout

Just talk a bit about how the harvest season is progressing in Western Canada and the amount of revenue that could be pushed from the third quarter into the fourth quarter? I think on average in the Canadian Prairie right now roughly 80% of the crop has been harvested but still waiting for that 20%. What is the likelihood yield that it gets harvested and what does that mean for you guys?

Garrett Ganden

Well, a couple of things, first off, yes about 80% but there are certain regions that are substantially lower than 80% finance are harvested completed, for example, Northern Alberta and going into Manitoba and east part of Saskatchewan for certain. So there is a little of it in left in those areas. The weather forecast out here right now has been quite good. We were high teens, low 20s and we're expecting to have that for the next few days. And there is significant progress being made on a daily basis. So from our perspective still believe that the crop all gets [indiscernible]. We just need Mother Nature to continue to support us here for the next little while.

Jacob Bout

And how that impacts you would be just more parts and service revenue if they continue harvesting in the fourth quarter?

Garrett Ganden

Yes that works into a more so in Q3, Q4 for sure. And the other thing is we will see what the commodity prices ultimately do to. We kind of made a comment there that the commodity prices have started to increase a little bit because everybody is wondering as to what the quality of the remaining crop is going to be. That impacts too because it's just cash in the farmers’ hands, right.

Jacob Bout

Right. On your SG&A reduction, I think you talked a bit about sub-10% as SG&A as a percentage of revenue. How low does this go and at what point do you start cutting to the bone?

David Ascott

Realistically I think our cost cutting for the most parts have been implemented. We haven’t necessarily seen it all flow through all the quarters because really in Q2 there was some additional as we have talked about with the industrial segment. But I think for the most part our cost cutting is appropriate for what we are expecting the business to do, we think we are well positioned from that perspective, I put a caveat in there if markets were to decline more there would be more that we would need to find, but the most part I think we hope for it now, Jacob.

Jacob Bout

And where you’re running right now revenue per employee and what’s your target for that?

David Ascott

Revenue per employee right now, we are sitting at $1.1 million or so million per employee. That is right in the range of where I would have wanted it to be I think there is a little bit of opportunity for us to get that higher as the market recovers but right in this range.

Jacob Bout

Okay, I leave it there. Thank you.

David Ascott

Okay, thanks, Jacob.

Operator

Your next question comes from Ben Cherniavsky with Raymond James. Please go ahead.

Ben Cherniavsky

Hi, guys.

David Ascott

Good morning.

Garrett Ganden

Good morning, Ben.

Ben Cherniavsky

The inventories that good to see them come down, good job on that but I had a – I just wanted to clarify on a year-over-year basis. The used inventories look like they’ve gone up, and new was down so can you maybe just elaborate on what’s happened there?

Garrett Ganden

Yes, if you look at last year we had an excessive amount of new agriculture equipment with newly divested in the late in the third quarter and into the fourth quarter of 2015. We are now working our way through that used piece as well. Really for us to have a healthy inventory profile, we need – the level of new ag that we have now is appropriate as we continue to move forward but to get that also – who we needed to sell the new and then get to the used and sell the used. So we are continuing to ratchet that down but we do have the new piece tied into where we wanted to be, and used is going to continue to come down over the coming 12 months.

Ben Cherniavsky

Isn’t used sometimes arguably the trickier one to sell, because you guys have sort of put a sticker value on it when you did the trade and you have to assume you can get that price before you take a loss, like its got little more risk around it which you have to manage?

David Ascott

Yes, it does. Yes, absolutely and we’ve got controls absolutely in place to make sure that the new equipment is valued how we think is appropriate and when we look at it from a margin perspective, we have talked about it - last year that we thought that it was going to be a little bit down from normal but we are actually seeing the bit of a recovery over that this year. And I think we have the pricing of it right. It’s just a little bit more time to be able to continue to get that down.

Ben Cherniavsky

And when you talk about the delays from the OEMs presumably that had an impact on your new inventory that had that stuffs all arrived you would have had more – you would have maybe had more sales, but I imagine you would have had more inventories too.

David Ascott

Yes, the majority of the inventory that we are waiting for is presold.

Ben Cherniavsky

Okay.

David Ascott

So it would have actually – new inventory still would have been very similar to the same level of what we have now. Used probably would have been a little bit higher as to complete that transaction.

Ben Cherniavsky

Right, right. Okay. So into the fourth – on a year-over-year basis would we expect that how would we expect the inventory to look at the MD&A or compared to where they are today?

Garrett Ganden

Well, we continue, so last year we ended inventory at around $500 million, we are still going on target and continuing to focus on having that inventory down to around that $450 million. So the end of the year which is the $50 million reduction half of it coming from construction, half of it coming from ag, we are still in that – we still believe that’s possible and that’s where we are driving for.

Ben Cherniavsky

But you…

Garrett Ganden

Finished over Q3.

Ben Cherniavsky

But you finished Q3 with $400 million in equipment inventory.

Garrett Ganden

I’m sorry, on total inventory – sorry, I mean total inventory.

Ben Cherniavsky

Total inventory, okay.

Garrett Ganden

Yes, sorry, about that.

Ben Cherniavsky

Okay. Thanks and then finally you mentioned the OEM incentives that helped on the gross margin a little bit. Can you just elaborate on what those where – I think there is sort of market share targets in volume incentives what exactly trigger those incentives to be higher this period?

Garrett Ganden

It was actually from one of the couple of the short-line products that we represent. And realistically volume was a little bit higher than where it was last year as well as the penetration we had in the marketplace. That’s where that finance come from. So just a little bit more than what we had actually expected. We try and accrue for that as we believe it's earned and we were a little under-accruing.

Ben Cherniavsky

Okay, great. Good problem to have. Thanks.

Garrett Ganden

Yes. All right, thanks, Ben.

Operator

Your next question comes from Sara O'Brien with RBC. Please go ahead.

Garrett Ganden

Good morning, Sara.

Sara O'Brien

Good morning. Can you talk about Q4, expected sales mix between used and new differing how that should trend?

Garrett Ganden

Expected to be fairly typical to the previous years, right, we're going to have a little bit more new sales than we have used sales. But we’re assuming it’s going to be a fairly typical quarter from that mix perspective.

Sara O'Brien

Okay. And then just there was a comment on infrastructure and residential and that's going to might further deteriorate. Just wondering what kind of impact would that have on your Industrial segment? Is it more of serve and absorption issue on the basis of SG&A or would that cause maybe a re-look at the Industrial segment and what you want to do with that going forward?

Garrett Ganden

I believe we have the Industrial segment’s position for the current market even with some modest decline they still think we're appropriately set up for it. What it would really come down to is parts and service sales because there just wouldn't be the hours getting put under the machine. Parts and service sales could have a negative impact under that as well as potentially some of the new equipment sales. I do not believe this, and again, it depends on the magnitude, but I do not believe the further reduction is going to have any material impact.

Sara O'Brien

Okay. And just in terms of the cost savings initiatives from consolidation of the stores, how much would you expect to see in addition in 2017 relative to what you’ve seen this year?

Garrett Ganden

Well, in regards to the industrial piece, on an annualized basis we expected to see above $3 million. If you normalize that over the four quarters that’s above $750,000 per quarter. So really you should have half a year's worth of improvement which should be $1 million half of four times.

Sara O'Brien

Okay. Thank you.

Garrett Ganden

Thanks, Sara.

Operator

Your next question comes from Cherilyn Radbourne with TD Securities. Please go ahead.

Cherilyn Radbourne

Thanks very much and good morning.

Garrett Ganden

Good morning, Cherilyn.

Cherilyn Radbourne

Wanted to start by asking if you could give some details on the timing and scale of the service technician rationalization that you undertook during the quarter, I'm sure that wasn't a decision you would've made easily given that until recently skilled labor was in short supply in Western Canada.

Garrett Ganden

Yes. The real reduction from that perspective happens few quarters ago. That was – it was done, really we were looking to drive efficiency. We were looking to make sure that’s – technicians that we had were as efficient as possible. And we wanted to make sure that they were correct first. It was not an easy decision when we did that, but that has also partially impacted our improvement in margin, that’s also partly impacted some of our SG&A reductions. As we're moving forward into 2017, we're actually looking to add modestly in the technician mix for – as we move forward into next year.

Cherilyn Radbourne

How many people approximately did you let go?

Garrett Ganden

It was approximately 20% percent of the technicians we had.

Cherilyn Radbourne

Wow. And then just in terms of the changes you made to your SG&A cost structure, can you help us think about what percentage of your SG&A cost would be fixed as we think about demand recovering?

Garrett Ganden

Yes. So our fixed costs usually are about three quarters fixed and about a quarter variable roughly, Cherilyn.

Cherilyn Radbourne

Okay. That's helpful. And then can you just comment a little bit on the overall inventory situation across the industry, whether in total or specific to used inventory and what progress you think has been made?

Garrett Ganden

I think the progress actually in Canada it has been pretty good. The progress in the United States is a lot slower than what we’ve been able to see in Canada. The manufacturers have really done a – been very responsive and really reduced what they are doing for production whether or not its tractors or combines as far as whatever the piece of equipment are. So the destocking seems to be going quite well in Canada. The U.S. is slower and I think for the most part that’s directly attributed to the corn price still continuing to be quite low.

Cherilyn Radbourne

And how much of an impact does a continued overhang of used equipment in the U.S. have on your business?

Garrett Ganden

The impact changes whether or not the U.S. dollar strengthens or weakens really what we’ve seen right now with it is not significant. We don’t perceive that to be significant as we move forward in the next 12 months to 18 months. That being said, I’m looking to try and keep all political comments out of this, but there was a new President elected yesterday and we’re not entirely sure what’s those impacts will – that he will be putting into place we’ll ultimately have on the dollar, but at this point in time, we don’t see any impact.

Cherilyn Radbourne

Great. That’s all from me. Thank you.

Garrett Ganden

Thanks, Cherilyn.

Operator

Your next question comes from Peter Prattas with AltaCorp Capital. Please go ahead.

Peter Prattas

Good morning, guys.

Garrett Ganden

Good morning, Peter.

Peter Prattas

You’ve got – having some temporary challenges on the balance sheet earlier in the year to now arguably being under leverage. So I’m just wondering can you discuss maybe how much more on capacity you think you might have to pursue acquisitions. And just given that it's been a while since you’ve made any acquisitions and presumably you are through the integration process on the one that you’ve done in the past. Are you increasingly interested or motivated to maybe make some deals happen, how does the pipeline look and are dealers anymore motivated just given the challenges we’ve seen over the last couple of years. Thanks.

Garrett Ganden

Okay. So first question, yes, we have been delevering the balance sheet. We’re going to continue to focus on doing that. Cash, we basically have available, our operating facilities at $60 million we’re not drawn on that. The long-term debt facility we have is about 75 and which we’re call at two-thirds funded on that piece. So that would give us call it $80 million to $90 million worth of the dry powder not counting what we might be able to get other inventories if we so desired.

So I would suggest that there is some good dry powder available. In regards to acquisitions on a stand through there are some out there. I am really waiting to see when the market is going to turn. I am not interested really in acquiring anything significance while, until we see that really see the market starts to turn, right. So I think we’ve got a bit of time, but we’re continuing – we’re just going to continue to focus on getting that leverage down. So when we see that market turning, we’ll be ready to do some.

Peter Prattas

Great. Thank you.

Garrett Ganden

Thanks, Peter.

Operator

[Operator Instructions] Your next question comes from John Chu with Laurentian Bank Securities. Please go ahead.

John Chu

Hi, good morning.

Garrett Ganden

Good morning, John.

John Chu

Maybe just following up on the M&A, what are you seeing in terms of valuations out there everything going up? Are they even still pretty steady?

Garrett Ganden

They’ve been pretty steady, but they’ve been pretty steady and elevated. But fairly steady as to what everybody’s expectations are.

John Chu

Okay. And then just regarding the timing of the OEM deliveries, is that safe to assume that the pre-showed inventory they’re going to be realized in Q4?

Garrett Ganden

Yes. That would be reasonable. It is – what we’ve got in there, it’s a modest amount, right. So but yes, we’re expecting that be in Q4.

John Chu

Okay. So not to not overly meaningful than inside?

Garrett Ganden

Right. It’s modest. Yes.

John Chu

Okay. And then just, I miss part of the early part of the call but Jacob was asking about the impact of the slow harvest. And so it was anything meaningful from a revenue perspective that were some of the purchasers decision were delayed and you see that in Q4 or in the early part of next year.

Garrett Ganden

Really the answer to that is, first and foremost, we’ve got to do everything we can’t help the farmers get the crop off. Some of the pieces in Northern Alberta as well as Eastern Saskatchewan and into Manitoba, there’s quite a bit still to go. I know they’re talking about the fact that 80% of the crop is off. But in some of those regions, we’re talking to whether 50% off to 60% off, so there’s some quite a bit to do there still. So really our focus right now has been, let’s help them get those crops off. And we’ll see as the quarter progresses, what that ultimately entails that.

John Chu

And do you find that insurance act as a nice backstop in terms of farmers being able to get comfortable enough of making their purchases or during the past is that something that…

Garrett Ganden

It helps, John. But at the end of the day they’re actually better off if they can get the crop off and actually have the product insurance as a backstop, just to cover your base costs for lack of better description. It is substantially better for the farming community for them to be able to get that crop and to be able to solve this. Especially the fact that the yields that have been seen in the yields that are continuing to be expected in the years that are done, are quite high in comparison to what the averages have been. So it helps, but its better I think for everybody if the crop gets off, even if the yield is not – if the quality of it is a little bit depressed.

John Chu

Okay. That’s helpful. And then last question just the agent with – the inventory what percentage is over 12 months, right now.

Garrett Ganden

We don’t actually talk about those pieces, but I’ll answer that question is John is we’re pretty darn happy with the profile that we have within our inventory right now. The focus that we’re continuing to do is to reduce it a little bit more. But the profile itself is well within our expectations.

John Chu

Okay, perfect. Thank you.

Garrett Ganden

Okay, thanks.

Operator

There are no further questions at this time.

Garrett Ganden

Thank you, Stephanie. We concluded the document on our website to help communicate the key messages from the quarter. And with that I would like to thank you for joining us on today’s call. Again, I’d like to remind everyone that comments made during this presentation may contain forward-looking statements and should be considered along with advisories on forward-looking information, and the risk factors outlined in our previously mentioned public disclosure documents available on our website and on SEDAR. Have a great day.

Operator

Thank you. This concludes today’s conference call. You may now disconnect.

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