Wajax Corporation (WJX) Earnings Call Transcript & Summary

Thank you for attending Wajax Corporation's 2021 Third Quarter Results Webcast. On today's webcast would be Mark Foote, Wajax's President and Chief Executive Officer; and Mr. Stuart Auld, Chief Financial Officer; and Mr. Iggy Domagalski, incoming President and CEO effective January 1, 2022. Please be advised that this webcast is being recorded. Please note that this webcast contains forward-looking statements. Actual future results may differ from expected results. I will now turn the call over to Mark Foote. Please go ahead.

Thank you, operator, and good afternoon, and thanks for participating in our third quarter call today. This afternoon, we'll be following a webcast, which includes a summary presentation of our third quarter 2021 financial results. The presentation can be found on our website under Investor Relations, Events and Presentations. I'll provide you with a general update, and then we'll turn the call over to Stu for comments on backlog inventory, cash and the balance sheet. Iggy, who will be succeeding me as Wajax's President and Chief Executive Officer effective January 1, is also with us today, and he will close our call. While Stu and I will handle the questions on the current business, you're welcome to ask any -- Iggy any general questions that you might have today. To begin, I'd like to draw your attention to our cautionary statement regarding forward-looking information on Slides 2, 3 and 4. And additionally, non-GAAP and additional GAAP measures are summarized on Slides 21 through 23 for your reference. If you turn to Slide 5, please. While pandemic conditions continue to improve in some areas of the country, Wajax has continued to adhere to 4 important objectives: first, to protect the health, safety and well-being of our team; second, to continue to provide strong service to our customers; third, to protect the financial health of our company; and finally, and consistent with our strategy, grow our company as conditions continue to improve. Our decisions in the third quarter and going forward will be made according to these objectives. If you turn to Slide 6. Revenue of $401 million was up $61 million or approximately 18% in the quarter. The increase in revenue resulted from increases in industrial parts and ERS sales in all regions, including the contribution from Tundra. Product support sales also increased and benefited from higher sales in Western Canada. Excluding Tundra, total sales increased approximately 6.05%. EBIT of $24.7 million was up $10.4 million or approximately 72% in the quarter. There is no benefit in the third quarter this year from the Canadian emergency wage subsidy, which last year had a positive effect on EBIT of $5.4 million. Excluding the effect of the wage subsidy and the pretax restructuring charge of $7.7 million taken in the third quarter of last year, EBIT increased $8.1 million or approximately 49%. The improved EBIT resulted from higher sales and margins, offset by increased costs due to the addition of Tundra, higher personnel costs due to volume and the effect of the wage subsidy. The gross profit rate of 21.2% was strong in the third quarter and was driven primarily by increased margins in product support and industrial parts and a shift in sales mix away from equipment. Adjusted net earnings of $0.72 was up $0.22 or approximately 44% in the quarter, noting the adjustments recorded on this chart. And at the end of the third quarter, the year-to-date TRIF rate of 1.34 declined 35% as business volumes increased, and we experienced an increase in injuries primarily in the second quarter of this year. We thank everyone on our team for their ongoing dedication to workplace safety and for excellent recent performance, resulting in a third quarter TRIF rate of 0.64%, which has begun to improve our safety trend back to its normally strong level. If you turn to Slide 7. As previously stated, the company did not recognize any reimbursement of compensation expenses from the CEWS program for this quarter. We've included a description of last year's wage subsidy in the application of the amounts here for your convenience. On Slide 7, as previously -- I'm sorry, on Slide 8. The revenue increase of 18% in the third quarter resulted from growth in Eastern and in Western Canada. Central Canada sales of $74 million increased approximately 1% in the quarter. Sales increases in product support, industrial parts and ERS offset reductions in equipment sales. Eastern Canada sales of $150 million increased 9% in the quarter due to strength in equipment sales, product support and industrial parts. And Western Canada sales of $177 million increased 37% in the quarter due to volume from Tundra, assisted by growth in product support and industrial parts. Excluding Tundra, growth in Western Canada was approximately 7%. If you turn to Slide 9. An update on equipment and product support sales and year-over-year variances are shown on this page. Equipment sales of $105 million decreased 1% compared to last year. Equipment sales in the majority of categories were comparable to the prior year. OEM supply chain challenges have primarily affected equipment supply and construction, forestry, material handling and power systems, and those challenges are expected to continue in the fourth quarter and to negatively affect equipment and related revenue. Product support sales of $114 million increased $13 million or approximately 13% due to strength in all regions. Western Canada increased 18%, Eastern Canada increased 10% and Central Canada increased 5%. Please turn to Slide 10. An update on industrial parts and ERS sales with year-over-year variances are shown on this page. Industrial parts sales are approximately $111 million, increased $27 million or 33%. Excluding Tundra, organic growth in industrial parts was 12% in the quarter. And ERS sales of $67 million increased $23 million or 49% due primarily to the inclusion of Tundra. And excluding Tundra, organic sales in ERS was up 4% in the quarter. If you turn to Slide 11. This slide summarizes sales at a category level for the quarter and year-to-date for our company's overall group in heavy equipment and industrial parts and services. In the third quarter, total growth in heavy equipment categories of $13 million or 6% was driven by growth in Power Systems, Mining and Material Handling that offset lower sales in Construction and forestry. And total growth in industrial parts and services categories of approximately $48 million or 38% was driven by the inclusion of Tundra and by organic increases in both industrial parts and ERS. Excluding Tundra, industrial parts and services in total, organic growth was approximately 7% -- up 7% in the quarter. If you turn to Slide 12, we'd like to provide an update on our upcoming transition that expands our direct distribution relationship with Hitachi. Change was announced in the news release dated August 19, 2021, which is available on our website, and we encourage you to review that release for more information. After 2 months of transition planning with our partners at Hitachi, we continue to be very confident that this change will provide Wajax with significant long-term benefits from enhanced access to product development, increased market responsiveness and improved reliability of equipment supply. It is also expected to increase Wajax and Hitachi market share by providing our customers with better access to products, which lead the market in terms of value, performance and reliability. Wajax and Hitachi will continue to work closely on transition planning, leading up to our transition date of March 1, 2022. I'll now turn the call over to Stu.

Thanks, Mark. Please turn to Slide 13 for my comments on backlog. Our Q3 backlog increased $54.7 million or 17% sequentially from the previous quarter, and increased $166.4 million or 81% on a year-over-year basis. The sequential increase was driven primarily by higher orders in most categories, offset partially by lower ERS orders. The year-over-year increase relates to higher orders in the construction and forestry, Material Handling and Power Systems categories and higher orders in the industrial parts and ERS categories with the addition of Tundra's backlog. These increases were offset partially by lower mining orders. Overall backlog reflects continued momentum in heavy equipment and industrial parts and services backlog, including Tundra. Please turn to Slide 14 for an update on our current inventory levels. Inventory, including net consignment, increased $2.4 million compared to Q2 2021. Net of consignment balance sheet inventory decreased by $5.1 million, while net consignment inventory increased by $7.5 million. Inventory, including net consignment, decreased $65 million compared to Q3 2020 due primarily to lower equipment inventory in most categories, partially offset by higher mining equipment inventory and higher parts and work-in-process inventory. Net consignment inventory decreased $46.3 million compared to Q3 2020. We continue to work with major suppliers with a focus on Construction, forestry, Material Handling and Power Systems equipment to attempt to secure additional inventory to meet our customer demand in the fourth quarter of 2021. Please turn to Slide 15, where I will provide an update on cash flow and leverage. Cash flow from operating activities in the quarter of $40.2 million increased $3.6 million from Q2 2021, due primarily to an increase in cash generated from changes in noncash operating working capital. Our leverage ratio decreased compared to Q2 from 1.73x to 1.39x due primarily to lower debt level in the current period. Cash flow results in the current quarter were positive, which contributed to a material reduction in debt and resulted in total leverage below the target range of 1.5x to 2x at the end of Q3. Our available credit capacity at the end of Q3 was $322.6 million, which is sufficient to meet short-term normal course working capital and maintenance capital requirements and certain strategic investments. Please turn to Slide 16, where I'll provide an update on financial position. We continue to focus on working capital efficiency, which is a key component in managing our overall leverage targets. The improvement in inventory turns from Q2 2021 is due to higher trailing 12-month average sales and lower average inventory levels. As previously disclosed, we continue to evaluate ways to unlock cash from the business and as such, have completed a market value assessment of our own real estate holdings. In the third quarter, we entered into sale and leaseback transactions for 2 of our own properties in Dartmouth and Fort St. John for proceeds net of transaction costs of $2.1 million and $3.2 million, respectively. Further opportunities to sell redundant real estate as well as sale and leaseback opportunities have been identified and are being pursued in 2021 and 2022. Proceeds from any real estate sales will be used primarily for debt repayment. The earnings impact from any sale and leaseback transaction is not expected to be material as any gains are expected to be approximately offset by the incremental lease costs over the term of the lease. Finally, the Board has approved our fourth quarter dividend of $0.25 per share payable on January 5, 2022, to shareholders of record on December 15, 2021. Please turn to Slide 17. And at this point, I'll turn it back to Mark.

Thanks, Stu. We'd encourage you to read the outlook completely, I think for today's call rather than reading the outlook verbatim. I'm going to point out 3 changes from our report at the end of the second quarter. First, I'm going to start with the market conditions have continued to be more positive than we originally expected, and those conditions generally continued into the third quarter. The second important point is OEM supply chain issues have been a factor throughout 2021, but became more pronounced in the third quarter, and those issues are expected to continue in the fourth quarter, which may negatively affect revenue and customer service levels. We are working very closely with each of our major suppliers to minimize to the extent possible the effect of these issues. As stated, supply chain issues are most pronounced in equipment and related sales in Construction, forestry, Material Handling and Power Systems specifically large engine systems. Third, we're pleased to report that we continued to expand the implementation of our new ERP system in the third quarter and have now successfully converted the majority of heavy equipment branches in Alberta, Saskatchewan and Manitoba, and are now totaling 13 locations, including a number of high-volume sites. While we will continue to take a cautious approach to the implementation over the next 18 months, we are very encouraged by the progress made to date. Finally, this is my last quarterly call as Wajax's CEO, leading to my retirement on December 31. And I wanted to express my sincere thanks to those listening. I greatly enjoyed my tenure as a member of the team and to reporting the progress of our business to our investors. And as many, if not all of you would be aware, Iggy Domagalski will replace me effective January 1, and we've asked Iggy to close our formal remarks today. Iggy?

Thank you very much, Mark. You are certainly leaving some very big shoes to fill. It is an honor to be chosen to lead this proud Canadian company. I am excited to continue the great work that Mark, Stuart and the Wajax leadership team have executed over the past decade, and I'm a firm believer in the current strategy for growing the business. Between now and the end of the year, I will continue to learn about this great company by visiting as many of our 114 branches across the country as I can. And as of January 1, it will be my turn to be a member of this team, and I look forward to reporting the progress of our growing business to our investors and to everyone on this call. Thank you for your time, and I look forward to working with you. And with that, I will ask the operator to open the line for questions.

[Operator Instructions] Your first question comes from Michael Doumet from Scotiabank.

Nice to see the strong performance in gross margins. I presume there are several such drivers, including the relationship between higher gross profit margins and lower inventories. How do you guys see that relationship evolve for the company and, I guess, the industry over the next couple of quarters?

Michael, it's Mark. Our general premise is that the margins at a category level are generally sustainable. A couple of things to think about. The -- particularly in the third quarter, the mix away from equipment was a bit more dramatic than it was in the first half of the year. So that was accretive to margin, but the extent to which equipment sales improve in 2022 beyond some of the supply chain issues that we face, that would obviously affect the margin negatively. But I think at the category level, our margins in industrial parts are quite strong. Our margins in product support, both labor and parts are pretty strong. And just given certain supply issues, our margins in equipment are stronger than they typically would be. I think that's an area where we would probably give a little bit back. But in total gross margin, that wouldn't be -- that wouldn't have too much of an effect. So I think the only thing that is not necessarily sustainable from what we see in the third quarter is likely to be a mix. And because the inventories are running very tight, margins are obviously quite healthy. But that's also a function of the fact that the extent to which we take hits on disposing of excess inventories, obviously, that has really gone down over the course of the last 12 months or so.

Got it. And you commented on the sourcing of equipment and that being a little bit more challenging in Q4. Do you have any visibility on when that improves? And you have a kind of better capability of meeting demand?

We are not expecting it to improve in the fourth quarter, Michael, to be perfectly honest with you. It's a vendor-by-vendor, category-by-category discussion. I think we're expecting construction in forestry to continue to be an issue for us for a while. That's a function of tight supply. That's a function of transition to Hitachi. It's a function of labor disruption in one of our primary manufacturers over the last month or so. So those are all negative issues, and we're expecting those issues to take a while to work their way through the system. We've got some real tight supply on the forestry equipment side, which we're managing. So we think that will be with us for a little while. And our partners in Material Handling, supply and large engine systems, I think they've got some challenges ahead of them, too. I think where we feel quite a bit better is post the transition to Hitachi. We think the access to equipment supply will be considerably more dependable. And our partners there have worked very closely with us in planning for our 2022 budget. So I think some of the issues we face towards the end of the third quarter will persist through the fourth and likely into the first half of next year.

Got it. And then turning to mining. You talked about a strong quoting activity. Can you disclose maybe what's to come into the backlog in the next several quarters and maybe longer term, what the largest opportunities are for the company, particularly as we think about the end of the HCM JV?

Yes. The -- I mean, the mining quote, it would be great to be able to tell you how the quotes are going to turn into backlog. I don't know if we really know how to do that right now. Quoting activity is pretty strong. I can tell you that as you get into next year, we've already gotten backlog one large shovel incremental to where we were this year, so that's worth about, call it, $20 million. So we're expecting the mining equipment business to be better next year than it was this year, and that's with booked orders. The extent to which some quoting activity turns into booked orders, that will obviously get a little bit better than that.

Got it. Okay. I'll leave it there. But I guess before I pass the line, Mark, I just want to say I appreciate it and enjoy these calls and our conversations over the years. So you'll be missed.

Thanks, Michael. Appreciate it.

Next question comes from Devin Dodge from BMO.

I just wanted to come back to gross margins. Just as you transition away from consignment with Hitachi, should we be expecting there to be a bit of an expansion to your gross margins? And if so, can you speak to how meaningful that could be?

You know what it is, it's expected to be a bit more positive in the normal course. And I suspect that you probably won't see the benefit of that in 2022 for a couple of reasons. We -- ourselves and our partners at Hitachi, really do want to do a proper job of the implementation of that line and managing that change. So we may trade some of that margin for increased aggressiveness from a retail pricing standpoint. I think in the normal course, that will reset itself a little bit, but we'll really want to get off the ground pretty aggressively. So we wouldn't necessarily expect any material increase in margin, at least in 2022.

Okay. That's good color. The balance sheet -- look, it appears to be in pretty good shape here. But I'm wondering if the need to rebuild your inventory position and the transition away from the consignment we just talked about, does that impact the timing for when you'd consider moving forward on some M&A opportunities?

The short answer to that one is definitely not. I think rebuilding inventory there -- I think that the team has done a superb job of spinning parts pretty quickly. We probably need more parts inventory, but I expect that will catch up from a sales standpoint. So I think the turns and parts are pretty strong, and I think they would stay that way. I think on the equipment side of things, the extent to which those inventories come up, there'd be zero effect on the ability of the company to finance the acquisition program. So I wouldn't worry about that one at all.

Okay. And then how does that M&A pipeline look now?

It's -- I would say it's a rich pipeline. We don't have anything of scale to report to you at this point in time. There are a couple of small deals in the Ontario market that the team is working on. They would not be consistent with an order of magnitude like a Delom or Tundra. So they're smaller deals that we continue to work on. But I think it's obviously a pretty big focus for the management team is to get some of those deals to the front of the queue and use some of that liquidity to invest in that growth strategy. It's just really important to the future of the company.

Okay. Look, before I turn it over, I just want to say congrats, Mark, on the upcoming retirement and best wishes for the next step.

Appreciate that. Thank you.

Your next question comes from Michael Tupholme from TD.

You've already talked a little bit about the supply chain issue. I'm wondering if you can also touch on how those issues may be impacting your industrial parts and -- business and any parts procured for your product support.

It is -- there are some emerging issues in industrial parts, Michael. I think the fundamental difference between IP and a lot of the heavy equipment categories, if not all of the heavy equipment categories, is there's the strength -- there is switching opportunities, excuse me, in industrial parts where if one brand is not available, we can usually successfully convert the customer to another. So to the extent to which the substitutability in the product line that works to our advantage, even though there are supply chain issues. So there are some issues there. I don't think we -- it's not that I don't think -- we don't see those as chronic as some of the heavy equipment supply, and we're reasonably confident that while they will continue through the fourth quarter, and into the first half of next year, they're not expected to have as significant an impact on the revenue line as the equipment side of things.

Okay. That's helpful. The comments that you plan to purchase all consignment inventory on hand at October 31 related to your Hitachi JV. Approximately how much of capital investment will be running in that business?

I'm looking to Stu to nod his head, but I believe that in October, roughly about $10 million came onto the balance sheet. And whatever is received from the current supplier between now and the end of February of next year, we would bring that onto the balance sheet also. I think what you want to watch, Michael, is that coming on to the balance sheet isn't necessarily negative from a cash flow standpoint because we're obviously trying to sell that stuff as soon as it's -- it arrives because we're short. So there is some inventory coming on to the balance sheet, but the likelihood it's going to stay there isn't very high, just given the demand and us being sure we're impacted...

And backlog.

And backlog. Yes, I apologize. Backlog and construction is up, obviously, so...

Okay. That sort of leads into my next question, which is about the backlog and a strong increase in the quarter. Sounds like you saw gains in most of product categories, I guess sort of a 2-part question. Number one, the gain in the [ JV ] were those driven primarily by strong demand? Or is there any impact here just from tightening availability in the supply issues? And then secondly, I'm wondering if you can kind of run through the gains that you saw across the categories, was it concentrated in certain areas? Or was it really broad-based?

Yes. I think the -- I guess to answer the first part of the question, Michael. The -- so I'm going to talk sequentially, okay, as opposed to year-over-year because there's obviously a pretty big difference year-over-year. So sequentially, it's probably the more relevant piece. So sequentially, there's about a $55 million increase in backlog. And trying to guide you as much as we can, the vast majority of that, say, something between $40 million and $45 million really has nothing to do with supply chain issues. It is simply orders that were booked with original delivery dates that were well into next year. So that's either mining or major power gen projects or aspects of Material Handling that are kind of larger units and later orders. So the majority of the sequential increase in backlog has nothing to do with supply chain. There's undoubtedly a wee bit of supply chain effect in there. But at the end of the third quarter, I would say that it was -- it certainly wasn't the biggest piece of that sequential increase. And I'm sorry, your second part was what are some of the categories?

It sounds like you saw gains in -- I think you said in most categories, but I'm just wondering if there's any more detail there if there were any particular areas that were major contributors to the quarter-over-quarter change.

Yes. So quarter-to-quarter, pretty solid increase in mining, pretty solid increase in power generation, and pretty solid increase in Material Handling and obviously, a nice amount of momentum in industrial parts.

Okay. Perfect. And then I guess just one last one related to that. It sounded like in the quarter, ERS orders were a little bit lower. Just wondering if you can comment on that. Was there a particular driver? Is that indicative of sort of what you're seeing in the market more generally? Or is it specific to some situation? And how do we think about that going forward?

Yes. No, I wouldn't read too, too much into that. In ERS, particularly as it relates to some of the bigger orders that affect the loan can be a bit of a lumpy business on a year-over-year basis. So I think momentum in ERS is actually quite good. And I think -- as I said, I think the momentum is actually quite good. So I wouldn't read too, too much into a quarter-to-quarter reduction in orders. I think our biggest issue in engineered repair services is really labor. It's just finding enough people and enough technicians to fulfill just kind of the day-to-day demand and some of the larger orders the company has got access to if it can staff them.

Okay. That's helpful.

[Operator Instructions] Your last question comes from Bryan Fast from Raymond James.

Just on the rental fleet, it looks like rental equipment on the balance sheet is at multiyear lows. What should we expect, I guess, for rental CapEx next year?

Bryan, it will be somewhat consistent with each of the past 2 years. So we continue to look at the rental fleet. And our biggest objective is to maintain the currency and get it to anything above 5 years, we don't really want to have on our books. So we look to sell that and try to keep it current. So we expect it to be about the same again in 2022.

Okay. And then just understanding that it is competitive out there. Can you just comment on what you're seeing on the labor side of things? Just some comments on, I guess, technician availability and the competitive environment.

Well, 2 things, I guess. First of all, it is very competitive. I think our most pronounced market for labor shortage is Quebec. It's not Alberta, B.C. and Ontario would be not too, too far behind, but Quebec would definitely be our most competitive labor market. We've -- with respect to wage inflation, I think we, like others, have adjusted some wages in regions and localities where we needed to in order to either hold on to the staff that we have or attract some additional folks. But we typically recovered that through the labor margins through to the customer. So at this point in time, it's really an attempt to make sure we hold on to the really good folks that work for the company, fill out the vacancies that we have. The issues are certainly most pronounced with technicians and that's on the heavy equipment and ERS side. To the extent to which there's wage inflation so far, that's been recovered through labor margins.

Okay. Great. And before I sign off here, just congratulations, Mark, on the retirement and best of luck.

Thanks, Bryan. Appreciate it.

And there are no further questions at this time. You may please proceed.

I was looking at Iggy because I thought he might close. But I probably didn't choreograph that very well in advance. So I just want to say thank you very much for listening to us today. And I'm sure my colleagues look very much forward to talking to you again in March, and I'll be here to support them for the first few months of next year. But I certainly appreciated your time and attention today and for all the other conference calls we've done together. Okay. So thanks very much. Talk to you again in March.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.