MISSISSAUGA, ONTARIO -- 08/12/08 --
Strongco Income Fund (TSX: SQP.UN) today released financial results for the second quarter ended June 30, 2008. The Fund concurrently announced a suspension of monthly distributions, beginning with the month ended August 31, 2008.
"While sales during the second quarter increased from the same period last year, profitability decreased," said Robert Beutel, Chairman of the Fund. "Given Strongco's lower than expected operating results, challenging market conditions and the need to position the Fund for the future, the Trustees decided to suspend distributions.
"We are fully aware of the importance of distributions to our unitholders. However, the Fund needs to conserve cash to maintain balance sheet strength and meet operating requirements. We believe suspending distributions is a fiscally responsible measure to maintain Strongco for the long-term."
Revenues during the quarter increased 19.4% from the same period in 2007 to $126.0 million. Of Strongco's two operating divisions, the larger Equipment Distribution unit - accounting for 94.6% of total revenues - benefited from improved equipment sales in existing operations and the acquisition of Champion Road Machinery during the first quarter. These gains offset reduced revenues from Engineered Systems, which contributed 5.4% of Strongco's top line.
Gross margin increased by 9.5% to $20.8 million, which equates to a gross margin percentage of 16.5%, down from 18.0% in the second quarter of 2007.
Administrative, distribution and selling expenses increased by $2.7 million to $17.1 million. More than half of this increase was a result of the incremental impact of Champion's ongoing operating costs and one-time expenses associated with the integration.
Earnings from continuing operations before taxes decreased to $3.0 million from $4.3 million.
Net income was $2.9 million, compared to $2.5 million in 2007. However, the 2007 figure was negatively affected by a one-time future tax expense adjustment of $1.8 million due to changes in federal tax rules governing income trusts. Basic and diluted net earnings per unit amounted to $0.28, versus $0.24 in the second quarter last year.
The Fund generated distributable cash of $2.4 million, compared to $4.8 million in the 2007 period. Unitholders received cash distributions totalling $1.5 million during the second quarter.
Financial Highlights
($ millions except per unit amounts)
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Period ended June 30 3 months 6 months
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2008 2007 2008 2007
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Revenues $126.0 $105.5 $210.1 $187.0
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Earnings from continuing
operations before income taxes $3.0 $4.4 $2.5 $4.7
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Net income $2.9 $2.5 $2.3 $2.5
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Basic & diluted earnings per unit $0.28 $0.24 $0.22 $0.24
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Distributions per unit $0.30 $0.30 $0.60 $0.60
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Equipment Distribution inventories at the end of the second quarter were higher than anticipated because suppliers of some high-volume lines delivered product late. The Crane Group was particularly challenged by difficulties securing sufficient product from manufacturers to meet customer demand. In addition, while orders are currently higher than at the same time a year ago, much of the order book consists of low-margin equipment.
In the Engineered Systems unit, business to date in 2008 is lower than in 2007 because some customers, sensing a softening economy, are deferring investment decisions. This division also faced more competition from U.S. firms that have entered the Canadian market in search of better business conditions.
Strongco's bank credit facility remains unchanged at $30 million. The Fund can also utilize credit from various equipment manufacturers to finance inventory purchases.
Conference Call Details
Strongco will hold a conference call on Tuesday, August 12, 2008 at 11:00 am ET to discuss second quarter results. Analysts and investors can participate by dialing 416-644-3429 or toll free 1-800-814-4890. An archived audio recording will be available until midnight on August 26, 2008. To access it, dial 416-640-1917 or 1-877-289-8525 followed by passcode 21278465#.
About Strongco
Strongco Income Fund is a trust established to hold one of the largest multi-line industrial equipment distribution providers in Canada. Over 700 employees provide retail service at 30 branches located from Nova Scotia to Alberta. Strongco sells, rents and services mobile industrial equipment to sectors that include construction, road building, mining, forestry, utilities and municipalities. Strongco represents several leading equipment manufacturers including Volvo, Case, Manitowoc, Cedarapids and more.
Strongco Income Fund is listed on the Toronto Stock Exchange under the symbol SQP.UN.
Information contact
Grant McCardle
Chief Financial Officer
905-565-3808
cfo@strongco.com
Forward-Looking Statements
All statements contained in this news release that do not directly and exclusively relate to historical facts constitute forward-looking statements as of the date of this press release. These statements include the statement concerning our outlook for 2008 and are not guarantees. Although we believe that these forward-looking statements are based on information and assumptions which are current, reasonable and complete, these statements are necessarily subject to a number of factors that could cause actual results to vary significantly from current expectations. Please refer to the "Forward-Looking Statements" section in the accompanying Management's Discussion and Analysis.
www.strongco.com
Management's Discussion and Analysis
The following management discussion and analysis ("MD&A") provides a review of the consolidated financial condition and results of operations of Strongco Income Fund, Strongco GP Inc. ("Strongco GP") and Strongco Limited Partnership (the "Partnership") collectively referred to as the "Fund" or "Strongco", as at and for the three and six months ended June 30, 2008. This discussion and analysis should be read in conjunction with the accompanying unaudited interim consolidated financial statements for the period ended June 30, 2008 and with the Fund's audited consolidated financial statements, accompanying notes and MD&A contained in the Fund's annual report for the year ended December 31, 2007 ("Annual Report"). For additional information and details, readers are referred to the Fund's quarterly financial statements and quarterly MD&A for fiscal 2007 as well as the Fund's Notice of Annual Meeting of Unitholders and Information Circular ("IC") dated March 4, 2008, and the Fund's Annual Information Form ("AIF") dated March 28, 2008, all of which are published separately and are available on SEDAR at www.sedar.com.
Unless otherwise indicated, all financial information within this discussion and analysis is in millions of Canadian dollars except per unit amounts. The information in this MD&A is current to August 11, 2008.
Strongco Income Fund
Strongco Income Fund is an unincorporated, open-ended, limited purpose trust established under the laws of the Province of Ontario pursuant to a declaration of trust dated March 21, 2005 as amended and restated on April 28, 2005 and September 1, 2006.
On September 1, 2006 Strongco completed a reorganization in which all of the operations of Strongco Inc. ("the Company") were transferred into a new limited partnership, the Partnership.
The transfer of the operations of the Company to the Partnership was recorded at the carrying values of the Company's assets and liabilities on September 1, 2006 in accordance with the continuity of interest method of accounting, as the Partnership is considered to be a continuation of the Company.
On December 1, 2007, the Fund sold the assets related to discontinued operations of the aerial rental business for proceeds of $1.7 million. The results of the related operations have been reported as discontinued operations and prior period amounts in this MD&A and accompanying financial statements have been reclassified to conform to the current period presentation.
On March 20, 2008, the Fund purchased substantially all of the assets (excluding real property) of the Champion Road Machinery division (the "Champion Business") of Volvo Group Canada Inc. for a total consideration of $25 million. The Champion Business provides full service sales, rentals, parts and service for the Volvo Motor Grader line in Ontario. In addition to graders, the Champion Business carries the Volvo Compact line in Ontario.
Distributions
The Fund's policy is to make distributions of cash and units in-kind consistent with balancing long-term growth strategies and the providing of current income to Unitholders. The Fund makes monthly distributions to Unitholders of record on the last business day of each month payable on or about the 20th day of the following month.
On March 14, 2007, the Fund announced that the monthly cash distributions to Unitholders were decreased from $0.18 per unit to $0.10 per unit commencing with the distribution in respect of the month ended March 31, 2007. This reduction was made in response to the increased level of competition and softening in the construction equipment sector.
On March 17, 2008, the Fund announced that the structure of distributions to unitholders were changed to distributions consisting of $0.05 per unit in cash and an "in-kind" distribution of $0.05 per unit, to be settled with additional units issued to unitholders, subject to regulatory approval and commencing with the distribution in respect of the month ended March 31, 2008. In-kind units are issued at a deemed price equal to the volume-weighted average price of all units traded on the Toronto Stock Exchange on the 10 trading days ending on the third trading day preceding the record date. This change in distribution structure will allow Strongco to retain more cash within the Fund for the purposes of reducing debt and facilitating expansion through internal growth and acquisitions.
On August 11, 2008, the Fund announced that distributions to unitholders will be suspended until further notice, commencing with the distribution for the month ended August 31, 2008. This change is in response to lower than expected year to date results in both of Strongco's operating segments, concerns about the near term economic outlook and a need to retain cash to maintain balance sheet strength.
Financial Highlights
Three Months ended Six Months ended
June 30 June 30
($ millions, except per unit amounts) 2008 2007 2008 2007
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Revenues $ 126.0 $ 105.5 $ 210.1 $ 187.0
Earnings from continuing operations
before income taxes $ 3.0 $ 4.4 $ 2.5 $ 4.7
Net income $ 2.9 $ 2.5 $ 2.3 $ 2.5
Basic and diluted earnings per unit $ 0.28 $ 0.24 $ 0.22 $ 0.24
Distributions per unit $ 0.30 $ 0.30 $ 0.60 $ 0.76
Total assets $ 253.0 $ 200.3
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Overview
Strongco's operations are comprised of two business segments. The Equipment Distribution segment is one of the largest multi-line mobile equipment distributors in Canada. This segment sells and rents new and used equipment and provides after-sale customer support (parts and service). This segment distributes numerous equipment lines in various geographic territories, including those manufactured by Volvo Construction Equipment North America Inc. ("Volvo"), Case Corporation ("Case"), and Manitowoc Crane Group ("Manitowoc"). The Engineered Systems segment designs, manufactures, sells, installs and services dry bulk material handling equipment, including belt conveyors, screw conveyors, idlers, feed milling and grain handling equipment and their related assemblies.
Strongco's strategy is to increase earnings in all segments by improving market share, increasing operating margins and managing expenses concurrent with continuing to strengthen the balance sheet. Additional revenue and earnings improvements will be achieved through acquisitions, organic growth and cost control.
Consolidated Results of Operations for the Three Months Ended June 30
($ thousands, except
per unit amounts) 2008 2007 $ Change % Change
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Revenues $ 125,974 $ 105,490 $ 20,484 19.4%
Cost of sales 105,193 86,511 18,682 21.6%
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Gross Margin 20,781 18,979 1,802 9.5%
Administration, distribution
and selling expenses 17,092 14,394 2,698 18.7%
Amortization of intangible assets 93 - 93
Other income (563) (588) 25 -4.3%
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Operating income 4,159 5,173 (1,014) -19.6%
Interest expense 1,159 791 368 46.5%
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Earnings from continuing
operations before income taxes 3,000 4,382 (1,382) -31.5%
Provision for income taxes 113 1,831 (1,718) -93.8%
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Earnings from continuing
operations 2,887 2,551 336 13.2%
Loss from discontinued operations - (96) 96
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Net and comprehensive income 2,887 2,455 432 17.6%
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Basic and diluted earnings per
unit 0.28 0.24
Number of units issued and
to be issued 10,403,458 10,403,458
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Key ratios:
Gross margin as a percentage
of revenues 16.5% 18.0%
Administration, distribution
and selling expenses as
percentage of revenues 13.6% 13.6%
Operating income as a
percentage of revenues 3.3% 4.9%
Revenue by Business Segment
Three months ended June 30 2008 % 2007 % Change
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Equipment Distribution $ 119.2 94.6% 94.5 89.6% $ 24.7
Engineered Systems 6.8 5.4% 11.0 10.4% (4.2)
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$ 126.0 100.0% $ 105.5 100.0% $ 20.5
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In the second quarter of 2008, Equipment Distribution segment revenues increased by $24.7 million (26.1%) over the second quarter of 2007. The acquisition of the Champion Business in Ontario made a significant contribution to the overall increase in equipment and product support revenues in Central Canada. Eastern Canada made gains in equipment and product support revenues. In the West, equipment sales were up compared to the second quarter of 2007. In large measure, the increase in revenues is due to the positive impact of rebuilding of our sales organization over the past twelve months. Supplier constraints on the delivery of in-demand equipment has restrained revenue growth in the Equipment Distribution segment.
During the second quarter of 2007, the Engineered Systems segment completed several large projects for the mining sector. This segment is facing strong competition from domestic and foreign competitors. The slowdown in the United States economy and, to some extent, in Central Canada has caused customers to delay or cancel capital projects and negatively impacted the Engineered Systems segment's revenues and related gross margins. The segment is taking steps to reduce its variable costs and increase its presence in the market. Small jobs and the supply of parts to completed projects is maintaining the segment's current revenue levels.
Revenue by Geographic Region
Three months ended June 30 2008 % 2007 % Change
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Eastern (Atlantic / Quebec) $ 33.1 26.3% $ 30.3 28.7% $ 2.8
Central (Ontario) $ 56.1 44.5% $ 38.5 36.5% 17.6
Western (Manitoba to B.C.) $ 36.0 28.6% $ 36.1 34.2% (0.1)
Other $ 0.8 0.6% $ 0.6 0.6% 0.2
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$ 126.0 100.0% $ 105.5 100.0% $ 20.5
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During the second quarter, equipment segment revenues were stronger in all regions. In Eastern Canada, the gains were mostly in the Equipment Distribution segment in Quebec, as that province continues its expanded infrastructure spending. The Atlantic Equipment Distribution segment increased its equipment sales. Gains in the Equipment Distribution segment offset reduced revenues in the Engineered Systems segment in both Atlantic and Quebec. In Ontario, Equipment segment revenues were enhanced by the acquisition of the Champion Business and by a healthy increase in equipment sales. In the West, gains in equipment sales revenues offset reduced product support revenues and reduced Engineered Systems segment revenues. Product support revenues in the West were negatively impacted by a weather related slow start to the construction season and our exit from the Tigercat product line in 2007.
Gross Margin
Strongco's gross margin increased by $1.8 million (9.5%) to $20.8 million (gross margin percentage 16.5%), in 2008 from $19.0 million in 2007 (gross margin percentage 18.0%).
Within the Equipment Distribution segment, business activities include the sale of machinery, customer support (parts and service) and equipment rentals. Equipment sales generate a significantly lower margin than customer support activities. In the second quarter of 2008, such sales accounted for 74.5% of revenues and 40.9% of gross margin, compared to 72.9% of revenues and 36.7% of gross margin in the second quarter of 2007.
Gross margin for the Engineered Systems segment decreased to $1.2 million, (a gross margin percentage of 18.2%), in the second quarter of 2008 from $2.7 million (a gross margin percentage of 24.5%) in the second quarter of 2007. The reduction in sales and gross margin reflects a decrease in the level of project sales from last year as a result of significantly increased competition in 2008.
Administrative, Distribution and Selling Expense
Administrative, distribution and selling expenses increased by $2.7 million to $17.1 million in the second quarter of 2008 from $14.4 million in the same quarter of 2007. Salary and benefit expenses were up due to changes in our sales structure, parts staffing and competitive wage pressures. In addition, increased occupancy costs resulted from the addition of a new facility in Fort McMurray, Alberta in the first quarter of 2008, a new facility in Boucherville, Quebec and an addition to our Calgary equipment facility in the second quarter of 2008. Strongco also experienced increased occupancy costs for existing facilities where leases have renewed or escalated. Expenses also increased as result of higher operating costs from increased activity in the customer support departments of the Equipment Distribution segment.
Included in the $2.7 million increase are approximately $0.4 million of costs incurred during the second quarter of 2008, to reorganize our branch network in Ontario and complete the integration of the Champion Business. The full impact of normal operating expenses resulting from the acquisition of the Champion Business, additional personnel, three new branches, and related support costs are included in the $2.7 million increase in expenses for the quarter.
Other Income & Expense
Other income and expense is primarily comprised of any gain or loss on disposition of fixed assets, service fees paid by manufacturers in compensation for sales made within the distributor's region from sources other than the distributor and any gains or losses recognized with respect to foreign exchange. Other income was unchanged at $0.6 million for 2008 and 2007.
As part of the "Champion Business" acquisition (please see note 5 in the accompanying financial statements), unfulfilled sales orders ("order backlog") at the date of acquisition were fair-valued at $0.2 million. A portion of these sales orders were completed in March 2008, and the Fund amortized to other income & expense in March 2008, the related fair-value of $0.1 million. The balance of $0.1 million was expensed in April of 2008.
Interest Expense
Strongco's interest expense increased to $1.1 million in 2008 from $0.8 million in 2007. This was a result of the Fund's higher level of interest bearing debt.
Net Income
The following summarizes Strongco's earnings from continuing operations before income taxes by segment:
Three months ended June 30 2008 2007
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Equipment Distribution $ 4.7 $ 5.1
Engineered Systems (0.1) 0.9
Corporate (1.6) (1.6)
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Earnings from continuing operations before income taxes $ 3.0 $ 4.4
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On an after-tax basis, net income for the three months ended June 30, 2008 was $2.9 million, $0.28 per unit basic and fully diluted, as compared to net income of $2.5 million, $0.24 per unit basic and fully diluted, last year. The Fund is taxable to the extent its taxable income exceeds distributions through taxation years ending in 2011. Beginning with the 2011 taxation year, distributions will be taxed at the Specified Investment Flow-Through Entity rate.
Loss and Loss per Unit from Discontinued Operations
Discontinued operations include the results of the former aerial rental business. On December 1, 2007, the Fund, consistent with previously stated intentions, sold assets of the aerial rental business for proceeds of $1.7 million. The results of the related operations have been reported as discontinued operations and prior period amounts have been reclassified to conform to the current period presentation. The results from discontinued operations for the three months ended June 30, 2008 and 2007 were as follows:
($ millions, except per unit amounts) 2008 2007
----------------------------------------------------------------------------
Revenues $ 0.5
Cost of goods sold 0.2
----------------------------------------------------------------------------
Gross margin - 0.3
----------------------------------------------------------------------------
Administration, distribution and selling expenses 0.1
Amortization 0.2
Other expenses 0.1
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Loss from discontinued operations before the following - (0.1)
Interest -
----------------------------------------------------------------------------
Loss from discontinued operations before income taxes - (0.1)
Provision for income tax - -
----------------------------------------------------------------------------
Loss for the period $ - $ (0.1)
Loss per unit, basic and diluted, from
discontinued operations. $ - $ (0.01)
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Financial Condition and Liquidity
Cash used in operating activities was $4.0 million in the second quarter of 2008 compared to $0.2 million cash used in operating activities in the second quarter of 2007. The increase in inventories in the second quarter was offset by the net increase in equipment notes payable. Net income for the quarter was $2.9 million. Significant components of the change in working capital requirements are as follows:
Three months ended June 30 2008 2007
----------------------------------------------------------------------------
Accounts receivable $ 7.6 $ 11.2
Inventories 6.5 5.3
Prepaids - (0.1)
Income & other taxes receivable - -
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14.1 16.4
Accounts payable and accrued liabilities (6.0) 4.3
Deferred revenue & customer deposits 0.9 0.3
Equipment notes payable - non interest bearing 15.0 7.3
Equipment notes payable - interest bearing (3.1) (0.7)
Other - -
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6.8 11.2
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Consolidated increase (decrease) in non-cash
working capital $ 7.3 $ 5.2
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The Fund has an operating line of credit to a maximum of $30.0 million with a Canadian chartered bank. In addition, the Fund has lines of credit available from various equipment lenders which are used to finance equipment inventory. All of these facilities are renewable annually. In addition to the foregoing lines of credit, the Fund has an additional term acquisition and construction term facility totaling approximately $12.0 million.
As at March 31, 2008, the Fund did not meet its consolidated debt service coverage and debt to tangible net worth covenants relating to the operating line of credit. On April 29, 2008, the Fund has received a waiver of its requirement to comply, as at March 31, 2008, with the consolidated debt service coverage ratio covenant under its operating line of credit. As at March 31, 2008, the Fund's consolidated debt service coverage ratio was 0.73:1, while the operating line of credit required a ratio of no less than 0.90:1. In connection with the foregoing, the Fund was required to and has provided additional information to its lender. In addition, the Fund obtained an amendment modifying its debt to tangible net worth ratio under its operating line of credit. The debt to tangible net worth covenant was amended from 3.0:1 to 3.25:1, reducing to 3.0:1 on July 1, 2008. As at March 31, 2008, the Fund had a debt to tangible net worth ratio of 3.16:1.
As at June 30, 2008, the Fund did not meet its debt to tangible net worth covenant relating to its operating line of credit. As at June 30, 2008, the Fund had a debt to tangible net worth ratio of 3.33:1. On August 11, 2008 the Fund received a waiver of its requirement to comply with the debt to tangible net worth covenant as at June 30, 2008, subject to providing additional information no later than August 30, 2008 in a form acceptable to the lender, and also entered into an amended credit facility agreement. Under the conditions of the amended credit facility, the Fund's lender has raised the Fund's borrowing rates by 0.25%, cancelled the Fund's $12 million term facility for real estate acquisition and construction, and restricted its operating line of credit to $20 million until such time as the Fund returns to full compliance with the covenants contained in the amended credit facility. Also under the amended credit facility, the debt to tangible net worth covenant was amended from 3.0:1 to 3.25:1, reducing to 3.0:1 for September 30, 2008, and the lender's prior written consent is required for the Fund to declare or pay distributions on any class or kind of its units, repurchase or redeem any of its units or reduce its capital in any way whatsoever or repay any unitholders' advance.
As a result of non-compliance with the operating facility covenant requirements, through cross-default provisions, the Fund defaulted on certain equipment notes payable from two creditors in the amount of $106,285 and $109,648 as at June 30, 2008 and March 31, 2008, respectively. On August 11, 2008 the Fund also received letters from each of the two creditors acknowledging the bank letters in respect of the first and second quarters, and as a result the two creditors waived the first and second quarter defaults.
Summary of Quarterly Data
In general, business activity in the Equipment Distribution segment, which comprises the majority of Strongco's revenue and earnings base, follows a weather related pattern of seasonality. Typically, the first quarter is the weakest quarter as construction and infrastructure activity is constrained in the winter months. This is followed by a strong pickup in the second quarter as construction and other contracts begin to be put out for bid and companies begin to prepare for summer activity. The third quarter generally tends to be slightly slower from an equipment sales standpoint, which is partially offset by continued strength in equipment rentals and customer support (parts and service) activities. Fourth quarter activity generally strengthens as companies make year end capital spending decisions in addition to the exercise of purchase options on equipment which has previously gone out on rental contracts. In 2006, the normal seasonal trend was influenced by carried-over strength of economic activity experienced in 2005 with a return to more normal seasonality in 2007.
2008
($ millions, except per unit amounts) Q4 Q3 Q2 Q1
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Revenue $ 126.0 $ 84.1
(Loss) earnings from continuing operations
before income taxes $ 3.0 $ (0.5)
Net (loss) income $ 2.9 $ (0.5)
Basic and diluted (loss) earnings per unit $ 0.28 $ (0.06)
2007
($ millions, except per unit amounts) Q4 Q3 Q2 Q1
----------------------------------------------------------------------------
Revenue $ 107.2 $ 99.9 $ 105.5 $ 81.5
Earnings from continuing operations
before income taxes $ 2.2 $ 3.1 $ 4.3 $ 0.3
Net income $ 2.7 $ 3.1 $ 2.5 $ -
Basic and diluted earnings per unit $ 0.26 $ 0.30 $ 0.24 $ -
2006
Q4 Q3 Q2 Q1
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Revenue $ 117.7 $ 100.2 $ 132.5 $ 103.5
Earnings from continuing operations
before income taxes $ 3.9 $ 4.5 $ 8.0 $ 5.4
Net income $ 3.8 $ 7.2 $ 6.7 $ 4.9
Basic and diluted earnings per unit $ 0.37 $ 0.69 $ 0.65 $ 0.47
A discussion of the Fund's previous quarterly results can be found in the Fund's quarterly Management's Discussion and Analysis reports available on SEDAR at www.sedar.com.
Consolidated Results of Operations for the Six Months Ended June 30
($ thousands, except per unit amounts) 2008 2007 $ Change % Change
----------------------------------------------------------------------------
Revenues $ 210,108 $ 186,952 $ 23,156 12.4%
Cost of sales 173,226 152,809 20,417 13.4%
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Gross Margin 36,882 34,143 2,739 8.0%
Administration, distribution and
selling expenses 33,050 29,166 3,884 13.3%
Amortization of intangible assets 217 - 217
Other income (997) (1,166) 169 -14.5%
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Operating income 4,612 6,143 (1,531) -24.9%
Interest expense 2,117 1,464 653 44.6%
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Earnings from continuing operations
before income taxes 2,495 4,679 (2,184) -46.7%
Provision for income taxes 162 1,831 (1,669) -91.2%
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Earnings from continuing operations 2,333 2,848 (515) -18.1%
Loss from discontinued operations - (360) 360 -100.0%
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Net and comprehensive income 2,333 2,488 (155) -6.2%
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Basic and diluted earnings per unit 0.22 0.24
Number of units issued and to be
issued 10,403,458 10,403,458
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Key ratios:
Gross margin as a percentage of
revenues 17.6% 18.3%
Administration, distribution
and selling expenses as percentage
of revenues 15.7% 15.6%
Operating income as a percentage
of revenues 2.2% 3.3%
Revenue by Business Segment
Six months ended June 30 2008 % 2007 % Change
----------------------------------------------------------------------------
Equipment Distribution $ 196.0 93.3% 161.5 86.4% $ 34.5
Engineered Systems 14.1 6.7% 25.5 13.6% (11.4)
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$ 210.1 100.0% $ 187.0 100.0% $ 23.1
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The increased revenues in the Equipment Distribution segment were primarily related to equipment sales with the largest gains in revenues made in Central Canada. The acquisition of the Champion Business was a significant factor in the increase in Central Canada. Both Atlantic and Quebec increased revenues in equipment sales and product support on a comparative basis. Western Canada revenues increased, but sales were constrained by the availability of certain types of construction and crane equipment; an unusually wet winter delayed project starts and early in the year, major oil companies delayed capital expenditures following the Alberta government's announcement to increase gas and oil royalties late last year.
During the first six months of 2007 as compared to this year, the Engineered Systems segment completed several large projects for the mining sector. These projects have not been repeated in 2008. The segment is facing competition from foreign and domestic suppliers in all segments of its business. The economic slowdown in the United States, coupled with a relatively weaker United States currency, has made it difficult for the Engineered Systems segment to close new business. Large capital projects have been stalled or not released. The segment is currently supplying parts to completed projects and working on smaller projects.
Revenue by Geographic Region
Six months ended June 30 2008 % 2007 % Change
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Eastern (Atlantic / Quebec) $ 56.0 26.7% $ 48.6 26.0% $ 7.4
Central (Ontario) $ 89.6 42.6% $ 72.6 38.8% 17.0
Western (Manitoba to B.C.) $ 63.3 30.1% $ 63.8 34.1% (0.5)
Other $ 1.2 0.6% $ 2.0 1.1% (0.8)
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$ 210.1 100.0% $ 187.0 100.0% $ 23.1
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During the first six months, equipment segment revenues were stronger in all regions, particularly Eastern and Central Canada. The Champion Business acquisition has added significantly to Central Canada revenues. Western Equipment Distribution segment revenues were up compared to 2007 despite the weather, equipment supply constraints and government royalty increases.
The Engineered systems segment revenues were down in all regions as discussed under revenues by business segment.
Gross Margin
Strongco's gross margin increased by $2.8 million, an increase of 8.2%, to $36.9 million, gross margin percentage 17.6%, in 2008 from $34.1 million in 2007, gross margin percentage 18.3%.
Within the Equipment Distribution segment, business activities include the sale of machinery, customer support (parts and service) and equipment rentals. Equipment sales, which generate a significantly lower margin than customer support activities, account for 72.6% of revenues and 39.2% of gross margin for this segment in the first six months of 2008 compared to 70.5% of revenues and 35.1% of gross margin in the first six months of 2007.
Gross margin for the Engineered Systems segment decreased to $3.0 million, gross margin percentage of 20.9%, in the first six months of 2008 from $4.7 million and a gross margin percentage of 18.5% in the first six months of 2007. The reduction in sales reflects a decrease in the level of project sales from last year and increased competition from last year. The increase in margin percentage is reflective of a higher proportion of the segment's revenues coming from parts sales to projects completed in earlier years.
Administrative, Distribution and Selling Expense
Administrative, distribution and selling expenses increased by $3.9 million to $33.1 million in 2008 from $29.2 million in 2007. For the six months ended June 30, 2008, salary and benefit expenses were up corresponding to changes in our sales structure, parts staffing and competitive wage pressures. In addition, occupancy costs have increased due to new facilities being added in Fort McMurray, Alberta and a new, larger replacement facility in Boucherville, Quebec and a completed addition to our Calgary equipment facility in the six months ended June 30, 2008. As well, Strongco experienced increased occupancy rates for existing facilities where leases have renewed or escalated. Expenses also increased as result of operating costs from increased activity in the customer support departments within the Equipment Distribution segment.
Included in the $3.9 million increase are approximately $0.4 million of costs incurred during the second quarter of 2008, to reorganize our branch network in Ontario and complete the integration of the Champion Business. The full impact of normal operating expenses resulting from the acquisition of the Champion Business, additional personnel, three new branches, and related support costs are included in the $3.9 million increase in expenses for the six months ended June 30, 2008.
Other Income & Expense
Other income and expense is primarily comprised of any gain or loss on disposition of fixed assets, service fees paid by manufacturers in compensation for sales made within the distributor's region from sources other than the distributor and any gains or losses recognized with respect to foreign exchange. For the six months ended June 30, other income decreased to $1.0 million from $1.2 million in 2007.
As part of the "Champion Business" acquisition (please see note 5 in the accompanying financial statements), unfilled sales orders ("order backlog") at the date of acquisition were fair-valued at $0.2 million. A portion of these sales orders were completed in March 2008, and the Fund amortized to other income & expense in March 2008, the related fair-value of $0.1 million. The balance of $0.1 million was expensed in the second quarter of 2008.
Interest Expense
Strongco's interest expense increased by $0.6 million to $2.1 million in 2008 from $1.5 million in 2007. This was a result of the Fund's higher level of interest bearing debt.
Net Income
The following summarizes Strongco's earnings from continuing operations before income taxes by segment:
Six months ended June 30 2008 2007
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Equipment Distribution $ 5.4 $ 6.0
Engineered Systems 0.1 1.2
Corporate (3.0) (2.5)
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Earnings from continuing operations before income taxes $ 2.5 $ 4.7
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On an after tax basis, net income for the six months ended June 30, 2008 was $2.3 million, $0.22 per unit basic and fully diluted, as compared to $2.5 million, $0.24 per unit basic and fully diluted, for the six months ended June 30, 2007. The Fund is taxable to the extent its taxable income exceeds distributions through taxation years ending in 2011. Beginning with the 2011 taxation year, distributions will be taxed at the Specified Investment Flow-Through Entity rate.
Loss and Loss per Unit from Discontinued Operations
Discontinued operations include the results of the former aerial rental business. On December 1, 2007, the Fund, consistent with previously stated intentions, sold assets of the aerial rental business for proceeds of $1.7 million. The results of the related operations have been reported as discontinued operations and prior period amounts have been reclassified to conform to the current period presentation. The results from discontinued operations for the six months ended June 30, 2008 and 2007 were as follows:
($ millions, except per unit amounts) 2008 2007
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Revenues $ 0.9
Cost of goods sold 0.5
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Gross margin - 0.4
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Administration, distribution and selling expenses 0.2
Amortization 0.4
Other expenses 0.1
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Loss from discontinued operations before the following - (0.3)
Interest 0.1
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Loss from discontinued operations before income taxes - (0.4)
Provision for income tax - -
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Loss for the period $ - $ (0.4)
Loss per unit, basic and diluted, from
discontinued operations. $ - $ (0.04)
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Financial Condition and Liquidity
Cash generated from operating activities was $17.2 million for the six months ended June 30, 2008 compared to $0.1 million cash used in operating activities for the six months ended June 30, 2007. The increase in inventories in the first six months was offset by the net increase in equipment notes payable. Net income for the six months ended June 30, 2008 was $2.3 million. The changes in working capital include the changes in the working capital assets acquired as part of the "Champion Business" acquisition effective March 20, 2008. Significant components of the change in working capital requirements are as follows:
Six months ended June 30 2008 2007
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Accounts receivable $ 7.7 $ (1.0)
Inventories 39.1 2.4
Prepaids 0.4 (0.2)
Income & other taxes receivable (0.2) (0.2)
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47.0 1.0
Accounts payable and accrued liabilities 1.8 (5.3)
Deferred revenue & customer deposits (0.4) (4.4)
Equipment notes payable - non interest bearing 13.9 (4.5)
Equipment notes payable - interest bearing 24.8 9.3
Other - -
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40.1 (4.9)
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Increase (decrease) in non-cash working capital
including the effects of the Champion Business $ 6.9 $ 5.9
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Less non-cash working capital acquired
with the Champion Business $ 21.3 $ -
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Consolidated increase (decrease) in non-cash
working capital related to operations $ (14.4) $ 5.9
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The Fund has an operating line of credit to a maximum of $30.0 million with a Canadian chartered bank. In addition, the Fund has lines of credit available from various equipment lenders which are used to finance equipment inventory. All of these facilities are renewable annually. In addition to the foregoing lines of credit, the Fund has an additional term acquisition and construction term facility totaling approximately $12.0 million.
Debt
As at As at
June 30 June 30
2008 2007
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Bank indebtedness $ 17.2 $ 9.9
Equipment notes payable - non interest bearing 61.3 35.7
Equipment notes payable - interest bearing 72.3 47.3
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$ 150.8 $ 92.9
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Strongco's working capital requirements are supported by a secured, revolving demand facility to a maximum of $30 million provided by a Canadian chartered bank. In addition, various non-bank lenders provide secured wholesale financing on equipment inventory ("equipment notes payable"), some of which is interest free for periods up to seven months from the date of financing. Interest rates float with the prime or one month banker's acceptance rate under most of the Fund's credit facilities.
Distributable Cash
Distributable cash is presented as a measure of the extent to which the Fund is able to generate cash sufficient to fund Unitholder distributions on an ongoing basis. Distributable cash and Distributable cash before tax are not measures of financial performance under Canadian Generally Accepted Accounting Principles ("GAAP") and therefore have no standardized meaning prescribed by GAAP and may not be comparable to similar terms and measures presented by other similar issuers. Distributable cash and Distributable cash before tax are intended to provide additional information on the Fund's performance and should not be considered in isolation, seen as a measure of liquidity or as a substitute for measures of performance prepared in accordance with GAAP.
Three months Three months
ended ended
Distributable cash (in thousands) June 30, 2008 June 30, 2007
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Cash (used in) provided by operating
activities $ (3,963) $ (210)
Add (deduct)
Net change in non-cash working capital
balances related to operations 7,311 5,213
Capital expenditures (960) (199)
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Distributable cash $ 2,388 $ 4,804
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Three months Three months
ended ended
Distributable cash (in thousands) June 30, 2008 June 30, 2007
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Net income and comprehensive income $ 2,887 $ 2,455
Add (deduct)
Provision for future income tax 155 1,842
Depreciation & amortization 277 435
Amortization of intangible assets 93
Gain on disposition of assets (1) (78)
Stock based compensation 10 15
Change in non-cash post retirement
benefits and accrued benefit assets (31) 197
Other (42) 137
Capital expenditures (960) (199)
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Distributable cash $ 2,388 $ 4,804
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Unitholder cash distributions declared $ 1,534 $ 3,012
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Excess / (shortfall) $ 854 $ 1,792
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Six months Six months
ended ended
Distributable cash (in thousands) June 30, 2008 June 30, 2007
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Cash (used in) provided by operating
activities $ 17,205 $ (124)
Add (deduct)
Net change in non-cash working capital
balances related to operations (14,352) 5,857
Capital expenditures (1,301) (491)
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Distributable cash $ 1,552 $ 5,242
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Six months Six months
ended ended
Distributable cash (in thousands) June 30, 2008 June 30, 2007
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Net income and comprehensive income $ 2,333 $ 2,488
Add (deduct)
Provision for future income tax 200 1,842
Depreciation & amortization 528 884
Amortization of intangible assets 217
Gain on disposition of assets (15) (113)
Stock based compensation 20 30
Change in non-cash post retirement
benefits and accrued benefit assets 194 289
Other (624) 313
Capital expenditures (1,301) (491)
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Distributable cash $ 1,552 $ 5,242
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Unitholder cash distributions declared $ 4,045 $ 7,632
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Excess / (shortfall) $ (2,493) $ (2,390)
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The Fund has added (deducted) the net change in non-cash working capital balances as Strongco currently has an operating line of credit to a maximum of $30.0 million which is available for use to fund general corporate requirements including working capital requirements. In addition, Strongco finances equipment inventory through the use of vendor floor plans and wholesale finance arrangements with various finance companies. While the operations of the Fund are subject to seasonality, as explained earlier in the 'Summary of Quarterly Data', the Fund has structured its distribution policy to declare regular monthly distributions evenly throughout the year, despite quarterly fluctuations in earnings. Consequently, the results of the three months ended June 30, 2008 should not be considered representative of a twelve month period of distributable cash. Cash Distributions for the six months ended June 30, 2008 have been partially funded from borrowings on the Fund's operating line to make up the shortfall between Distributable Cash and Cash Distributions.
Contractual Obligations
The Fund has contractual obligations for operating lease commitments, notes payable and contingent contractual obligations where the Fund has agreed to buy back equipment from customers at the option of the customer for a specified price at future dates ('buy back contracts') which are more fully explained in the Fund's Management's Discussion and Analysis included with its Annual Report which is available on SEDAR at www.sedar.com.
As at December 31, 2007, the Fund, as a result of the review of new vehicle lease contracts in 2007, reclassified certain leased vehicles as assets under capital leases based upon the respective contract terms and past experience. During the first quarter of 2008, the Fund renegotiated the lease contract terms and reclassified the leases as operating leases. The contractual obligations due by period under operating leases have been adjusted for this reclassification.
As part of the acquisition of the Champion Business, the Fund assumed a number of 'buy back contracts' and the information presented below has been adjusted for these acquired obligations. The contractual obligations under operating leases also include those lease obligations assumed by the Fund as part of the acquisition.
Contractual obligations are set out in the following tables. Management believes that these obligations will be comfortably met through cash flow generated from operations.
Payment due by period
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Less Than 1 to 3 4 to 5 After 5
Total 1 Year years years years
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Operating leases $41.0 $4.7 $20.0 $7.1 $9.2
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Contingent obligation by period
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Less Than 1 to 3 4 to 5 After 5
Total 1 Year years years years
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Buy back contracts $7.9 $1.9 $2.0 $3.1 $0.9
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Outstanding Units
The Fund is authorized to issue an unlimited number of units pursuant to the Declaration of Trust. Each unit is transferable and represents an equal beneficial interest in any distributions from the Fund and in the net assets of the Fund. All units are of the same class with equal rights and privileges.
Issued and outstanding Units at: Number of Units
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At at December 31, 2007 10,043,185
Issued April 21, 2008 91,902
Issued May 20, 2008 84,325
Issued June 20, 2008 88,598
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As at June 30, 2008 10,308,010
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On July 18, 2008, the Fund issued 95,448 new units in settlement of the "in-kind" units portion of the distribution. The established volume-weighted average price per unit is $5.397737.
Responsibility of Management and the Board of Trustees
Management is responsible for the information disclosed in this MD&A and the Consolidated Financial Statements and accompanying notes, and has in place appropriate information systems, procedures and controls to ensure that information used internally by management and disclosed externally is materially complete and reliable. In addition, the Fund's Audit Committee, on behalf of the Board of Trustees, provides an oversight role with respect to all public financial disclosures made by the Fund, and has reviewed this MD&A and the accompanying unaudited interim consolidated financial statements.
Disclosure Controls and Procedures and Internal Control Over Financial Reporting
The Fund has designed disclosure controls and procedures to provide reasonable assurance that material information relating to the Fund is made known to the Chief Executive Officer and the Chief Financial Officer, particularly during the period in which the interim filings are being prepared. The Fund has designed internal controls over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. There has been no change in the Fund's internal control over financial reporting that occurred during the six mo
