Strongco Corporation Management s Discussion and Analysis

Transcription

1 Strongco Corporation Management s Discussion and Analysis The following management s discussion and analysis ( MD&A ) provides a review of the consolidated financial condition and results of operations of Strongco Corporation, Strongco GP Inc. and Strongco Limited Partnership, collectively referred to as Strongco or the Company, as at and for the year ended December 31, This discussion and analysis should be read in conjunction with the accompanying audited consolidated financial statements as at and for the year ended December 31, For additional information and details, readers are referred to the Company s quarterly unaudited consolidated financial statements and quarterly MD&A for fiscal 2018 and fiscal 2017 as well as the Company s Annual Information Form ( AIF ) dated March 19, 2019, all of which are published separately and are available on SEDAR at Unless otherwise indicated, all financial information within this discussion and analysis is in millions of Canadian dollars except per share amounts. The information in this MD&A is current to March 19, COMPANY OVERVIEW Strongco is one of the largest multiline mobile equipment distributors in Canada. Strongco sells and rents new and used equipment and provides after-sale product support (parts, service and warranty recovery from the OEM) to customers who operate in infrastructure, construction, mining, oil and gas exploration, forestry and industrial markets. This business distributes numerous equipment lines in various geographic territories. The primary lines distributed include those manufactured by: i. Volvo Construction Equipment North America Inc. ( Volvo ), for which Strongco has distribution agreements in each of Alberta, Ontario, Quebec, New Brunswick, Nova Scotia, Prince Edward Island and Newfoundland; ii. Case Corporation ( Case ), for which Strongco has a distribution agreement for a substantial portion of Ontario; and iii. Manitowoc Crane Group ( Manitowoc ), for which Strongco has distribution agreements for the Manitowoc, Grove and National brands, covering much of Canada. The distribution agreements with Volvo and Case provide Strongco exclusive rights to distribute the products manufactured by these manufacturers in specific regions and/or provinces. In addition to the above noted primary lines, Strongco also distributes several other equipment lines and attachments which are complementary to its primary lines, including Allied Construction, Dressta, ESCO, Fassi, Konecranes, Sennebogen, SDLG and Terex Trucks. Strongco is listed on the Toronto Stock Exchange under the symbol SQP. FINANCIAL AND OPERATING HIGHLIGHTS FOR THE YEAR Lease Termination Fort McMurray In management s continuing efforts to streamline the business and reduce costs, effective July 1, 2018, the Company terminated the lease of its branch at 205 McAlpine Crescent in Fort McMurray, Alberta, and entered into a new lease agreement to sublet a smaller building at 310 MacKenzie Boulevard as its new branch in Fort McMurray. The total cost for termination of the existing lease and relocation to the new facility amounted to approximately $3.4 million and has been recorded as a restructuring cost in the third quarter of These costs include a termination fee of approximately $2.7 million plus real estate fees, legal fees, relocation costs and impairment of property and equipment. The termination fee of $2.7 million was satisfied by the issue of 150,000 common shares (with an approximate value of $0.3 million) and cash payment of $0.2 million on closing, followed by 22 equal monthly payments of $0.1 million plus interest at 6% to May Management estimates the net savings after the lease termination costs from exiting the current leased facility in favour of the smaller sublet facility will exceed $5.6 million over the remaining 11 years of the terminated lease. From a cash flow perspective, after the initial cash payments on closing, management anticipates the impact on the Company s cash flow from this transaction to be relatively neutral over the period of monthly payments after which the cash flow impact will be positive. Income Statement Strongco generated revenue of $412.1 million, compared to $376.1 million in 2017, an increase of $36.0 million from a year ago. Revenue in the year were affected by the following factors: o Higher sales of construction equipment across the country o Higher sales of used equipment, especially in Western Canada o Lower crane sales particularly in Western Canada due to ongoing weak markets o Increased rental revenue across the country, particularly in Western Canada o Higher product support sales (parts and service) across the country, particularly in Central Canada Gross profit of $73.4 million (17.8% of revenue) up from $68.1 million (18.1% of revenue). Operating income, before restructuring costs, of $11.8 million compared to $4.7 million from higher gross profit and lower operating expenses. EBITDA increased to $30.0 million from $21.0 due to improved operating income. Interest expense was $8.2 million compared to $6.2 million in 2017 due to higher equipment financing and higher interest rates. 1

2 Pre-tax loss before restructuring charges $3.6 million, improved from a loss of $1.6 million Net income of $0.2 million ($0.01 per share) compared to net loss of $2.2 million (loss of $0.17 per share). Balance Sheet Equipment inventory of $167.5 million, up from $153.3 million at December 31, The increase was mainly to support growth in equipment sales and increased rental activity and the purchase of a large quantity of certain products in the fourth quarter to secure product availability for 2019 and take advantage of lower purchase prices. Equipment notes payable of $141.4 million, compared to $131.0 million at December 31, Trade and other payables of $40.3 million, down slightly from $40.5 million at December 31, Bank Indebtedness improved at $28.5 million from $29.0 million at December 31, SUMMARY OF OPERATING RESULTS CONTINUING OPERATIONS Year Ended December / /2016 ($ thousands, except per share amounts) $ Change % Chg $ Change % Chg Revenue $ 412,108 $ 376,141 $ 390,736 $ 35,967 10% $ (14,595) -4% Cost of sales 338, , ,277 30,715 10% (18,244) -6% Gross margin 73,360 68,108 64,459 5,252 8% 3,649 6% Selling and administrative expenses 61,531 64,432 72,650 (2,901) -5% (8,218) -11% Other (income) expense 14 (1,008) (1,339) 1, % % Operating income (loss) 11,815 4,684 (6,852) 7, % 11, % Restructuring costs 3, ,605 2,765 (2,927) Impairment of intangible asset ,499 - (16,499) Interest expense 8,215 6,239 6,648 1,976 32% (409) -6% Earnings (loss) before income taxes 157 (2,233) (33,604) 2, % 31,371 93% Provision for (recovery of) income taxes - - 4,745 - (4,745) -100% Net income (loss) from continuing operations 157 (2,233) (38,349) 2, % 36,116-94% Net income from discontinued operations - - 1,036 - (1,036) -100% Net income (loss) $ 157 $ (2,233) $ (37,313) $ 2, % $ 35,080-94% Basic and diluted earnings (loss) per share - continuing operations $ 0.01 $ (0.17) $ (2.90) $ % $ % - net income (loss) 0.01 (0.17) (2.82) % % Weighted average number of shares - Basic and diluted 13,297,335 13,221,719 13,221,719 Key financial measures Gross margin as a percentage of revenues 17.8% 18.1% 16.5% Selling and administrative expenses as a percentage 14.9% 17.1% 18.6% Operating income (loss) as a percentage of revenues 2.9% 1.2% -1.8% EBITDA (Note 1) $ 29,992 $ 21,047 $ 6,623 $ 8,945 43% $ 14, % Balance Sheet Highlights December 31, December 31, December 31, ($ millions) Trade and other receivables Total equipment inventory Parts and Work-in-process Trade and other payables Equipment notes payable Other working capital amounts (1.9) (0.8) (2.5) Working capital (Note 1) (excl bank indebtedness) Property and equipment Funded debt (Note 1 ) (Note 1 see Non-IFRS Measures ) Strongco s revenues were up in 2018 due in part to improving market conditions but also due to strong sales performance and improving market shares across the country. Strongco s market share for general purpose construction equipment ( GPE ) was up overall in Canada and up in all regions of the country. Sales of construction equipment were up 18% over the prior year with increase in all regions of the country. However, cranes sales were down 11% due primarily to lower sales in Western Canada due to continuing weak market conditions. In addition, with improving construction markets, rental activity remained strong across the country resulting in a 9% increase in rental revenue. Product support activity across the country also remained strong which led to a 5% increase in product support revenues in the year. With higher revenues gross profit was up in 2018 and at the same time 2

3 operating expenses were lower resulting in a significant increase in operating income to $11.8 million from $4.7 million last year. While interest expense was higher as a result of higher levels of equipment inventory and related financing and higher interest rates, earnings before restructuring charges showed a substantial improvement over the prior year to $3.6 million from a loss before restructuring costs $1.6 million in After restructuring charges of $3.4 million related to the Fort McMurray lease termination, there was a small net profit of $0.2 million compared to a net loss of $2.2 million in As noted equipment inventory levels have increased to support the increase in equipment sales and rental activity and the purchase of a large quantity of certain products in the fourth quarter to secure product for 2019 and take advantage of lower purchase prices. Total equipment inventory at December 31, 2018 was $167.5 million compared to $153.3 million at the same time last year. OUTLOOK The Canadian economy is expected to continue at its current pace of moderate growth in With the modest economic recovery there has been renewed confidence in construction markets which has led to increased demand for heavy equipment. This trend is expected to continue into Economic conditions in Alberta are expected to continue to improve in 2019 and lead to increasing construction activity and demand for heavy equipment. With a provincial election expected in the second quarter, there is optimism for improved economic conditions post-election, however, a wait and see attitude has developed which is curtailing demand in the first quarter. In addition, while market conditions have improved in Alberta, an air of caution remains which has resulted in a shift more towards used equipment and rentals as markets continue to slowly recover, a trend that is expected to continue in The near-term outlook for cranes is for continuing weak markets in the province. While the price of oil has risen, it is not yet at a level to stimulate significant new development in Northern Alberta. As a result, demand for cranes, especially large hydraulic and rough terrain cranes, is expected to remain depressed. The economy in Ontario has been growing modestly throughout 2018 and there is an expectation of continued economic improvement in A cold and snowy winter in the province has somewhat curtailed demand for equipment in the first quarter of 2019 but improving economic conditions has increased confidence in construction markets and higher demand for heavy equipment in the balance of the year. Construction activity is expected to pick up in the second quarter as the summer season approaches and demand for construction equipment and rentals is expected to improve as the year progresses. The market for cranes in Ontario has been soft in 2018 and while there was some improvement towards the end of the year, demand for cranes, especially large cranes, is expected to remain weak in In Quebec, overall demand for heavy equipment increased modestly in 2018 and the pace of growth is expected to continue in With no plans for significant new government infrastructure spending, construction activity in the province is not expected to be robust in the near term which could restrain demand for heavy equipment. However, with strength in the price of gold and some improvement in iron ore prices, mining activity in northern regions of Quebec is expected to remain active and lead to demand for associated heavy equipment. Demand for cranes in the province was lower in 2018 and while there was modest improvement in the third and fourth quarters, the outlook for the near term in 2019 is for a continued weak crane market in Quebec. In the Atlantic region, overall demand for heavy equipment was soft in 2018 and is expected to remain weak throughout With no significant new government infrastructure spending and no meaningful uptick in housing, construction activity in the region is expected to remain soft in the near term. As the majority of heavy equipment is priced in US dollars, the weaker Canadian dollar has resulted in rising costs for new equipment to Canadian dealers and in the current competitive landscape it has become more difficult for dealers to pass on these higher costs. This is expected to continue to put pressure on sales and margins and cause customers to look to used equipment and rentals to meet their needs. Competition is expected to remain strong especially from dealers carrying lower cost tier 3 product, which will continue to impact sales and margins in With this economic backdrop, the overall markets for heavy equipment across Canada are expected to show continued but modest improvement in 2019 while the market for large cranes is expected to remain weak. While encouraged by the improvement in the Company s results in 2018, management remains cautiously optimistic regarding the outlook for FINANCIAL RESULTS ANNUAL Market Overview Strongco participates in a number of geographic regions and in a wide range of end-use markets that utilize heavy equipment and cranes and which may have differing economic cycles. Construction markets generally follow the cycles of the broader economy, but typically lag by periods ranging up to 12 months. When construction markets are robust, demand for heavy equipment is normally strongest. In addition, as the financial resources of heavy equipment customers strengthen, they have historically replenished and upgraded their fleets after a period of restrained capital expenditures. Demand in oil and gas and mining markets is affected by the economy but also tends to be driven by the global demand and pricing of the relevant commodities. Activity in 3

4 equipment markets is normally first evident in equipment used in earth moving applications and followed by cranes, which are typically utilized in later phases of construction. Cranes are also extensively utilized in the oil and gas sector. Rental of heavy equipment is typically greater following periods of recession until confidence is restored and financial resources of customers improve. However, over the last several years rental activity has remained strong even when markets were robust and is expected to continue to grow. Economic conditions in Canada continued to show signs of improvement in Construction activity was stronger in many regions of the country and with strength in the price of gold and some improvement in iron ore prices, mining activity was also stronger in 2018.This contributed to increased demand for construction equipment in most regions of the country. The market for general purpose equipment ( GPE ) was estimated to be up overall by approximately 10% and up in all regions of the country. Rental activity remained strong across the country as more customers continued to show a preference to rent or rent with an option to purchase. Alberta continued to show signs of recovery, although an air of caution remained which continued to impact customer purchase decisions and result in more customers choosing to rent equipment or purchase used machines. While demand for construction equipment was stronger, the market for cranes remained weak, especially demand for larger cranes. The crane market was particularly weak in Alberta. Revenues A breakdown of revenue for the years ended December 31, 2018, 2017 and 2016 is as follows: 2018/ /2016 ($ millions) % Chg % Chg Eastern Canada (Atlantic and Quebec) Equipment Sales $ 78.1 $ 66.9 $ % -23% Equipment Rentals % -17% Product Support % 8% Total Eastern Canada $ $ $ % -12% Central Canada (Ontario) Equipment Sales $ $ $ % -1% Equipment Rentals % 12% Product Support % -7% Total Central Canada $ $ $ % -3% Western Canada (Manitoba to British Columbia) Equipment Sales $ 63.0 $ 57.1 $ % 17% Equipment Rentals % 63% Product Support % -8% Total Western Canada $ $ 93.9 $ % 9% Total Revenue Years Ended December 31 Equipment Sales $ $ $ % -6% Equipment Rentals % 10% Product Support % -2% Total $ $ $ % -4% For the year ended December 31, 2018, total revenues were $412.1 million compared to $376.1 million in 2017, up $36.0 million or 10%. The following factors affected revenues in 2018: Total equipment sales were up by $28.2 million or 12%. Sales of construction equipment were up $32.8 million or 18% year over year with increases in each region of the country, but crane sales were down $4.6 million or 11% due primarily to lower crane sales in Alberta. Strongco s sales of construction equipment were up significantly in Alberta due in particular to strong sales of articulated trucks from RPO conversions and construction equipment sales were up in other regions of the country from strong sales of excavators and loaders. The market for GPE in Canada was estimated to be up 10% in total and was up in all regions across the country as improving economic conditions led to increasing demand for equipment. Strongco outperformed the market with GPE market share gains in all regions of the country due to strong growth in excavators, articulated trucks and loaders. Rental revenues were up 9% over last year due to higher rentals of construction equipment in all regions of the country. Demand for rentals has been strong across the country but particularly so in Alberta. As the Alberta economy and 4

5 construction markets in the province continued to recover, demand for equipment has improved but an air of caution has remained which has led more customers choosing to rent to meet their equipment needs. Product support revenues were up overall by 5% from last year. Sales of parts and service outside of warranty were up year over year by 8% but revenue from warranty recovery from the OEM was lower due to reduced warranty activity principally in Alberta where there was a high volume of warranty service jobs in the first quarter of Gross Profit ($ millions) Year Ended December / /2016 Gross Profit GM% GM% GM% $ Change % Chg $ Change % Chg Equipment Sales $ % $ % $ % $ 0.4 2% $ % Equipment Rentals % % % 0.2 9% - 0% Product Support % % % % (1.8) -4% Total Gross Profit $ % $ % $ % $ 5.3 8% $ 3.6 6% Strongco s overall gross profit was $73.4 million or 17.8% of revenue in 2018, up from $68.1 million or 18.1% last year. Higher revenues, especially equipment sales, contributed to an increase in gross profit in the year. As a percent of revenue, gross margin was lower due primarily to the higher proportion of equipment sales and lower gross margins on equipment sales. The gross margin on equipment sales was slightly lower due primarily to lower crane sales which typically command higher margins than construction equipment. The gross margin on product support was higher due primarily to a higher proportion of service sales relative to parts sales. Selling and Administrative Expense Administrative, distribution and selling expense in 2018 were $61.5 million or 14.9% of revenue, down from $64.4 million or 17.1% of revenue in Expenses continue to be managed closely following the restructuring initiatives undertaken in 2016 and 2017 and while certain variable expenses and headcounts have increased slightly with the rising revenues, improved efficiencies and other lower operating expenses contributed to the year over year decline in expenses. Occupancy costs, in particular, were lower primarily due to lower rent in Alberta as a result of termination of the Company s facility lease in Fort McMurray. Other Income and Expense Other income is primarily comprised of foreign exchange gains or losses, gains or losses on disposition of fixed assets, service fees received by Strongco as compensation for sales of new equipment by other third parties in the regions where Strongco has distribution rights for that equipment and commissions received from third party financing companies for customer purchase financing Strongco places with such finance companies. Other income and expense in 2018 was nominal compared to other income of $1.0 million in 2017 which was primarily foreign exchange gains. Operating Income Higher revenues and gross profit resulted in operating income of $11.8 million in 2018, before lease termination costs, which compared to $4.7 million in Restructuring Costs As noted above, effective July 1, 2018, Strongco terminated the lease of its branch at 205 McAlpine Crescent in Fort McMurray, Alberta, and entered into a new lease agreement to sublet a smaller building at 310 MacKenzie Boulevard as its new branch in Fort McMurray. The total cost for termination of the existing lease and relocation to the new facility amounted to approximately $3.4 million and has been recorded as a restructuring cost in the third quarter of Interest Expense Strongco s interest-bearing debt comprises interest-bearing equipment notes and an operating line with the Company s bank. Strongco typically finances equipment inventory under lines of credit available from various finance companies, many of which are the captive finance affiliate of the OEM supplier. Most equipment financing has interest-free periods of up to 6 months from the date of financing, after which the equipment notes become interest-bearing. The rate of interest on the Company s bank operating lines and interest-bearing equipment notes payable vary with bank prime rates and Bankers Acceptance rates ( BA rates ). (See discussion under Cash Flow, Financial Resources and Liquidity. ) Prime rates and BA rates have increased by 125 bps since March 2017 which has contributed to higher total interest expense. 5

6 Primarily as a result of a higher level of interest-bearing equipment notes and the increase in prime lending rates, interest expense for 2018 was $8.2 million, up from $6.2 million a year ago. The Company has been building equipment inventory levels to support revenue growth and the increase in rental activity which has resulted in an increase in the level of interest-bearing equipment notes. Earnings / Loss Before Income Taxes Before restructuring costs, the earnings before tax was $3.6 million which was improved significantly from a pre-tax loss before restructuring costs of $1.6 million in After restructuring costs, the pre-tax earnings were $0.2 million in 2018 compared to a loss of $2.2 million in Provision for / Recovery of Income Taxes Tax loss carry forwards were used to offset the net income in 2018 resulting in no tax provision being recognized. Given the Company s history of losses, there is uncertainty that available cumulative tax losses would be recovered in the future. As a result, no additional recovery of income taxes has been recorded in 2018 or Strongco currently has non-capital losses of approximately $36 million with a value of approximately $13 million at current tax rates, which have not been recognized on the Company s balance sheet at December 31, Net Income / Loss Strongco s net income in 2018 was $0.2 million ($0.01 per share) compared to a net loss of $2.2 million ($0.17 per share) in EBITDA EBITDA in 2018 was $30.0 million (7.3% of revenue) which was up from $21.0 million (5.6% of revenue) in 2017 and $6.6 million (1.7% of revenue) in EBITDA was calculated as follows: Year Ended December 31 Change EBITDA ($ millions) / /2016 Net earnings (loss) from continuing operations $ 0.2 $ (2.2) $ (38.3) $ 2.4 $ 36.1 Add back: Interest (0.4) Income taxes (4.7) Impairment of intangible asset (16.5) Lease termination costs Depreciation of capital assets (0.3) (1.0) Depreciation of equipment inventory on rent Depreciation of rental fleet (0.4) (0.1) Amortization of computer system (0.9) EBITDA (see non-ifrs Measures) $ 30.0 $ 21.0 $ 6.6 $ 9.0 $ 14.4 Cash Flow, Financial Resources and Liquidity Cash Flow Provided By (Used In) Operating Activities: In 2018, cash of $32.1 million was provided by operating activities before changes in working capital. By comparison, in 2017, operating activities provided $22.5 million of cash before changes in working capital. After changes in working capital, payment of interest and funding of future benefits obligations, cash provided by operating activities was $4.3 million compared to $3.1 million of cash provided by operating activities in The components of the cash provided by operating activities were as follows: 6

7 Year Ended December 31 ($ millions) Net income (loss) $ 0.2 $ (2.2) Non-cash items: Depreciation equipment inventory on rent Depreciation capital assets Depreciation rental fleet Lease termination costs Gain on sale of rental fleet - (0.2) Share-based payment expense Interest expense Employee future benefit expense Changes in non-cash working capital balances (18.5) (12.7) Purchase of rental fleet - (0.1) Proceeds from sale of rental fleet Employee future benefit funding (1.2) (1.9) Interest paid (8.1) (6.3) Income tax receovery received Cash provided by operating activities $ 4.3 $ 3.1 Non-cash items include depreciation of equipment inventory on rent of $15.5 million, which compared to $13.7 million in During 2018, there was a net increase in non-cash working capital of $18.5 million resulting primarily from an increase in inventories in the year, largely to support growth in sales and the increase in rental activity, but this was partially offset by an increase in equipment notes payable. By comparison, during 2017, there was a net increase in non-cash working capital of $12.7 million. Components of cash flow from the net change in non-cash working capital for 2018 and 2017 were as follows: ($ millions) Year Ended December 31 (Increase) Decrease Trade and other receivables $ 1.6 $ (2.4) Inventories (30.8) (29.6) Prepaids and other assets $ (28.9) $ (31.6) Increase (Decrease) Trade and other payables 0.3 (9.4) Deferred revenue and customer deposits (0.3) (0.3) Equipment notes payable $ 10.4 $ 18.9 Net (increase) decrease in non-cash working capital $ (18.5) $ (12.7) Trade and other receivables at December 31, 2018 were $37.9 million, down slightly from $39.5 million at December 31, The average age of receivables at end of the year has improved compared to the end of Equipment inventory at the end of 2018 was $167.5 million, up from $153.3 million a year earlier. The increase was mainly to support growth in equipment sales, increased rental activity and the purchase of approximately $15 million of certain products in the fourth quarter to secure product availability for 2019 and take advantage of lower purchase prices. At December 31, 2018, Strongco had $52.8 million of equipment on rent, both short-term rental contracts and contracts with purchase options, down from $61.8 million at the same time last year due to the conversion to sale of several RPO contracts in the fourth quarter and the discontinuance of a large seasonal rental contract from A breakdown of equipment inventory at December 31, 2018 compared to prior quarters is as follows: ($ millions) December 31, 2018 September 30, 2018 June 30, 2018 March 31, 2018 December 31, 2017 Equipment in-stock $ $ $ $ $ 88.0 Equipment on rental contract with a purchase option Equipment on a short-term rental contract Equipment with customer return option Equipment inventory - total $ $ $ $ $ With the increase in equipment inventory, equipment notes payable have increased. Equipment notes payable at December 31, 2018 was $141.4 million up from $131.0 million at the end of

8 A breakdown of equipment notes payable at December 31, 2018 and the change throughout the year is as follows: ($ millions) December 31, 2018 September 30, 2018 June 30, 2018 March 31, 2018 December 31, 2017 Non-interest-bearing $ 48.7 $ 58.8 $ 45.2 $ 38.4 $ 38.9 Interest-bearing Equipment notes - total $ $ $ $ $ Trade and other payables at December 31, 2018 were $40.3 million down slightly from $40.5 million at December 31, Cash Provided By (Used In) Investing Activities: Net cash used in investing activities amounted to $1.0 million in 2018 related to the purchase capital assets related to branch upgrades and miscellaneous shop equipment purchases. Net cash provided by investing activities in prior year was $1.2m ($1.6 provided from funds released from escrow and $0.4 used related to the purchase of capital assets) Cash Provided By (Used in) Financing Activities: For the twelve months ended December 31, 2018, $3.2 million of cash was used in financing activities to reduce bank indebtedness, repay finance leases and pay the lease termination obligation. During 2017, cash of $4.3 million was used in financing activities to service debt obligations and reduce bank debt. The components of cash used in financing activities are summarized as follows: Year Ended December 31 ($ millions) Decrease in bank indebtedness $ (0.4) $ (1.7) Repayment of finance lease obligations (1.7) (2.6) Repayment of lease termination obligation (1.1) - Cash used in financing activities (3.2) (4.3) Bank Credit Facilities The Company has credit facilities with a bank in Canada. Operating Lines The Canadian bank credit facility includes a revolving demand facility which provides an operating line totaling $30 million. Borrowings under the operating line are limited by standard borrowing base calculations based on the balance of accounts receivable and inventory, which are typical of such bank credit facilities. As collateral, the Company has provided a security interest in accounts receivable, inventories (subordinated to the collateral provided to the equipment inventory lenders), capital assets (subordinated to collateral provided to lessors), owned real estate and other assets. The bank operating line bears interest at rates that vary with bank prime rates or Bankers Acceptances Rates ( BA rates ). Interest rates range between bank prime rate plus 2.00% and bank prime rate plus 4.00% or between the one-month Canadian BA rate plus 3.00% and the one-month Canadian BA rate plus 5.00%, depending on the Company s ratio of debt to tangible net worth. Under its bank credit facilities, the Company is able to issue letters of credit up to a maximum of $5 million. Outstanding letters of credit reduce availability under the Company s operating line of credit. For certain customers, Strongco issues letters of credit as a guarantee of Strongco s performance on the sale of equipment to the customer. At December 31, 2018, there were outstanding letters of credit totaling $0.05 million. In addition to its operating lines of credit, Strongco has a line of approximately US$18.4 million for foreign exchange forward contracts as part of its bank credit facilities ( FX Line ) available to hedge foreign currency exposure. Under this FX Line, the Company can purchase foreign exchange forward contracts up to a maximum of US$18.4 million. As at December 31, 2018, the Company had outstanding foreign exchange forward contracts under this facility totaling US$3.4 million at an average exchange rate of $ Canadian for each US$1.00 with settlement dates between January 2019 and June Bank Financial Covenants The bank credit facilities in Canada contain financial covenants typical of such credit facilities that require the Company to maintain certain financial ratios and meet certain financial thresholds. In August of 2018, the bank credit agreement was amended to allow 8

9 for the impact of IFRS 16, the new accounting standard for leases, which becomes effective in Under IFRS 16 all of the company s finance leases (which includes all of its property leases) will now be reflected as an asset and corresponding liability. The increase in the reported liabilities, which is estimated will be in the range of $45 million to $50 million, will increase funded debt per the bank financial covenants. Accordingly, the Debt to Tangible Net Worth covenant was amended to increase the maximum ratio of funded debt to tangible net worth to 10.0 to 1. In addition, the Interest Coverage Ratio was also amended to reduce the minimum ratio of EBITDA to total interest to 2.75 to 1. A summary of the financial covenants under the bank credit facilities at December 31, 2018 is as follows: Minimum ratio of total current assets to current liabilities ( Current Ratio covenant ) of 1.0:1, Minimum tangible net worth ( TNW covenant ) of $20 million, Maximum ratio of funded debt to tangible net worth ( Debt to TNW Ratio covenant ) of 10.0:1, and Minimum ratio of EBITDA to total interest ( Interest Coverage Ratio covenant ) of 2.75:1. In addition to these financial covenants, the Company s bank credit facility requires the Company to remain in compliance with the financial covenants under all of its other lending agreements ( cross default provisions ). The Company was in compliance with the financial covenants under its bank credit facilities and all other lending agreements at December 31, Equipment Notes In addition to its bank credit facilities, the Company has lines of credit available totaling approximately $188 million from various non-bank equipment lenders in Canada that are used to finance equipment inventory and rental fleet. At December 31, 2018, there was approximately $141 million borrowed on these equipment finance lines. Typically, these equipment notes are interest-free for periods of up to 6 months from the date of financing, after which they bear interest in Canada at variable rates based upon 30-day and 90-day Bankers Acceptance rates ( BA ), the prime rate of a Canadian chartered bank, and 30-day and 90-day LIBOR rates plus the financing company s margin. As at December 31, 2018, the rates ranged from 6.45% to 8.45% with a weighted average effective rate of 7.10%. As collateral for these equipment notes, the Company has provided liens on the specific inventory financed and any related accounts receivable. In the normal course of business, these liens cover substantially all of the equipment inventories. Monthly principal repayments equal to 3.00% of the original principal balance of the note commence 12 months from the date of financing and the remaining balance is due in full at the earlier of 24 months after financing or when the financed equipment is sold. While financed equipment is out on rent, monthly curtailments are required equal to the greater of 70% of the rental revenue and 2.5% of the original value of the note. Any remaining balance after 24 months, which is due in full, is normally refinanced with the lender over an additional period of up to 24 months. All of the Company s equipment notes facilities are renewable annually. Equipment Notes Financial Covenants Two of the Company s equipment finance credit agreements contain restrictive financial covenants, similar to the bank credit facility, that require the Company to remain in compliance with certain financial covenants, including requiring the Company to remain in compliance with the financial covenants under all of its other lending agreements ( cross default provisions ). Under the equipment finance agreements, the covenants are identical to those under the Company s bank agreement and the Company was in compliance with those covenants at December 31, Summary of Outstanding Debt The balance outstanding under Strongco s debt facilities at December 31, 2018 and 2017 consisted of the following: Funded Debt As at December 31 ($ millions) Bank indebtedness (including outstanding cheques) $ 28.5 $ 29.0 Equipment notes payable non-interest-bearing Equipment notes payable interest-bearing Finance lease Total Funded Debt (see "Non-IFRS Measures") $ $ Total borrowing under the Company s debt facilities was $177.0 million at December 31, 2018 compared to $166.2 million a year ago. The increase of $10.8 million was due to the increase in equipment notes payable to finance a higher level of equipment inventory. As at December 31, 2018, there was $5 million of unused credit available under the Company s bank credit lines. While availability under the bank lines fluctuates daily depending on the amount of cash received and cheques and other disbursements clearing 9

10 the bank, availability normally ranges between $1 million and $8 million. The Company also had approximately $47 million available under its equipment finance facilities at December 31, FINANCIAL HIGHLIGHTS FOURTH QUARTER Income Statement Strongco generated revenue of $102.1 million, compared to $97.6 million in the fourth quarter of Revenue in the quarter was affected by the following factors: o Higher sales of construction equipment in Eastern and Western Canada o o Slightly lower rental revenue from construction equipment partially offset by slightly higher crane rental revenue Higher product support revenue from sales of parts and service for construction equipment offset slightly by lower sales of crane parts and service Gross profit of $18.1 million (17.7% of revenue) up slightly from $18.0 million (18.4% of revenue). Operating expenses of $14.9 million, down from $17.2 million in 2017 Operating income of $2.9 million up from $0.8 million due primarily to lower operating expenses. EBITDA increased to $7.9 million from $6.1 million due to improved operating income. Interest expense of $2.1 million, compared to $1.7 million in 2017 due to increased interest-bearing equipment finance debt and higher prime lending rates. Earnings before tax for the quarter increased to $0.8 million from a loss of $0.9 million in Net income of $0.8 million ($0.06 per share) compared to net loss of $0.9 million (loss of $0.07 per share). SUMMARY OF OPERATING RESULTS FOURTH QUARTER Three Months Ended December /2017 ($ thousands, except per share amounts) $ Change % Change Revenue $ 102,115 $ 97,637 $ 4,478 5% Cost of sales 84,023 79,632 4,391 6% Gross margin 18,092 18, % Selling and administrative expenses 14,932 17,231 (2,299) -13% Other (income) expense 264 (47) 311 n/a Operating income 2, , % Interest expense 2,113 1, % Earnings (loss) before income taxes 783 (901) 1, % Provision for income taxes Net income (loss) $ 783 $ (901) $ 1, % Basic and diluted earnings (loss) per share - net income (loss) $ 0.06 $ (0.07) $ % Weighted average number of shares - Basic and diluted 13,371,719 13,221,719 Key financial measures Gross margin as a percentage of revenues 17.7% 18.4% Selling and administrative expenses as a percentage of revenues 14.6% 17.6% Operating income as a percentage of revenues 2.8% 0.8% EBITDA (see non-ifrs Measures) $ 7,876 $ 6,145 $ 1,731 28% Strongco s revenue in the final quarter of 2018 was up 5% from the same quarter in 2017 due to higher sales of construction equipment and cranes and higher sales of parts and service, which were partially offset by slightly lower rental revenue. The higher revenue contributed to higher gross profit, and combined with lower operating expenses, resulted in an operating profit of $2.9 million in the fourth quarter which was substantially improved from of $0.8 million last year. Interest expenses were slightly higher in the quarter from higher equipment financing but the earnings before tax of $0.8 million was substantially improved from the pretax loss of $0.9 million in the fourth quarter of Revenues A breakdown of revenue for the three months ended December 31, 2018 and 2017 is as follows: 10

11 Three Months Ended December /17 ($ millions) % Chg Eastern Canada (Atlantic and Quebec) Equipment Sales $ 22.7 $ % Equipment Rentals % Product Support % Total Eastern Canada $ 37.6 $ % Central Canada (Ontario) Equipment Sales $ 27.9 $ % Equipment Rentals % Product Support % Total Central Canada $ 42.4 $ % Western Canada (Manitoba to British Columbia) Equipment Sales $ 13.7 $ % Equipment Rentals % Product Support % Total Western Canada $ 22.1 $ % Total Equipment Distribution Equipment Sales $ 64.3 $ % Equipment Rentals % Product Support % Total Equipment Distribution $ $ % For the three months ended December 31, 2018, total revenues were $102.1 million compared to $97.6 million in the same period of 2017, up $4.5 million or 5%, due primarily to higher sales of construction equipment and parts and service. Gross Margin ($ millions) Three Months Ended December /2017 Gross Margin GM% GM% $ Change % Change Equipment Sales $ % $ % $ (0.7) -12% Equipment Rentals % % (0.1) -14% Product Support % % 0.9 8% Total Gross Margin $ % $ % $ 0.1 1% Strongco s overall gross profit was $18.1 million in the fourth quarter of 2018, up from $18.0 million in the same period last year. As a percentage of revenue, gross margin declined to 17.7% from 18.4% in the fourth quarter of 2017 due to a higher proportion of equipment sales and lower margins on equipment sales. Gross margin on equipment sales was down from the fourth quarter of 2017 which included the sale of several large cranes to a power station in Northern Ontario at high margins. A higher proportion of service sales contributed to the increase in product support margins. Selling and Administrative Expense Administrative, distribution and selling expense in the fourth quarter of 2018 were $14.9 million, or 14.6% of revenue, compared to $17.2 million, or 17.6% of revenue in the fourth quarter of The Company has made significant progress in reducing expenses in response to the challenging market conditions, especially in Alberta. Occupancy costs, in particular, were lower primarily due to lower rent in Alberta as a result of termination of the Company s facility lease in Fort McMurray. Other Income and Expense Other income and expense is primarily comprised of foreign exchange gains or losses, mark to market adjustments on foreign exchange contracts, gains or losses on disposition of fixed assets, service fees received by Strongco as compensation for sales of new equipment by other third parties in the regions where Strongco has distribution rights for that equipment and commissions received from third party financing companies for customer purchase financing Strongco places with such finance companies. 11

12 Other income and expense in the fourth quarter of 2018 was an expenses of $0.3 million primarily from foreign exchange losses. By comparison, in the fourth quarter of 2017, other income and expense was nominal. Operating Income Stable gross margin and lower operating expenses resulted in operating income of $2.9 million in the fourth quarter of 2018, compared to $0.8 million in the same quarter last year. Interest Expense Strongco s interest expense was $2.1 million in the fourth quarter of 2018, compared to $1.7 million in the fourth quarter of 2017 as a result of a higher level of interest-bearing equipment notes financing the increase in equipment inventory. Earnings (Loss) Before Income Taxes After interest, pre-tax earnings were $0.8 million in the fourth quarter of 2018 compared to a loss before taxes of $0.9 million in the same period in Provision for Income Tax Due to the uncertainty of recovering available cumulative tax losses, no recovery of income taxes has been recorded during 2018 and Net Income (Loss) Strongco s net income in the fourth quarter of 2018 was $0.8 million ($0.06 per share), which compared to net loss of $0.9 million ($0.07 per share) in the same quarter of the prior year. EBITDA EBITDA in the fourth quarter of 2018 was $7.9 million (7.7% of revenues), compared to $6.1 million (6.3% of revenue) in the fourth quarter of EBITDA is calculated as follows: Three Months Ended December 31 Change EBITDA ($ millions) /2017 Net income (loss) $ 0.8 $ (0.9) $ 1.7 Add back: Interest Income taxes Depreciation of capital assets Depreciation of equipment inventory on rent (0.2) Depreciation of rental fleet (0.1) EBITDA (see non-ifrs Measures) $ 7.9 $ 6.1 $ 1.8 Cash Flow, Financial Resources and Liquidity Cash Flow Provided By (Used In) Operating Activities: During the fourth quarter of 2018, Strongco provided $8.4 million of cash from operating activities before changes in working capital, which compared to $6.5 million in the same quarter last year. After changes in working capital, payment of interest and funding of future benefits obligations, cash of $0.9 million was provided by operating activities. By comparison, in the fourth quarter of 2017, net cash of $1.5 million was used in operating activities. 12

13 The components of the cash used in operating activities from continuing operations were as follows: Three Months Ended December 31 ($ millions) Net income (loss) $ 0.8 $ (0.9) Non-cash items: Depreciation equipment inventory on rent Depreciation capital assets Share-based payment expense Interest expense Income tax expense - - Employee future benefit expense Changes in non-cash working capital balances (5.0) (5.7) Employee future benefit funding (0.4) (0.5) Interest paid (2.1) (1.8) Cash provided by (used in) operating activities $ 0.9 $ (1.5) Non-cash items in the quarter include depreciation of equipment inventory on rent of $4.3 million, compared to $4.7 million in the fourth quarter of During the fourth quarter of 2018, non-cash working capital increased by $5.0 million due primarily to decreases in trade and other payables and equipment notes payable, and an increase in inventories offset partially by a reduction in trade receivables, as shown in the table below. By comparison, during the fourth quarter of 2017, net working capital increased by $5.7 million due to a large reduction in trade and other payables offset partially by reductions in trade and other receivables and inventories. Components of cash flow from the net change in non-cash working capital for 2018 and 2017 are as follows: ($ millions) Three Months Ended December 31 (Increase) Decrease Trade and other receivables $ 9.3 $ 3.7 Inventories (6.6) 5.0 Prepaids and other assets $ 3.0 $ 9.1 Increase (Decrease) Trade and other payables (4.0) (14.9) Deferred revenue and customer deposits Equipment notes payable (4.1) (0.2) $ (8.0) $ (14.8) Net (increase) decrease in non-cash working capital $ (5.0) $ (5.7) Equipment inventory at the end of the fourth quarter was $167.5 million increasing slightly from $165.0 million at September 30, The increase was mainly to support growth in equipment sales and the purchase of approximately $15 million of certain products in the fourth quarter to secure product availability for 2019 and take advantage of lower purchase prices. Equipment notes at December 31, 2018 was $141.4 million compared to $145.5 million at September 30, Cash Provided By (Used In) Investing Activities: Cash used in investing activities in the fourth quarter of 2018 totalled $0.1 million and related to the purchase of miscellaneous shop equipment. This compared to $0.1 million cash used in investing activities in the fourth quarter of Cash Provided By (Used In) Financing Activities: In the fourth quarter of 2018, cash of $0.8 million was used in financing activities, to pay for finance leases and the obligation from termination of the facility lease in Fort McMurray. By comparison, net cash of $1.6 million was provided by financing activities in the fourth quarter of 2017 primarily from increasing in bank indebtedness. 13

14 The components of cash provided by financing activities in the fourth quarter are summarized as follows: Three Months Ended December 31 ($ millions) Increase (decrease) in bank indebtedness $ - $ 2.1 Repayment of finance lease obligations (0.5) (0.5) Repayment of lease termination obligation (0.3) - Cash provided by (used in) financing activities (0.8) 1.6 SUMMARY OF QUARTERLY DATA In general, business activity follows a weather-related pattern of seasonality. Typically, the first quarter is the weakest of the year as construction and infrastructure activity is constrained in the winter months. This is followed by a strong gain in the second quarter as construction and other contracts begin to be tendered 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 activities. Fourth quarter activity generally strengthens as customers make year-end capital spending decisions and exercise purchase options on equipment which has previously gone out on RPOs. In addition, purchases of snow removal equipment are typically made in the fourth quarter. A summary of quarterly results for the current and previous two years is as follows: 2018 ($ millions, except per share amounts) Q4 Q3 Q2 Q1 Revenue $ $ 99.0 $ $ 89.0 Earnings (loss) before income taxes 0.8 (2.4) Net income (loss) 0.8 (2.4) Basic and diluted earnings (loss) per share $ 0.06 $ (0.18) $ 0.13 $ ($ millions, except per share amounts) Q4 Q3 Q2 Q1 Revenue $ 97.6 $ 87.9 $ $ 90.0 Earnings (loss) before income taxes (0.9) 0.2 (0.5) (1.1) Net income (loss) (0.9) 0.2 (0.5) (1.1) Basic and diluted earnings (loss) per share $ (0.07) $ 0.02 $ (0.04) $ (0.08) 2016 ($ millions, except per share amounts) Q4 Q3 Q2 Q1 Revenue $ 87.6 $ 93.6 $ $ Income (loss) before income taxes from continuing operations (6.2) (19.1) (7.3) (1.1) Net income (loss) from continuing operations (6.1) (26.1) (5.3) (0.9) Net income (loss) (6.3) (25.5) (4.8) (0.7) Basic and diluted earnings per share - income (loss) from continuing operations $ (0.46) $ (1.97) $ (0.40) $ (0.07) - net income (loss) $ (0.47) $ (1.75) $ (0.37) $ (0.05) A discussion of the Company s previous quarterly results can be found in the quarterly Management s Discussion and Analysis reports available on SEDAR at 14