RB Global Inc (RBA) 2016 Q2 法說會逐字稿

Good morning. My name is Mike, and I will be your conference operator today. At this time I would like to welcome everyone to the Ritchie Bros. Auctioneers second quarter results conference call. (Operator Instructions).

I will now turn the time over to Jamie Kokoska, Director of IR, you may begin your conference.

Thank you Mike. Good morning everyone, and thanks for joining us for our fiscal second quarter 2016 results conference call. Discussing Ritchie Bros.' performance today are Ravi Saligram, Chief Executive Officer, and Sharon Driscoll, Chief Financial Officer. Joining them for the Q&A session following the formal remarks well be Jim Barr, Group President, Randy Wall, President of Canada, and Terry Dolan, President of US and Latin America, as well as Doug Olive, SVP Pricing and Valuations.

The following discussion will include forward-looking statements, as defined by SEC and Canadian rules and regulations. Comments that are not a statement of fact, including projections of future earnings, revenue, gross auction proceeds, and other items are considered forward-looking, and involve risks and uncertainties. The risks and uncertainties that could cause our actual financial and operating results to differ significantly from our forward-looking statements are detailed in our SEC and Canadian Securities filings, available on the SEC and SEDAR websites, as well as our Investor Relations website at Investor.RitchieBros.com.

Our definition of gross auction proceeds may differ from those used by other participants in our industry. It is not a measure of financial performance, liquidity or revenue, and is not presented in our statement of operations. Our second quarter 2016 results were made available yesterday after-market close. We encourage you to review our earnings release and Form 10-Q interim report, which are available on our website, as well as EDGAR and SEDAR. On this call, we will discuss certain non-GAAP financial measures, for the identification of non-GAAP financial measures to the most directly comparable GAAP financial measures, and a reconciliation between the two, see our earnings release and Form 10-Q.

Presentation slides accompany our commentary today; these slides can be viewed through the live or recorded webcast, or downloaded from our website. All figures discussed on today's call are in US dollars, unless otherwise indicated. While we may use $1 million or $1 billion figures, for brevity in today's discussion, all percent changes have been calculated using full unrounded figures. I will now turn the call over to Ravi Saligram, Chief Executive Officer.

Thank you Jamie, and thanks to everyone for joining us for our earnings call today. Our second quarter was marked by modest GAAP and revenue growth, but higher expenses than we recorded in the same quarter last year, which unfavorably affected operating profits and EPS.

Notwithstanding this quarter's shortfalls, we remain absolutely committed to achieving our evergreen model in the long-term. I will outline some key actions we'll be undertaking in the second half of the year to improve performance, towards the end of today's call. I will review some of the high level performance figures, and then I will discuss our operations and market environment.

GAAP for the second quarter increased 1% relative to Q2 last year, but as with recent quarters foreign exchange translation muted some of this growth. On a constant currency basis, using the same foreign exchange rates as this period last year, GAAP would have grown 3%.

Revenue for the quarter increased 2%, or 4% on a constant currency basis. Revenue increased more than GAAP as the result of a higher revenue rate than the year ago period. As we discussed last quarter, our growing fee-based revenue streams, which are not associated with GAAP, are now supplementing our revenue rate.

Expense growth during the quarter outpaced revenue growth, causing margin compression, and ultimately led to a 15% lower operating income year-over-year, or a 13% decline on a constant currency basis. Much of this quarter's expense increase was related to running a larger platform, important new strategic hires, a larger stock base to prepare us for scaling the business, and new operating expenses related to recent acquisitions.

While we're not pleased with the expense growth we experienced during the quarter, we believe cost investments were needed to better prepare our business for further growth and growing competitive intensity. Had our underwritten business performed as we expected, and straight commission shoot prices had not been affected by the precipitous decline in equipment pricing in June, we believe our revenue would have been better aligned with this cost base.

Operating free cash flow during the quarter also declined, but importantly, much of this decrease was simply due to auction timing and inventory contracts we have strategically entered into. Return on net assets and ROIC, which are calculated on a 12-month trailing basis, improved meaningfully year-over-year, increasing 260 and 60 basis points respectively.

The growth of our gross auction proceeds this quarter was impacted by ongoing foreign exchange headwinds, the mix of what we sold, and overall equipment pricing declines relative to the same quarter last year. While total auction volumes increased a meaningful 14%, GAAP grew only 1%.

Used equipment values in the second quarter, and June in particular, were impacted by supply/demand dynamics, that ultimately led to an overall decline in pricing. The sharp pricing correction in June did take us by surprise, and unfavorably affected the performance of our underwritten contracts in that month.

While all categories of equipment saw some decline, not all categories were affected equally. Construction assets specifically saw declines of around 6% on average compared to equipment values in the second quarter last year. Transportation and agricultural assets saw further pricing erosion.

In terms of specific equipment, motor graders and motor scrapers, articulated trucks, large excavators, and over the road trucks saw the most significant declines during the quarter while smaller construction assets, such as skid steers, loader backhoes, and small excavators continued to generate solid pricing. As you can expect, assets related specifically to the oil and gas and mining sectors continued to experience pricing weakness.

The supply/demand dynamic is one that we're acutely aware of, and is one of the underlying reasons we have stepped up our marketing efforts significantly in the last few months. While our sales team does a good job of sourcing equipment, our marketing efforts drive bidders and buyers to our auctions and other sales platforms. So the growth in marketing spend during the quarter was a deliberate increase, to help generate some pricing support for our equipment selling customers, during this period of pricing volatility.

Operationally, our auction volumes continue to demonstrate strong growth. Industrial auction lot volumes increased 15%, and our core auction revenue rate improved 4 basis points relative to Q2 last year. Much of this revenue strength can be attributed to a growing proportion of lower value assets sold at our auctions this year.

As a reminder, our buyer's fee structure is capped, which ultimately means that assets sold for less than $38,000 generate incrementally more buyer's fee revenue per dollars sold, than assets sold over this amount, and any lot sold for less than $2,500 generates a 10% buyer's fee. To help demonstrate the increase in lower value lots, during the second quarter, 53% of the lots sold had a value less than $2,500 in local currency. This compares to 50.7% in the same quarter of 2015, and 49.8% in the second quarter of 2014.

We're not proactively trying to grow our low-value lots, but it has been a trend for the last several quarters, and a consequence of full and partial dispersals, interest in our timed auction lot offering, and a way of introducing first time sellers to the unreserved auction. While low-value lots do generate more revenue per dollar sold in buyer's fees, they also generate higher costs associated per dollar sold, for sale processing and labor.

Underwritten transactions during the second quarter comprised nearly 26% of GAP sold, which was lower than the 29% of GAP in the second quarter last year. While many of the underwritten contracts we entered to in the quarter performed well, the sudden pricing erosion experienced in June did detract from our underwritten rate, which ultimately declined 177 basis points, compared to the quarter 2 last year, when equipment trends surprised us on the upside; I'm talking about last year. Our revenue growth would have been far stronger had we been able to maintain the same underwritten rate as we achieved in Q2 last year.

As mentioned, lot volumes grew 14%, and 15% specifically in industrial auctions, to generate record second quarter auction volumes. Much of the improvement is attributable to volume from customers in the transportation sector, where we experienced a 56% increase relative to the same quarter last year of 3,100 more lots. Equipment consigned from customers in the sales, leasing, and rental channels saw a 14% increase in auction volumes, and customers in the light construction sector, such as home builders, saw a 31% increase. Equipment consigned from oil and gas customers increased 11% during the quarter, contributing just 290 incremental more lots for our auctions than in Q2 last year.

All other auction operational metrics improved meaningfully during the quarter as well, with record second quarter figures for number of consignors, registered bidders, and buyers as well. Equipment consignors increased 11% compared to the same quarter last year, while registered bidders and buyers grew 5% and 11% respectively. We are particularly proud of the bidder and buyer number improvements, which reflect the strong marketing efforts we drove during the quarter, to better balance the increased supply of equipment being sold at our auctions.

There were several notable auctions that occurred during the second quarter, including our record-breaking five-day auction held in Edmonton in April. We had CAD240 million of assets sold. This makes it the largest auction we have ever held in Canada, and attracted 16,700 registered bidders from 55 countries. More than 10,000 lots sold at this auction in just five days, which demonstrates the operational logistic expertise of our Edmonton and online auction operations team. Importantly 86% of the assets sold went to Canadian buyers, including 46% sold to buyers in Alberta, revealing that equipment demand in Canada is still quite robust.

During the quarter, we also held our largest-ever Toronto auction in May, where CAD36 million of equipment was sold, an indication that the efforts of our sales teams in Ontario are generating results.

We also hit a new significant milestone in the second quarter that demonstrates the importance of our digital and multi channel strategy. For the very first time in our Company's history, more than half of our GAP was generated through online transactions, including through live online bidding at our auctions and through EquipmentOne. In addition to the record 51% of GAP being generated through online transactions, 54% of the total number of buyers were online, a 400 basis point leap from just last quarter.

While smaller value assets are more likely to be purchased by online buyers, we did see increases in online purchase activity across nearly all values of equipment sold, including assets sold over $100,000. It's a telling and notable trend that we believe underscores the importance of the investments we're making to enhance the online experience we provide our customers.

Our purchase of a 75% stake in Xcira, our online live auction simulcast technology provider, the launch of the Ritchie Bros. app to provide bidding ability from smartphones, and ongoing improvements for the EquipmentOne website to enhance the user experience are all examples of how we're bringing our digital capabilities to the forefront of our business. The Ritchie Bros. app, which was soft launched during the first quarter, and formally launched on app stores in July, has already generated some early but positive results for us. Early reviews of the app shows strong user endorsements, and we're planning on more aggressively promoting the app in the coming months. Since the initial creation of the app, bidding through app users has already generated 68 successful winning bids, worth approximately with $1.35 million in GAP.

As just one example of how our EquipmentOne solution is better catering to the needs of its customer base, we recently launched an enterprise sales solution that provides an end to end solution to companies that provides better asset management control. The product includes data integration, automated process work flows, remarketing solutions, disposition channels, and detailed reporting. The portal has already generated new business for EquipmentOne, including one of the world's largest transportation OEMs, and energy companies.

EquipmentOne and Mascus, which both fall under our other business segment in our financial reporting, continue to perform well, with the segment producing $6.3 million in revenue during the second quarter, and generating positive EBITDA. As we noted last quarter, depreciation and amortization does continue to weigh on the overall EBIT performance of EquipmentOne.

As we announced last month, we completed our acquisition of the remaining 49% stake in Ritchie Bros. Financial Services on July 12th, which means shareholders will start receiving the full benefit of RBFS growth and earnings beginning in the third quarter, but for context, full ownership of RBFS during the second quarter would have contributed another penny to diluted earnings-per-share for stock holders. Operationally the business continues to demonstrate solid growth. Credit applications grew 28%, relative to the same quarter last year, and funded volume grew 26%, providing $91 million of loans to RBFS customers.

Market penetration of addressable GAP improved 18 basis points, to 11.37% compared to a year ago period. We define addressable GAP as assets greater than $10,000 that are eligible for financing, and purchased by end users in a country where financing is available. With that operational overview, I will now pass the call on to Sharon for a detailed review of our financial performance.

Thank you Ravi, and good morning everyone. As Ravi mentioned briefly at the start of today's call, our second quarter was marked with modest GAP and revenue growth, but increases to our overall cost base negatively impacted operating income, with our operating income margin contracting 660 basis points, to 33.8% during the quarter. Ultimately this led to a 13% decline in EBITDA, and a 12% decline in diluted earnings-per-share, with diluted EPS of $0.37.

Our revenue rate during the second quarter improved 13 basis points relative to the same quarter last year, with the year-over-year improvement driven by fee-based revenue streams not associated with GAP. In fact, 25 basis points of the quarter's revenue rate was generated by Mascus and Xcira, two businesses that were not on our platform a year ago.

Weakness in equipment pricing in June did translate into lower than expected GAP growth, and weaker performance on June's underwritten contracts, negatively impacting revenue rate and the resultant revenue growth for the quarter. We continue to believe that our core auction business will generate a revenue rate between 11% and 12% on an annual basis, and that our group revenue rate, including EquipmentOne and all fee-based revenue streams, to generate a revenue rate in excess of 12%.

As of prior quarters, foreign exchange changes relative to same period last year muted our reported growth. Sales volume increases led to 3% revenue growth, while rate improvements provided another percent, leading to 4% revenue growth on a constant currency basis. Factoring in the impact of translational foreign exchange, revenue growth fell to just 2% during the quarter.

These foreign exchange impacts also contributed to a slightly larger proportion of revenue being generated from our US operations, compared to Q2 last year. 43% of revenue was generated by our US teams this quarter, compared to 41% in the second quarter of 2015. On a local currency basis, without factoring in any foreign exchange impacts, the US, Canada and regional segments all generated revenue growth, while Europe continues to contend with a depressed market environment.

Turning to expenses, both our cost of services and SG&A expenses increased relative to the same quarter last year as a result of newly-acquired businesses, increased headcount to support our strategic initiatives, and growth in volume. Total operating expenses, including depreciation and amortization were 13% higher than Q2 of last year. More specifically, new businesses, Xcira and Mascus, added $3.5 million of additional cost of services and SG&A expenses to our cost base. The other $8.6 million of higher operating expenses were largely weighted to higher staffing levels to support our strategic initiatives and growing business volumes, as well as higher marketing and advertising costs, associated with driving demand for equipment and awareness of our sales channels.

Cost of services also rose in our core auction business, which is a reflection of handling more auction volume, and holding more off-site auctions. You'll recall lot volumes, including both industrial and ag auctions, increased 14% over the same period last year, as it takes more temporary staff, fuel, and security costs to handle that incremental lot growth.

Core auction SG&A expenses, excluding Xcira, increased by $6.4 million, primarily due to higher staffing levels, including a fully staffed executive team that was not in place this time last year.

The increase in our share price during the quarter was the primary driver of a $3.4 million increase in share based employee compensation payments, but that was mostly offset by a $3 million reduction in incentive compensation accrual, due to a change in bonus accrual methodology to better reflect quarterly performance. IT software costs related to CRM license fees in 2016 not in 2015, as well as an increase in the leasing of yard equipment and company cars, which were previously capitalized, also added $1 million in additional expenses during the quarter.

That being said, our operating cost growth has significantly outpaced our revenue growth during this quarter, and the full first half of the year. The actions being taken to address and change this trend will be discussed by Ravi later on this call.

Given revenue grew 2% during the quarter, while total expenses including depreciation and amortization rose 13%, our net income attributable to shareholders declined 12% from the same period last year to $39.7 million. I also want to acknowledge that we're cycling a very strong second quarter performance in 2015, where revenue was up 10% and operating income was up 21%.

In addition to affecting GAP and revenue, translational foreign exchange also affected reported expenses and operating income. On a constant currency basis, operating expenses rose 16%, but FX positively impacted this line item, given that many head office expenses are in Canadian dollars, leading to a 13% overall increase in costs. Operating income declined 13% on a constant currency basis, but was negatively affected by FX, which added another 2% decline, for a total decline of 15%.

Turning to our balance sheet and cash flow metrics, you may note that some metrics on our balance sheet scorecard are no longer included in our earnings release. This change is only a result of the SEC's new interpretations of the use of non-GAAP financial measures, which would need us to add significantly more tables and reconciliations to our news release. As this information is already discussed at length in our quarterly report, we encourage you to review our balance sheet metrics in our 10-Q quarterly report filing available on EDGAR and our website going forward.

Our balance sheet and cash flow metrics remain strong, although we have seen some temporary regression in working capital and operating free cash flow performance. I will provide more color on the drivers of the first half performance on these metrics shortly.

Return on net assets and ROIC, both 12-month trailing June 30th figures, improved to 25.4% and 15.1% respectively, with RONA improving 10 basis points from the year ago period, and ROIC improving 60 basis points. Excluding the term loan reclassification, that was booked in Q2 of 2015, RONA improved 260 basis points.

Cash flow was negatively impacted by lower operating income, auction timing, and an increase in inventory, and I'll discuss this in more detail now. Changes in working capital resulted in a use of cash of $53 million in the first half of 2016, versus being a source of cash of $44 million in 2015, or a $97 million negative change to cash flow year-on-year. 39% or $37 million of this decline is due to an increase in inventory purchases and advances, somewhat impacted by sector specific bankruptcy cycles in mining and oil and gas.

29% or $28 million of this decline is due to an increase in restricted cash, offset by the increase in auction proceeds payables. This is primarily due to timing with large auctions held near the end of the quarter in regions requiring restricted cash, specifically Alberta and Texas. For more details regarding net changes in working capital, please refer to our Note 11, supplemental cash flow information in our 10-Q.

We will continue to focus on the basics of cash management, and our cash management principles have not changed. We will continue to use our strong balance sheet as a competitive advantage when pursuing underwritten transactions. The Company remains a very strong cash generator.

As a reminder, our capital allocation priorities remain unchanged, with first priority being growing our dividend payout in line with earnings; our second priority, to hold our share count flat; and our third being acquisitions. As announced yesterday in our earnings release, our Board of Directors has approved a 6.3% increase, or an increase of one penny to our quarterly cash dividend, bringing our dividend to $0.17. We know our shareholders value our dividend, and believe this increase appropriately aligns our dividend payout in line with our trailing 12-month adjusted income attributable to shareholders growth of 2%. It also brings us at the high end of the stated 55% to 60% payout range disclosed in our evergreen model on a trailing 12-month basis.

As many of you know, we do have a solid balance sheet, and one that we regularly leverage as a competitive advantage for underwritten transactions. But we have also taken great strides in the last few months to best deploy capital in both strategic growth initiatives and for shareholder returns. In fact, in the first half of 2016, we have already returned nearly $71 million to shareholders in the form of dividends and share repurchases, which obviously does not capture yesterday's announced dividend increase. We also deployed more than $28 million towards acquisitions in the first half, for a total of $99.3 million to supplement growth initiatives and shareholder returns.

It is also worthwhile noting that since June 30th, we have announced an additional $48 million deployed for M&A activity that has closed so far in the third quarter, which Ravi will discuss shortly. The strength of our balance sheet is what allows us to pursue strategic growth initiatives when they arise, and it is something we believe will be advantageous to us as we explore further M&A opportunities. With that financial overview, I will now pass the call back to Ravi for some closing remarks.

Thank you Sharon. We continue to stay focused on M&A as a way to accelerate growth in the long-term. Most recently we announced the acquisition of Petrowsky Auctioneers on August 2nd, a business we believe will meaningfully grow our market presence in the northeast United States, a region we have not historically been a market leader.

We are pleased to welcome Sammy Petrowsky and his entire team to Ritchie Brothers. In 2015 Petrowsky Auctioneers built on their foundation of strong customer relationships, generated $50 million of gross auction proceeds. We believe that with the additional support the Ritchie Bros. platform will provide, the GAP contribution from this business could grow considerably.

Subsequent to the end of second quarter, we also announced the completion of our acquisition of the 49% minority interest in Ritchie Bros. Financial Services. While the operating results of this business are already fully consolidated within our results, we are pleased shareholders will now fully benefit from the earnings and growth potential of this business.

In the last two years, we have diligently executed against our strategy to build a stronger platform for future growth. A multi channel approach and investments in digital initiatives are proving valuable to customers, with many large packages of equipment now being dispersed among sales channels to best suit the needs of equipment sellers.

Our second quarter results clearly affected our first half performance, especially given how much larger our second quarter is seasonally compared to the first. GAP during the first half of the year grew 4%, relative to the first half of 2015, or 6% on a constant currency basis. And revenue grew 7%, or 10% on a constant currency basis.

Operating income declined 3% from the same period last year, or 2% removing the impact of foreign exchange. However, diluted EPS attributable to shareholders grew 2%.

While our second quarter results were not what we hoped to achieve, we're already encouraged by the trends we have seen so far in the third quarter. Pricing appears to be stabilizing, our auction volumes, bidders and buyers continue to grow, and we have secured several large consignments for the second half of the year.

As you may have seen in our monthly auction metrics disclosure on Friday, our July GAP was up 7.8% compared to July last year, or 9% on a constant currency basis. This growth is due largely to better auction performance or comparable sales relative to last year. We also added four new auctions to the calendar in July, further bolstering GAP.

And while we held fewer agricultural auctions during the month, the ones that were held were significantly larger than those held a year ago. Overall, I am pleased to see GAP up 4% year-to-date through July 2016, or 6.1% higher on a constant currency basis.

Although we had a tough second quarter and we're not pleased with the results, one quarter does not make a trend. We acknowledge the sudden pricing erosion in June surprised us. And we got caught in an environment where supply far exceeded demand. It negatively affected our underwritten business, as well as our straight commission business. Net our revenue growth was far lower than what we had expected or the cost base was supposed to support. Of course growth in small lots exacerbated an increase in operational expenses.

I would like to reassure our investors that the operating leverage model of our core auction business and equipment model is still intact. We do acknowledge that our service businesses, including Xcira, Mascus, and Refurb and paying, have a different cost structure model, and not the high level of operating leverage as the core business. Having said this, our primary focus is growing our core business, specifically RBA, EOne, and RBFS. Xcira and Mascus are strong strategic enablers of growth, while providing predictable fee-based revenue streams.

In order to ensure operating income growth, and achievement of the evergreen model, we're undertaking several actions to contain cost and accelerate revenue growth. Let me outline a few specific actions. First, we will enforce very strict discipline on SG&A costs, with a strong focus on overtime reduction, travel expenditures, trade show participation, and professional services.

Second, we have already implemented a partial hiring freeze, and will be very strict about creating new or adding Director and VP positions and above, unless absolutely critical to the business. We will however, continue to allow hiring of TMs in the field, especially replacements. Our Head of HR, Todd Wohler, is now personally overseeing and approving any new hires above the manager level. We will proactively look for procurement efficiencies.

Fourth, we have started our program to address inefficient sites that do not have critical mass, and will not meet our growth targets in the foreseeable future. As a first step, we have decided not to renew our lease in Beijing, China. We are in the process of evaluating other inefficient sites in all of our geographies, and we'll make the appropriate decisions during the next 6 to 9 months.

Fifth, we are reemphasizing being disciplined in our underwritten contracts, especially in sectors with oversupply. For example, transportation assets. We'll also be more judicious in choosing underwritten deals in geographies with volatile pricing and oversupply. For instance in the Middle East and parts of Europe. As a reminder, we already stopped doing most underwritten contracts in Mexico.

Finally, we're working on incorporating more forward-looking indicators, versus relying largely on history in our at-risk modeling.

Sixth, we're strongly encouraging our sales force to be disciplined about small lots, and instead focus on higher-value items.

Seventh, we are relaunching our "Cash is King" program to reignite awareness of cash flow. We will also enforce stronger control on inventory deals.

And finally, we are restoring focus on our core construction sector. Although we're pleased with the gains we have made in transportation, we want to make sure that we do not lose sight of the most important construction sector.

I'm confident that over the next six months, we will start to regain the proper balance between revenue growth and cost growth. My management team and I are fully committed to this.

And with that, we would like to welcome questions from analysts and institutional investors. Given the level of participation on today's call, we would ask that you please limit yourself to one question, before requeuing to provide time for others on today's call. Operator.

(Operator Instructions). Your first question is from Nate Brochmann from William Blair.

Good morning, and thanks for taking the question.

Sure Nate. Thank you. Good morning.

Ravi, clearly this is a trait of the business where sometimes you get caught with pricing swings, and that has always happened. And clearly, you're taking the actions to realign the SG&A after getting caught by surprise with that. But how do you think of the business long-term, in terms of doing the right things, in terms of doing all the investment, and positioning the business with all the new channels, versus kind of managing through these swings in the proper notion, because they're probably always going to come up over the course of history, and just wondering how we balance that a little bit? Thanks.

Great question, and very perceptive comment. Look, this is a lumpy business, and I've said over and over again, this is a business for long-term investors than very short-term investors. The lumpiness sometimes goes your way, like it did in first quarter, where there was jubilation, and second quarter, where there's a lot of disappointment.

But I think we have to work through it, and not lose sight of the long-term. Because in the long-term, I very firmly believe, A, we have a fantastic operating model with great leverage -- now, that leverage works backwards too, when you get it wrong. Two, I think there is still a lot of growth prospects with the multiple channels. So we don't want to throw the baby out with the bath water just because of a poor quarter.

However, there is learnings from this quarter, which is that you do have to be careful of the investments that you make, and our evergreen model, we were very committed to say, grow operating expenses lower than revenue growth, and you can't always hope for revenue growth.

So what we want to do over the next six months, and it will take us some time to get our cost base right, is what are the things that we can live without, what are the things we absolutely have to live with? Some of the strategic investments we made, like getting a world-class CMO, a world-class CIO, those are all very important for the long-term health of the business. So I think it is just achieving the balance.

So first quarter, we were surprised positively with the revenue growth. This time, we have been negatively surprised by the cost. I think over time, we will just get some more balance in, but I firmly believe that our strategic plan is intact, the moves we are making are absolutely right, and we just need to stay focused on the long-term, while not just -- we should take -- this was a little bit of a wake-up call, and we'll take the necessary actions.

Okay, great. Thanks, I think that is my one.

Thank you, Nate.

The next question is from Scott Schneeberger from Oppenheimer.

Ravi, could you elaborate on -- you mentioned changing on looking at the underwritten business, moving more towards forward indicators versus historical indicators, and just as a second part of the question, what were the asset classes most affected in the June pricing change impact? Thanks.

I'll answer the first question, and I'll let Doug Olive answer the second. The quick thing is, we have got a lot of pricing history over 50 years, and more recent 10, we have a real good sense. But most of the times, when markets suddenly turn on you, and if you made the deals a few months in advance, it can really cause some pain.

So we're trying to work on trying to understand, and it's not easy in this business, but trying to get metrics which are more predictive about the future. So we have got analytics work underway that ties some factors so we can get some -- so whether it's in construction housing starts, non-res construction, et cetera, a whole model. And we have got Frank Roth, who heads our strategic initiatives, to do some work on that. So we're looking at some big data modeling to help us with it.

It's going to be -- it's not something that easy, especially in volatile environments, but it's one way for us to at least better predict where sectors are going. I'll let Doug answer where are some of the sectors we got affected on, at risk, in second quarter.

Thank you, Ravi. Good morning, just to comment and just to add to some of the dialogue that has been said already. We did see an overall decline of pricing in the construction assets alone of about 6% in Q2. And on top of that, Scott, we did see quite an erosion of transportation assets, as there continues to be a glut of trucks entering the market. So it has been transportation, construction, and we're still seeing a decline of pricing on oil and gas related equipment. And also anything tied to mining as well, Scott, we have also seen a further erosion.

So it's a changing environment, a changing landscape. And we're aware of it and we are watching it. And we're confident now, though, watching some pricing already into July, into Q3 already, where we have seen some stabilization of pricing, so we're confident moving forward.

I think Scott's question was which sectors did we have at-risk deals where we got hit?

Sure. Oil and gas sector and transportation sectors.

I think that too, Scott, was really transportation, and one of the reasons that transportation can be volatile is because if you have too many assets of the same type, so if you have 100 trucks, and while you have the volume, and people know that there's 100, if the pricing starts falling, it can really have a boomerang effect on the whole portfolio. One of the learnings for us, as we are learning more about the transportation sector, is you can't treat at-risk deals in transportation the same way that you treat them in construction, where there are more unique assets in any particular portfolio whereas there's too many like assets in transportation. So we're learning from that, and being more careful and judicious as we go forward. So as we've been pushing transportation, perhaps there was just maybe too aggressive a push in portfolios on that.

Got it. Thanks for the color, guys.

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

Ravi, just notice: in terms of the SG&A increase and cost of goods sold increase, a lot of it came from employee compensation, and not just related to the employee numbers, but actual comp per employee went up significantly. I am just wondering if there was a change in the way base pay or overall pay is looked at from Ritchie's perspective, or were these one-offs related to signing bonuses for senior employees?

Sharon, do you have any view on that?

Yes, there would have been some small sign-on components, but not material, Sara. I think this is more reflective of having the full executive management team in place, and some of the regional management support teams, which would take some of the costs per employee up.

Sara, there were several exec positions not there last quarter, last year's quarter, or even the first quarter, which was President of the US. We did not have CMO, did not have CIO, et cetera. So that is partially reflective of it.

We have not changed fundamentally. If anything the changes we've made on comp levels are more performance-driven. So I don't know, Sharon, if any of the mark to market affected that.

So we did call out that mark to market was an impact of about $3.4 million on the quarter. That is a combination. It is primarily driven by the change in the stock price. Slightly, also just added number of people that are on the LTI programs, to better align our executives with shareholder interests. Those were somewhat offset, because of the performance on the short-term incentive bonuses.

Okay, and maybe just related to that, if you can comment on employee turnovers, is that an issue that is causing additional cost, or is it pretty in line with historical trends?

I think the employee turnover is pretty much stable. I don't know if Todd is on the line, but I think it has been around 15%, 16%, and we have not seen any sharp increase in it, Sara, and TM turnover actually is now stabilizing, it has come down. So that's not occurring.

Okay, thanks.

The next question is from Bert Powell from BMO.

Thanks, good morning. Ravi, just want to stay on the cost focus a little bit here. So you did indicate that there was a step-up in efforts to support some of the pricing volatility that you saw in the quarter, and there was a pretty big jump in your promo line, and I would assume with the transactions that you did in the quarter, that the professional fees were also up there as well. So I wonder if you could give us a sense of how those behave going forward.

Just trying to think about the operating leverage in the business, heading into the end of the year. Can we get -- if we define operating leverage as your EBITDA margin, for lack of a better way to do it, can you get back to or above where you exited the year last year?

I'll take a shot at it, and then maybe Sharon can add to that. So we have got to separate out our core auctions versus things like Mascus and Xcira, because those do have a -- they're more fee streams, more stable, more predictable. And that's a reason we've brought them on, so that, one, they're strategic enablers, the fact like Mascus gives you a lot of buyer base. So I think in our core auction business, I don't think anything has fundamentally changed on operating leverage.

And what you're seeing is, we did, the Company had been starved of the right type of management teams at different levels. We have been going about upgrading the teams, and we also started decentralizing a bit. I think what we are now is at an inflection point, where -- hey, the wake-up call here is making sure that we have not gone too far on the investment side. And making sure that we protect ourselves when things, when the revenue growth doesn't come in.

So we're going to undertake a very thorough review; in the meanwhile, we have put the actions we have. But I fundamentally and very strongly believe that the operating leverage of this business is very much intact, and that is the beauty of the model. What we need to do is tweaks on the cost front, and I think we'll take some short-term actions, just to make sure it doesn't accelerate from here.

As far as the marketing is concerned, we're also within the marketing group looking for efficiencies and saying, where do you redeploy costs to support the auction volumes directly? Where are spending, what is effective? So this is where some of the work that Becky and her team are doing, on how you drive more digital marketing, as opposed to your regular or brochure oriented, historic stuff. So I think we'll find the right balance for that.

I think we went through -- the other part of it is second quarter being the volume it is, and we had a lot of volume, and we went out of the way to make sure that we marketed to it. But the net of it is that I don't believe that there is anything fundamentally changed about the operating leverage of our model. And what we need to do, as a management team, and we are fully committed to doing, is to get that cost base back on track.

The investments are necessary for the long-term, so we want to be a bit careful and not go too far. On the other hand, I think we do want to get it back, because we don't want inadvertently to give the wrong messages about the leverage of this very compelling model.

I think, Bert, also that -- a couple of things. First, we're very encouraged with the pipeline that we are seeing, on a few deals that we have secured for Q3 in particular, so we will be marketing to be able to ensure there is sufficient demand for some of those critical packages that we will be selling in Q3.

I will also point out that in Q4, we did have a fairly significant surprise in the cost base last year, related to the bonus plans. Our change in bonus accrual methodology is an attempt to mitigate that, and so we think that will be perhaps an easier cycling of costs for Q4.

Okay. That's very helpful. And just to be clear, when you talk about the package, you're really talking about a mix shift away from small to larger to drive more efficiency, or relatively lower costs as a percentage of the GAP? Is that what you're referring to, or just better at-risk pricing going into this quarter?

So let me address that, and Doug can also maybe add to it. We're talking about, when we say larger packages, we talk about value. Higher value dollars of the overall.

Doesn't mean it won't have smalls in it. Because if it's a full dispersal-- so we secured a very large bankruptcy package, which was an inventory deal, which we have got slated for Columbus, Ohio. It will be one of our very large at-risk deals. Not as big as Wyoming, but really big. And we won that in a very strong competitive environment. But we made sure, all of the way from Terry, Doug, myself, all of us had really got into the deal.

And so that's the sort of a deal, if it goes well, can really hit the ball out of the park. Now, it can also go the other way. So I'm not saying that there are some out there, but we're confident we have done enough homework, and we're going to market that.

So that's what Sharon meant by, and we have got similar to that other things in different parts of the globe we're working on. Maybe not to that size, but certainly for us, when we say large packages, anything, Doug would say, more than $5 million packages and so on. So that's the sweet spot of Ritchie Bros. Doug, anything that you want to comment on?

I would agree, just anything over $5 million in a mixed portfolio of assets that you know are not like assets. A mixed portfolio, it is a vacuum in the marketplace, where you're going to sell a bunch of assets. Where there is some demand, and you create demand by selling the amount of those types of assets in a certain marketplace.

Okay, that's very helpful. Thank you.

Does that help?

It does, yes. For sure it does, Ravi. Absolutely. Thanks.

The next question is from Cherilyn Radbourne from TD Securities.

Hi, Cherilyn.

Thanks very much, and good morning. I wanted to ask you a question on used equipment pricing. You comment that it declined suddenly in June. Just curious, was that post-Brexit, or can you elaborate a little bit more on what you think caused that?

It was not; because post-Brexit was June 23rd. And so while Brexit probably had a little bit of an impact on our Moerdijk auction, I think this was really more what we saw throughout the globe. It was an interesting one; it was not just contained to any particular country.

Part of it is we ourselves had a lot of volume out there, so we are a market maker, so we put a lot of supply out there. But it was pretty much -- and one of the things that really took us a bit by surprise, our at-risk is very strong in Canada, in Australia, and even those countries who are stalwarts at this, took a little bit of a beating. So this was global that we saw this.

And it was especially notable in the transportation side, where, one, we had a lot of supply, but also the imbalance, there was a huge imbalance that suddenly got created. And sometimes you see that in this business. It doesn't mean it's permanent. This is not one that we would describe as a permanent trend, because we have been very encouraged seeing things back up in July again, in most places. Doug or Randy, do you want to comment?

A bit of a Canadian perspective. We also got hit by the transportation swing. And you've got a large amount of assets were pumped out into the marketplace after 2008, 2009, 2010. The OEMs were producing record number of trucks in 2011 and 2012 and 2013. And those are the assets that are now starting to hit the used marketplace.

So there's still ample demand, however supply has swung significantly higher than demand. So some of that was a little bit beyond where our pricing predictions were.

A little bit of the remaining exuberance in western Canada on the construction sector ran out of gas, where the amount of supply available on the market has now exceeded the amount of pricing and demand that we had seen in the past. So I think there's a bit of a catch-up issue going on in the construction circles. That was tempered by relative strength in the eastern half of the country, however.

And agriculture was some ups and some downs. It was traditionally lumpy, but actually it held its own relatively well in that space.

And Randy, I think just in the quarter you had two big Edmonton auctions, one which was a record. So it, really towards June, when you had the June Edmonton auction up to such a record in the end of April, that also had some issues.

I mean we had $350 million between two auctions alone in Edmonton, plus more in other areas within Alberta. And there was a sharp change in pricing experienced in June, than there was just at the end of April. So it was quite a change.

Great, that is helpful color. Thank you.

The next question is from Ben Cherniavsky from Raymond James.

Good morning guys. I know that it's not a big acquisition with Petrowsky, but it does strike me as somewhat unique, in that these guys run a reserved model. And that in your press release you said you were going to run this as a separate brand.

Can you talk about the rationale for acquiring a reserved platform, how you integrate that into your model, how you might scale it if it's a separate service, and how it doesn't conflict with the secret sauce of Ritchie being unreserved?

Good question Ben. So the rationale for buying Petrowsky was not because it was a reserved auction. And frankly, the reserved portion, based on our due diligence, is actually fairly small. And somewhere between 10% and 15% or so. Even that, we're going to make sure that it will be very transparent to customers.

Because of the reserve, we did not want that integrated, because for us, for RBA, for the RBA Ritchie Bros. Auction brand, the unreserved model is absolutely sacrosanct. And we will not let anything pollute that or change it, because that is the heritage of this brand.

What we wanted, the prime reason for us to get Petrowsky, was that historically we have been weak in the New England area, and in the Northeast. And Sammy Petrowsky has done a very good job of wooing customers and building relationships. He has got a good brand equity with people. So for us, we felt that would help bolster for us, get those relationships, et cetera.

We're going to study how, whether over time -- because this has not been uncommon where we do buy a regional player, and then once it's fully unreserved, to really bring them into the fold. So we're going to study it to see how that will be, and what's the appropriate time, whether the brand gets absorbed into RBA. But if it is, it has to be 100% unreserved.

Until such time, we want to leave that; we want to understand what works in that region. But the key reason was not because they're running at a -- so it's very different from a Mascus, which is more part of our digital side, or EquipmentOne. This is really about a geographic thing for the core auction business, and to leverage the relationships Sammy brings with customers.

So you're not contemplating building out a reserved platform as a separate kind of service or auction channel?

Yes. That was not the strategy here, Ben. As we understand it better, we'll think about that. But that was not the rationale or the strategy.

We believe that with the scale we have at RBA, that for the live auction model, the unreserved works. So at this time -- and we will better understand it; if there is an opportunity, clearly we'll look into it, but that was not the prime reason for doing this.

I guess it might be a poor metaphor, but if you take a sales guy, who has been selling Fords his whole life, and then ask him to sell Mercedes, does that work? Is there a risk that the Petrowsky model had some strength in the region, because it offered a reserved option, and when you or if you try to convert these guys who have been participating in that auction into the unreserved channel, they go elsewhere?

That's a great point, and that would have been a huge risk had 50% or more of their volume been from the reserves. Our due diligence indicates that's not the case, and in fact, Sammy is fully prepared to and confident that -- and look, this is where the Ritchie Bros. infrastructure and our buyers, et cetera, will help provide.

So I don't believe that to be an issue, and long-term, our view and our hope would be that we could convert this to the right unreserved model, if that's what we believe for the live auctions is the appropriate point. We're going to take our time and not do anything drastic overnight.

But as I said, I'll just reiterate, I'm sorry I'm being a broken record, but we did not buy it for the reserved model. It was really because of the strength of relationships in a region, where historically we have been weak.

Great. Thanks so much, Ravi.

Thank you, Ben. One more question, Jamie?

We can do two more.

The next question is from John D'Angelo from Macquarie.

Good morning and thanks for taking my questions. So the underwritten business, a little bit of trouble in the quarter. Can you guys share with us how you guys price that business? Is it whatever the seller agrees to, or do you guys look at the level of used equipment values in pricing the stuff, or do you guys look at the trend? Any color there would be appreciated.

Yes, clearly, this is -- I'll just give a quick view of it. And then Doug can supplement it, or Randy. But this is our secret sauce. So don't -- be understanding that we don't want to reveal all our trade secrets, because this is one of our most important weapons. We do somewhere between $800 million to $1 billion a year, and this is something that we are very good at.

Yes, we had a difficult quarter, but we have also had now four or five quarters where we have had huge improvements. But generally speaking, we have performance guarantees, which is the mainstay, as well as some inventory deals. Our strong performance is for performance guarantees.

Basically, we appraise the equipment, our people appraise, because we're pretty good at equipment pricing, and our salespeople do it. But we have valuators under Doug's group who then provide their own view. Then we look at our models to see historically how it is.

Then there is a negotiation with the seller. Because the seller wants to do it at a certain level; we want to do it at a certain level; we get to the right place in the middle. Assuming that we have good margins built in for us, appropriate for the risk. And that's how we go to market.

A piece of color to say is that in the last ten years in aggregate, we have never ever lost money overall in our at-risk business, and even in this quarter, while we suffered a little shortfall or our rate went down, clearly we still made money on the business. So what we're always trying to do is minimize the losses. You'll always have a few contracts that will lose, because if you don't, that means you didn't try to bring in enough. That's part of the game.

So we look at things called loss to win ratios, et cetera. Typically in good sound environments, this is a very attractive thing. Occasionally you get caught out when you didn't anticipate that the market would turn very sharply, and even when we are conservative in our pricing, sometimes you can be caught out, which is what happened in second quarter. Randy or Doug, do you think there is any other thing you want to add to what I've said?

I would agree fully, Ravi. As we alluded to, some of the assets this quarter that we were surprised with were some of the transportation assets, where we had older packages that were stale inventory, and when the market or pricing changes that quickly, when you have like units, that's when you see a quick erosion of value of revenues on packages such as that.

This cycle, we saw it, we certainly saw it. As Randy also alluded to, it was a worldwide effect, so it was not just regionalized to certain areas, it was everywhere. So it quickly turned.

We have seen these cycles before. And we watch it very closely and we're on top of it. And as Ravi alluded to as well, we are already happy with the prices and returns we have seen in July, and we have seen a more stable pricing environment so far.

Great. Thank you.

Thank you, John.

The last question is from John Healey from Northcoast Research.

Thank you. I just wanted to maybe delve in a little bit on some of the competitive trends that you talked about, and maybe a little pickup there, is that from traditional competitors, is that from new channels? And how was the form of that taking place, and I'm trying to understand how you are responding there a little bit?

Sure, I think -- look, we have competitors, regional competitors, national competitors, and then ones that we compete with overseas, so there's a plethora of competitors in this business. Some of them, the regional ones could be live auction competitors; then you have online competitors, a number of them that you'd be familiar with. And clearly, the online side is beginning, just the same trends we're seeing, is gaining strength.

And so there is for sure more competitive intensity, as well as for at-risk contracts, et cetera. But definitely different models, where you don't have to move equipment, versus our traditional site, which is why sometimes we're doing more off-site auctions, et cetera, to respond to what we're seeing in the marketplace.

Thank you.

Okay, let me conclude by saying, look we were not happy, and we are disappointed with the second quarter results, but we are looking forward, not back. I don't want to let one quarter say it's a trend, and that the model is broken. We in fact very much want to reassure investors that we are very confident of the model. My management team and I are very committed to getting this back on track, and so hang in there with us.

The results in July are a positive note. And we will start working on the cost issues. And I very firmly believe that the evergreen model was not just an academic piece of paper, but one that we're very committed to. Over time, we will get back on track. Thank you.

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