Earnings Call: Q3 2020

Nov 6, 2020

Good morning. Today is Friday, 11/06/2020. Welcome to the Toromont Third Quarter twenty twenty Results Conference Call. Please be advised that this call is being recorded. Your host for today will be Mr. Michael McMillan. Please go ahead, Mr. McMillan. Great. Thanks, Elena. Good morning, everyone. Thank you for joining us this morning to discuss the results of Toromont Industries Limited for the third quarter and nine months ended 09/30/2020. Also on the call with me today is Scott Medhurst, President and Chief Executive Officer. As noted in the press release issued yesterday, we will be referring to a package posted to our website, and we encourage listeners to download and follow along. At this time, and as noted on slide two of our presentation, I'd like to advise listeners that this presentation may contain forward looking statements and information that are subject to certain uncertainties and assumptions that may lead to actual results or events differing materially from those expected. For a complete discussion of these factors, refer to our press release from yesterday, which is available on our website. As is our practice, we will focus on key highlights for the current quarter. Scott will begin with a few general remarks, followed by comments on our overall results, after which I will provide some highlights on our divisional results and financial position. After our prepared remarks, we will be more than happy to answer questions. Over to you, Scott. Thank you, Mike, good morning, everyone. Before I begin, I would ask that you move to Slide three of the package. We are pleased with the gradual improvement experienced over the last quarter. However, the operating environment is complex and still quite fluid. Our customers are understandably cautious, as a result, overall business activities are still below last year's levels. From the start of the pandemic, our teams have shown their resilience and the ability to adapt to an ever changing environment. We are proud to continue to support our customers, keeping our employees safe while providing essential services and protecting the business for the future. During the quarter, we completed the transition of our operating system at our Quebec dealership branches. This was a significant undertaking and we are very pleased with the outcome, thanks to the team's incredible effort while executing in a unique landscape. With one common platform, we are now able to align our operations at the ground level and continue to leverage best practices, go to market approaches and efficiencies across our territory. We continue to closely manage and de risk our balance sheet with sharp focus on inventory turns, collection of AR and on aged assets. Our financial position remains strong with ample sources of liquidity. Expense reduction is a priority, but we remain ultra careful not to negatively impact our ability to meet future market demands. While we have seen sequential improvement in our markets, there remains considerable uncertainty in the marketplace and we expect cautious tone to persist leading into Q4. Turning now to our financial results highlighted on Slide four. Backlogs were CAD472 million at 09/30/2020. Simcoe backlogs were at near record levels on strong industrial booking activity in early twenty twenty. Equipment backlogs were lower on reduced activity levels, reflecting the cautious tone throughout the quarter. Overall revenues decreased 5% in the quarter versus last year. This improvement over the declines experienced in Q2, revenues were still below that of Q3 of twenty nineteen. Year to date revenue was down 6% to £2,500,000,000 Operating income was 1% lower in the third quarter on the lower revenues, partially offset by lower expenses. Cost containment strategies continued. Sales related expenses such as travel and other discretionary variables were lower. We continued to incur some additional costs to protect our employees and customers such as additional safety supplies, benefits extension costs, work from home practices, facility and field sanitation procedures. Additionally, we expect to receive £7,300,000 under the Canadian Emergency Wage Subsidy Program, which is based on revenue declines in the quarter. CEWS was helpful adding to our focus on protecting our skilled labour and salary positions as best possible, managing with a balanced approach in the short term as well as not taking our eye off the long term needs. Net earnings decreased 3% in the quarter versus a year ago. EPS tracking the reduced earnings was $0.94 per share or $04 below 2019. Moving to Slide five, given the challenging environment, we have included a look at the sequential quarter performance. Q3 results have improved from the second quarter as economic activity gradually phased in. Revenues improved, however, new equipment sales remained relatively low, where rentals, used equipment and product support showed the most improvement. Rental fleet utilization improved, which translates into higher margin operating income and earnings. Product support activity is a function of customer activity and was better this quarter as customers were able to go back to work and site restrictions eased. Mike, I will turn it over to you for some detailed comments on the group results. Thanks, Scott. Let's put a bit more color on the operating results, starting with the Equipment Group on Slide six. Revenues were down 5% in the quarter versus a year ago and 6% year to date on reduced economic activity. New equipment sales, product support and rental activity were lower across all geographic markets and product groups. As Scott noted, we did see some improved activity during the quarter, but a tone of caution was evident and activity was still below last year's levels. Cost containment strategies continued to be employed, including human resource initiatives and reduced travel and discretionary spend. New equipment revenues were down 16%, where used was up 37% in the quarter, down 918%, respectively, on a year to date basis, demonstrating the cautious tone that we have emphasized. Construction sales were down 10% in the quarter and down 3% year to date. Sales into mining markets were down 16% in the quarter, 25% year to date across most regions. Material handling sales were down 17% in the quarter, 5% year to date, again mainly due to general to lower general economic activity. Two bright spots included power system sales, which were up 36% in the quarter and 12% year to date, reflecting progress on prime power projects. Sales into agricultural markets were also up 7%, where the strong harvest year to date was relatively unchanged. Rental revenues were down 11% in the quarter, 15% year to date. Most markets and segments were lower, reflecting the gradual phase in of market activity. Light equipment rentals were lower 7%, power 31%, material handling 16%, and RPO rentals 43% in the quarter. That said, heavy rental in the construction market increased 10%. Product support revenues declined 3% in the quarter and 6% year to date with improvement, as Scott noted, in the third quarter as compared to Q2 as restrictions eased. Gross profit margins decreased 50 basis points in the quarter as lower product support activity levels dampened margins down 70 basis points, partially offset by improved sales mix, up 20 basis points with a larger proportion of product support revenues to total revenues. For the first nine months of 2020, gross margins decreased 90 basis points, reflecting challenging markets in the second quarter of the year. On a year to date basis, equipment margins were down 30 basis points, mainly due to sales mix. Rental margins, while improved from Q2, are still lower by 50 basis points than last year on a lower average utilization in the quarter, which is a drag on earnings against our straight line depreciation model. Selling and administration expenses decreased 100 basis points to 12.1% of total revenues and were down 13% in the quarter and 6% year to date, reflecting lower activity levels as well as cost containment initiatives that phased in from Q2. Governmental subsidies under CWS program reduced expenses by 6,500,000.0 for the group during the quarter, totaling 7,300,000.0 year to date. However, excluding these subsidies, selling and administration expenses were down downward trending in both the quarter and year to date, reflecting lower compensation costs, discretionary spending, travel, and training. Bad debt expense was also lower in the quarter, but up prudently on a year to date basis, reflecting the current economic environment. Information technology related costs also increased in both the quarter and on a year to date basis, GBP 1,100,000.0 and GBP 2,100,000.0, respectively, as system enhancements and support for integration efforts at the dealership continued. Let's turn to CIMCO on Slide seven. Revenues were down 7% in the quarter and 10% year to date on lower construction activity stemming in part from construction site restrictions and closures related to the pandemic. Timing of receipt of orders and customer specific construction schedules also affect timing of revenue recognition. Package revenues were down 5% in the quarter. In Canada, revenues remained relatively flat during the quarter as an increase in industrial revenues were offset by a decrease in recreational revenues. In The U. S, package sales decreased mainly due to weaker recreational activity. Product support revenues decreased 10% for the quarter and 4% year to date. With site restrictions and recreational activities limited, usual site maintenance and false start up activities have not been possible and were factors in the quarter. Gross profit margins increased in both the quarter and year to date on good project execution. Operating income decreased 8% in the quarter and 20% year to date, largely reflecting the lower revenues. Selling and administrative expenses were down 3% in the quarter, including the government CWS subsidy reducing expenses by $800,000 Some additional costs are being incurred in this business to support the substantial backlog orders, while other expenses such as travel and discretionary were lower. Bookings were up 15% to £40,000,000 in the quarter and 37% primarily on good activity in the Industrial segment. Backlogs were healthy at two sixteen million dollars at the September, with industrial being higher in Canada and recreational higher in both Canada and The U. S. Approximately 35% of this backlog is expected to be realized in Q4 subject to construction schedules. On Slide eight, I'd like to touch on a few key financial highlights. Management of our working capital continues to be a focus area. Accounts receivable aging is monitored daily and trending well. DSO is consistent with prior years. Inventory levels are also closely monitored, and our order boards have been adjusted in light of market activity. Accounts payable reflects the timing of purchasing and lower extended terms balances. As of September 30, we maintained our strong financial position with cash on hand of GBP $471,000,000 and available liquidity of GBP $714,000,000. Good cash flow allowed us to repay our GBP 100,000,000 draw on the term facility as well. Our returns remained strong. And although impacted by contribution in Q2 and Q3 resulting from the pandemic, They benefit from the actions taken by our team to control spending and manage capital employed. The Board also approved the regular dividend at a rate of $0.31 per share consistent with last quarter. On Slide nine, we conclude with some key takeaways as we look forward to Q4. We will continue to focus on our three key priorities as we have done from the start, protecting our employees, serving our customers and protecting our business for the future. We continue to monitor the situation closely to evolve our business practices appropriately. Our disciplined operating culture combined with the diversity of our customers and installed base, expanding product and service offerings and financial strength position us well to respond to business requirements and execute on our long term business plan. We appreciate our entire team's efforts and commitment to supporting our valued customers during this challenging time and thank our customers, supply partners and shareholders for their continued support. That continues our prepared remarks. We'll be pleased to take questions. Alana, back over to you to set up the first question. Thank you. Please go ahead. Thanks very much, and good morning. Good morning, Cherilyn. With respect to SUs, the convention on the street has been to exclude dues and look at results that way. But the issue with that is that high performing organizations would have made other cost adjust adjustments in the absence of a dues program. So can you talk about how you're thinking about that internally and how you've been approaching that in discussions with your board? Sure. Let me start with that, Shailan. I think, like you say, we we try to be very transparent and disclose, what we're seeing there. And I think Scott made in his prepared remarks, we are very conscious of protecting our skilled labor and managing that balance, right, between what we need short term being cost effective, but also not taking our eye off the ball for the long term needs of the business, right? And so I think again, I think we have incurred other incremental costs, which I think are notable too. I mentioned some IT costs which we accelerated, which is a pull forward. But we have incurred things such as incremental PPE. We've bridged benefits for employees on temporary layoff. And we advanced training. And we've done a number of things, sanitization and so forth, that we're also very mindful of which are embedded in our results, right? Yeah, just, Shirley, mean it was helpful helping us continue to focus on protecting our skilled labor and other personnel in our business. But we're trying to stay disciplined to our operating practices and ensure that it's balance between making sure we're operating in a very tight controlled environment and being conscious of our variable costs, but also we're very attentive to protecting ourselves when an upturn starts. And we're just trying to be very conscious of that. Great. And we don't have a lot of history with the expanded Caterpillar territory, but bookings of three seventy one million dollars looked pretty healthy to me. Was that your take on it? I think it's acceptable in the environment we're operating in. The team did a nice job in there. I think we're proud of the team. This is a unique landscape. But as Mike said, I think the team should be applauded because we also went live with our integration Quebec with the ERP transition. And that was no easy feat. And I'm really pleased and delighted we had no hiccups interfacing with customers. A lot of effort in there. We're still a lot of effort and dynamic in play. But so far, we're pleased with that. And I think the team should be commended with everything going on, COVID impact plus an ERP. I think that was a decent results with and combined with bookings. And then last one for me. Your used equipment sales were quite strong. Is there any perspective you can give us there on how much of that was just rate trade ins, disposals from the rental fleet or packages that your team may have sourced opportunistically? Yes. Good observation, Cherilyn. So we were fortunate how the team positioned us with our used and having options for customers again. I think it's reflective of the cautious environment and the focus on customers' cash flows and things that we had some good value offerings with demo class. I mean our demo class was up over 35% in the quarter sales. We were the teams were more opportunistic with the used purchase developments. And so that was up over 35%, I think. So a combination of that with some rental fleet disposition and trade sales was combined for a very positive outcome on the used revenue sales. So that was a good outcome. The next question is from Yuri Lynk with Canaccord Genuity. Please go ahead. Hey. Good morning. Good morning. Good morning. Just wondering on the when when the the new territory, will be fully leveraging the the ERP and when what that might look like, in terms of the the financial results and and what are some of the goals that you want to see once they get fully up and running? I'm assuming they have to be trained and whatnot on the new system. Yes. It's a good question. I'll start with that one, Yuri. So we did convert to our operating platform the September, about the fourteenth we completed that. And so as you mentioned, I think getting them on one platform, getting the whole company, we did, just as a reminder, we did the Maritimes back in April. And so this brings the new territory onto our platform. And we're in the process now of working through our next quarter. As you can imagine, there are lots of process changes and some change management as the teams get used to the new environment. But what it does do is it does give us very consistent visibility into the different parts of the business. It aligns a lot of the data, a lot of the accounting as well and things like that as we get through the close. And so as we go forward, it's an advantage. But there are certainly there are processes and changes that we are working through with the team so they get used to the new operating environment from their former one. And so, again, that's in support of Toromont Cat business. We did convert the Battlefield rental business a year ago, June. And so they've been well on that system and starting to see some of those benefits to help us grow that business as well over the course of the last year. Yes. Just we've got a ways to go here. And once we plugged in and like we're delighted with what took place there. But as you say, there's a lot of training. We had our branch model embedded last year, so that was good. But now we get to really focus on our operational excellence variables that we can we believe we can leverage more. And some of our best practices with our go to market approaches, we think we can improve on that and improve on logistics and things of this nature. So there is some heavy lifting to come, but the great part is represents opportunity. Now we have to execute. But the great thing is that we are plugged in and we are on a common platform. We still have one more event to go with material handling, but we will get to that in Ontario next year. But we are pleased and looking forward to executing on these opportunities from an operational and go to market approach. That's helpful. My second one, just on mining. Lots of interest industry wide on autonomous hauling, not something that traditionally fit the type of mining in your territories. But is that changing? Are you seeing any increased interest in autonomous hauling? Yes, I think, and we applaud Caterpillar and how they're positioning us in the marketplace there. Lots of dialogue going on, on that front, and we'll see how things materialize. Okay. I'll turn it over there, guys. Thanks. Okay. Thanks, Yuri. Thank you. The next question is from Jacob Bout with CIBC. Please go ahead. Good morning. Good morning, Jacob. Wanted go back to the Quebec Maritimes. And so the integration of the ERP system is now complete. Can you just talk a bit about what is left as far as major steps in the Quebec Maritime integration? Leveraging on an operational side, we look at our product support operational component, and now we have better visibility to the KPIs. There was some I mean, when you are operating off two different platforms, there are some differences in there on how we are handling the flow of data and how we are managing some of the KPIs that we zero in on. So now we have consistency and we'll have better visibility across the enterprise to these KPIs on a consistent basis operationally also how we are managing our assets, right? It was I'll use the word a little clunky at times and how we're working through that. But I applaud how the team were able to maneuver through that. But so we're in a better position with how we are going to manage assets and our return on asset base at the branch levels. And then you get into the interface with the customers. I think we will provide more consistency with our approaches there, our logistics, some of the synergies. It sets us up. But again, we can talk about it. And I think we've made great progress. There's a ways to go even with our heavy rents and power systems fleets. We can manage those more effectively. But now we have got to go execute. We have got to prove it out more, but we are ready for that next phase. Okay. And then activity levels in Quebec Maritimes versus Ontario, you see much difference in the quarter? It was well, what we are encouraged with on the rental services side We saw great improvement in Quebec. Actually, the utilization improved to a touch quarter by quarter. So that was encouraging. Still have a ways to go because we want to get higher utilization in there. But that was encouraging on our Quebec side and Maritimes. The what we saw was the markets improved in Quebec and the Maritimes as the quarter progressed. But we've seen a shift, and this isn't just in QM, it's throughout. A real shift was increase in small product sales activity. So I call it your building construction products in compact. They were extremely active. I think we were up over 35% compared to previous quarter. So that was significant relative to the larger iron activities we saw. And again, I think it's just again, there was if you that landscaping area was very active, things of that nature, but still a cautious environment with some of the larger iron. Last question for me, just on the so equipment bookings, obviously, quite strong, but mining was down 4%. Maybe just comment on levels of engagement and expectations for, say, the next six, twelve months. Yes. So what I mean, mining can be lumpy, as you know, on a quarter by quarter comparison. But it's I think there's a caution. But we keep as you recall in Q2, there was a major shutdown. So Q3, I think it was about getting up and running, which took place. Production improved, activity levels improved, but still a cautious tone when it came to CapEx. And we'll see how things play out here in the coming months in terms of activity on prime products. Thank you very much. Great. Thanks, Jake. Thank you. The next question is from Michael Doumet with Scotiabank. Please go ahead. Hey, good morning, Scott. Good morning, Michael. Good morning. I assume a gradual recovery in product support revenues through The quarter over quarter recovery, going from minus 16% to minus 3%, would imply that you may have exited the quarter in positive territory. Any way you can confirm that? If not, maybe just discuss the overall cadence? Well, it improved and we are pleased with that, but there is still caution in there. And again, our customer here is how we have interpreted what's taken place. So there was obviously some hard stops in there in Q2 and customers were very focused on getting back to work, getting up and running and on all the segments we operate in. And understandably, that's where their focus was and with less so attention to repairs. Mean, our rebuild activity unit basis was down in the quarter about 10%, but that's understandable because customers were focused on executing their jobs and getting back into production mode. So our WIP is down at the end of the quarter, which always concerning going into the next quarter. So but I think it's just reflects the environment we are operating in. And we will see how things progress. Machine utilization is improving and we will see how things transcend. But are in a cautious mode here with the WIP and we'll see how. But again, we are very focused on ultra focused, I'll say, on making sure that we are preparing for an uptick in the product support side. In actual fact, we are back hiring techs. That's the mode we are in. But it's a fine line you are walking, right? And we're focused on the future. Great. Interesting commentary there. Thanks, Scott. And then maybe just what you called out product support as the main area of gross margin pressure in this quarter. And I don't think that was the case last quarter. So I'm wondering here, I mean, if it's strictly volume related or if there's an element there of no lower productivity due to social distancing or other measures. Just any sense of how to think about that going forward? Yeah. I think it's it's a combination of a bit of volume in the mix and, and what took place there. I mean, as I said, the rebuilds were were down. And, but Mhmm. That sort of sums it up there. Yeah. Okay. That that makes sense. And then just and maybe correct me if I'm wrong, but I I don't think you flagged lower rental as a driver for lower gross margins in the quarter. I'm not sure if I missed that, but were you able to offset maybe some lower utilizations with higher rates or lower costs or mix? Just what played a factor there that we didn't see it in gross margin pressure? Well, the utilization improved, but there's still rate pressures in there if you look at the overall activities in the fleets. And power was down on the revenues. We had some shifts in there. It was a bit lumpy on a quarter by quarter comparison. So I mean there's pressures in there. But we were pleased with the uptick in the utilization in the Rental Services side. And but it's a competitive environment right now. Yes. I think to add to that, too, Michael, just like we did speak to the phase in, and I think it's important to understand the utilization rates on average, right? As it sort of phased in over time, activity improved. And so going into July, we have a straight line depreciation model that's pressure on the margins for rental. And you have to get to a certain point before you start to recover that fixed cost, right? And so think of it as a bit of a blend from that perspective, right? Yes. We had a bit of pressure in their material handling as well. Got you. Okay. Well, thanks guys. Nice quarter. Thank you. Thank you. Thank you. The next question is from Maxim Sytchev with National Bank Financial. Please go ahead. Hi. Good morning, gentlemen. Good morning, Max. Was wondering, Scott, maybe if you don't mind talking about how you feel about the rental opportunity over, let's call it, the medium term. COVID know, changing the behavior of the clients sort of permanently, or you think that we're gonna be back to, you know, normal, what whatever that means over, let's call it, I I don't know, nine to twelve months? What what what are your thoughts there? Yes. Well, we're not in a normal environment. But I think the Q3, we saw improvement. But just as an overall rental, even our if we look at our new RPO rental purchase option, I mean, there was a massive shift in there from a year over year basis. Had we've got a decline there of almost 58%. We had over $90,000,000 on rent coming into at the end of Q3 twenty nineteen, and this year, we're down significantly. So it just shows where the environment we're operating in. But I'd say still overall, we are still very much committed to this strategically. When we look at the dollar opportunity and the trends in rental, we are not going to slow down there with our approach. Are just I'd say we are in a unique situation. We're maneuvering through it. It is a bit of a drag, but we're we're still looking at this as strategically a great opportunity, particularly with the expanded territory. Right. Do do you mind maybe I I don't know if you have already done this work, but what are your thoughts in terms of kind of rental CapEx for for 2021, or is this just too early to even contemplate this? Our teams are are going through the planning process right now, and we'll have a better read on that in a couple weeks. But, I mean, we hey, Mike. We were down on our Yeah. Yeah. If you look at our if look at our notes and so forth, you'll see it's that's a big area for us in terms of how we curbed our capital spend and just try to manage the fleet through this period, right? And so an indication would be that we are going to increase our CapEx somewhat, but it's going to be based on the business plan and what we see going into the year as we get closer. And so we'll look to optimize that, Max, as we get into the year. We'll keep our discipline in there, relative to the age some of the aging where you have to stay committed to the level of investment or you'll hurt yourself over the long term, right? Yes. Okay. Okay. That's very helpful. And then curious to see I mean, we've seen Ontario budget yesterday Sounds, you know, pretty, pretty positive from an info perspective. What what are your kind of large construction, clients? Like, what's the body language from from those guys? Maybe any color on on that end market if it's possible. Well, I think that our tone for our customers right now, they're focused on just getting some work done that they have right now. But I think it's all about timing and shovel ready and how quickly things can materialize here. I mean, it's encouraging, but I think we'll sort of in a I think everybody's in a wait and see and see what type of work is released and the timing. Okay. Fair enough. And and and last quick one. Balance sheet is an extremely strong position and and probably going to get stronger over the next twelve to eighteen months. I was wondering if, you care to comment on, capital deployment, priorities over that time frame. Sure. Yes. Great segue. I think keep in mind, the team has done a tremendous job on working capital and CapEx and we're in a good position. Again, what we are preparing for is just to have liquidity and we're in a good position to help as activity picks up and warrants, we will see working capital investment as things build. And so we anticipate that certainly on the inventory receivables side. We talked a little bit, our AP is down and that's just commensurate with timing of purchases and some terms we had. But CapEx is the other variable. So we are, I would say, from a priority perspective, we'll continue to manage our cash flow very carefully. Working capital will be the first draw. We have a number of initiatives for organic growth that will take priority on capital. If the returns are there, we'll continue to push really hard on those metrics and challenge the team to drive those returns. Debt repayment, of course, we're in a good position at this point. We want to maintain that cash balance and liquidity depending on demand and where things go. And again, we're committed to our dividend and so forth and and that sort of thing. But it would be, you know, really operational care and feeding of the business as priority and then have dry powder for for the future. Right? So Okay. That's fair enough. Thank you so much. That's it for me. Thank you, Max. Thank you. This will conclude today's question and answer session. I will now turn the meeting back over to Mr. McMillan. Great. Thank you, Alana. Thanks, everybody, for your participation today. That does conclude our call. We wish you a great day and please stay safe. Thanks again. Thank you. The conference has now ended. Please disconnect your lines at this time and we thank you for your participation.