Earnings Call: Q4 2019

Feb 12, 2020

Earnings release

Good morning. Today is 02/12/2020. Welcome to the Toromont to Announce Fourth Quarter and Full Year twenty nineteen Results Conference Call. Please be advised that this call is being recorded. Your host for today will be Mr. Paul R. Jewer. Please go ahead, Mr. Jewer. Thank you, operator, and good morning, everyone. Thank you for joining us today to discuss the results of Toromont Industries Limited for the fourth quarter and full year of 2019. Also on the call with me is Scott Medhurst, President and Chief Executive Officer. Before we continue, I'd like to advise listeners that this presentation may contain forward looking statements and information that are subject to certain risks, uncertainties and assumptions. For a complete discussion of the factors, risks and uncertainties that may lead to actual results or events differing materially from those expected, refer to Toromont's press release and MD and A from yesterday, which is available on our website. We assume you've had an opportunity to review our press release and related financial information from yesterday, as such, we'll focus on key highlights. Scott will begin with a few general remarks and some comments on our outlook, after which I'll provide some highlights on the financial results. Then we'll be more than happy to answer your questions. Scott? Thank you, Paul, good morning, everyone. On October 27, we passed the two year mark of the acquisition of the Quebec and Maritime operations, and we are very pleased with the progress to date and the benefits achieved. Thanks to the team's effort and execution, our focused on measured and steady pace of integration has already delivered tangible improvements in operating results. The first two years included aggressive system rental prime product and product support investments. This helped lead to increased product support revenues combined with favorable market penetration. We now move to Phase two of the journey, including the integration of a common operating platform at Toromont Cat after completing a successful rental services system integration. We continue on the path to leverage the strengths of the larger geographic footprint and standardize best practices and operational efficiencies across the organization, all while delivering quality and standards that our key stakeholders expect. Much work still remains on the integration, but we are well underway and continue to believe that this expansion presents opportunity for the long term performance and success of our company. With that being said, we delivered solid results in the fourth quarter and full year of 2019 on revenue growth and disciplined expense management. The Equipment Group recorded solid organic growth across its expanded territory on good market penetration into key sectors and strong product support and rental activity on the growing population. Within the equipment group, the core dealership business saw significant growth in key performance metrics, largely reflective of continued success in business integration and market penetration. As we discussed a little in the last quarterly call, the rental services business was challenged to fully absorb the past two years' significant rate of fleet expansion, expectedly leading to reduced profitability on higher depreciation and branch expansion costs. The agricultural equipment business created a $4,900,000 drag on operating income as ongoing adverse market conditions led to a reevaluation of inventory late in the year on top of weak equipment sales. CIMCO generated improved profitability year over year on improved project execution and inventory write down recorded in the prior year that was not repeated. Even with the headwinds, strength of the Equipment Group and CIMCO led net earnings to increase 14 versus a year ago on a 5% increase in revenues. In the equipment group, investment in infrastructure projects and broader construction activity continue to present opportunities for equipment sales, product support and rental businesses and the long term outlook remains positive across most territories. The parts and service business has realized significant growth in recent years, driven by the larger installed base of equipment and provides opportunity for further growth, together with the increased stability and predictability in a variable business environment. Our shops and technicians remain busy and we continue to hire and invest in infrastructure to address growing demand signals. Developing technology supporting remote diagnostics and telematics is very exciting for us and also present opportunities for long term growth. We continue to assess our rental footprint with a disciplined investment approach, which includes a balanced diversified fleet and strategic go to market strategies to stabilize seasonality. We are pleased with the results to date, recognizing it is an aging process which takes time to build the proper infrastructure and absorb these investments. In the mining sector, deliveries in the year were down against a strong year in 2018 with some of this attributed to uncertainties in the broader global economy. Production however continues and we did see an uptick in the fourth quarter and entered 2020 with the solid backlog. The growing installed base of equipment is a good bellwether for future product support activity. Simcoe's project execution improved, but markets remained competitive with a tight pricing environment. Product support growth continues to bode well for long term success, reflecting its strong presence and solid reputation as a leader in the key markets it serves. Booking activity levels were up over last year with higher backlogs entering 2020. Across all our businesses, the diversity of our regions and the markets served, extensive product support offerings and financial strength combined with a disciplined operating culture position us well for the long term. Supported by a strong balance sheet, we remain well positioned to continue to build shareholder value, remaining cautiously optimistic about the significant potential which lies ahead. Considering the company's solid financial position and positive long term outlook, I am pleased to announce that the Board of Directors yesterday approved a 14.8% increase in the quarterly dividend to CAD0.31 per share per quarter. This marks the thirty first consecutive year in which the company has increased dividends. Before turning the call over, I would like to remind everyone that on 03/01/2020, we will begin to initiate an orderly transition, handing the CFO reins over to Michael McMillan as announced on May 1939. Paul will remain throughout the year to assist as needed. Management and the Board thank Paul for his dedicated service and contributions over the past fourteen years. So for the last time, I will now turn the call over to Paul to take you through highlights of the financial results. Paul? Thanks, Scott. Let's put some color on the operating results starting with the Equipment Group. Revenues were up 7% in the quarter and 6% for the year. Total equipment sales were up 7% in the quarter and 2% for the year. Sales in the construction markets increased 8% in the quarter and 9% for the year with good activity levels and market penetration in Quebec and Ontario offsetting lower deliveries into Atlantic Canada, which benefited from one time project activities last year. In mining, sales were up 7% in the quarter, but down 19 for the year. Power Systems sales were up 23% in the quarter and 1% for the year. Sales in the agricultural and material handling markets were down in both quarter and the year. Rental revenues were up 1% in the quarter and 8% for the year. Light equipment rentals were up across all regions on good market penetration and the larger diversified rental fleet equipped to address market demand signals year round. Heavy rentals were lower overall. However, Quebec reported growth on a larger fleet and good project wins. RPO revenues were up 13 in the quarter and 27% for the year with a larger rental fleet. Product support revenues grew 9% in the quarter and 10% for the year on a larger installed base of equipment in the field and good market activity across most segments. Gross profit margins decreased 120 basis points in the quarter and 40 basis points for the year largely on competitive pricing pressures, softness in certain market segments and lower rental fleet utilization stemming from the time required to fully absorb our significant recent investments. The overall sales mix of product support revenues to total revenues had a favorable impact on margins in the quarter and for the year. Selling and administrative expenses were largely in line with last year and lower as a percentage of revenues. Allowance for doubtful accounts decreased in both periods on good collection activity. Compensation costs were up on increased headcount, annual increases and higher profit sharing, partially offset by a $5,000,000 pension curtailment gain recorded in the first quarter of twenty nineteen. Investments in information technology were higher as we roll out proprietary systems across the territory to align best practices and operational efficiencies. Operating income increased 2% in the quarter and 10% for the year. Operating income as a percentage of revenues increased 50 basis points for the year to 11.5%. Bookings decreased 2% in the quarter and 4% for the year. For the quarter, only Power Systems and Material Handling lift truck orders were up, while on a year to date basis only construction orders increased. Backlogs, can vary significantly from period to period were 20% lower at $272,000,000 We expect most of this to be delivered through 2020. Now let's talk about CIMCO. CIMCO's results in the 2018 included a $6,000,000 charge for inventory write down, which was not an item experienced this year. Over and above this, results still improved on better project execution despite the lower revenues. Package revenues were unchanged in the quarter, but down 12% for the year. In Canada, recreational sales were strong in the quarter and year, while industrial sales were unchanged for the quarter, but lower for the year. In The U. S, strong recreational sales more than offset lower industrial sales in both the quarter and year. Product support revenues continued to positively impact results. For the quarter, revenues were in line with the record set last year and up 11% for the year with growth in both Canada and The U. S. Gross profit margins excluding last year's write down increased 150 basis points in the quarter and 190 basis points for the year on improved project execution and a favorable sales mix of higher product support revenues to total revenues. Selling and administrative expenses increased in the quarter and year largely on higher compensation costs related to growing the technician base along with higher profit sharing accruals. Most other expense categories were unchanged or lower as expense management remains critical to mitigating margin pressures broadly. Operating income margin increased to 11.4% in the quarter and 8.5% for the year, principally due to higher margins as a result of the broad based improvements in execution. Bookings in the quarter increased 20% with increases in both Canada and The U. S. For the year, bookings were up 5% with higher recreational orders offsetting lower industrial orders. In Canada, both market segments were up, while in The U. S, higher recreational orders served to offset lower industrial orders. Backlogs of $123,000,000 were up $10,000,000 or 9% versus last year and we expect most of this backlog to be delivered in 2020. On a consolidated basis, net earnings increased 7% to $90,500,000 in the quarter and 14% to $286,800,000 for the year. Basic earnings per share were up $0.06 to $1.1 for the quarter and up $0.42 to $3.52 for the year. Investments in non cash working capital were up $154,000,000 to $464,000,000 versus a year ago, largely due to lower accounts payable resulting from the timing of payments for inventory purchases. In light of transitional terms from suppliers, we strategically managed inventory levels for better positioning and penetration into the expanded territories, which resulted in carrying higher accounts payable in 2018 relative to 2019. With these terms expected to end mid year twenty twenty, accounts payable will revert to more normal levels. At December 31, we maintained our very strong financial position with cash of $366,000,000 and a strong balance sheet. Leverage is represented by the net debt to total capitalization ratio was 15% compared to 18% at this time last year. We're also pleased to continue our long track record of delivering superior shareholder returns, including the 14.8% increase in dividends announced today and a 21.4% return on opening shareholders' equity and a 22.9% return on capital employed. That concludes our prepared remarks, and we will be pleased to take your questions. Laurie? Thank you. We will now take questions from the telephone lines. If you have a question, please press star one on your telephone keypad. If at any time you wish to cancel your question, please press the pound sign. Please press star one at this time if you have a question. There will be a brief pause while participants register for questions. Thank you for your patience. And the first question is from Cherilyn Radbourne from TD Securities. Please go ahead. Thanks very much and good morning. Good morning, As we look at the Equipment Group's results for the year, a couple of things that we noticed. It looks like new equipment demand improved in the second half of the year, while at the same time rental growth seemed to slow in the second half. And product support really remained quite robust through the entire twelve months. So just curious, when you look at that in totality, how would you say that market activity evolves over the course of 2019? So in terms of the equipment sales, Cherilyn, a couple of things going on in there. The Quebec market was solid throughout the year and came off a bit in the fourth quarter, but it was very active and I am talking about overall industry numbers throughout the year. And we are pleased with our market presence throughout the year and some solid execution on that front. The actual Ontario, Manitoba markets were down a bit, but we saw some uptick in the fourth quarter, but we attribute that to smaller sales and snow business and then Atlantic was down. But overall, we are very pleased with our market presence. So we had solid execution on that front. Other thing to take into account, Cherilyn, is whenever you do a year over year comparison as you know, we're not quarter to quarter guys, right? And we consistently say that. But as you look at year over year comparisons now breaking it down into half one, half two, you have to take into account what was happening last year as well, right? So we had some really good uptick in Quebec last year in the second half and especially in the fourth quarter with some good deliveries. Okay. But overall, Cherilyn, the activity we're pleased with our activity and presence throughout the entire Eastern Canada territory. And but there was a shift to smaller iron. Okay. And so in terms of the anecdotal feedback that you are getting on customer backlogs and just customer confidence levels, can you make any comments in that regard? Yes. Well, as you know, the backlog, there were some shifts in there regarding power last year in the fourth quarter that had an impact if you do a quarter over quarter comparison year over year. So as we've always said, you get some lumpiness in there due to the mining and the power. And then availability was good. We had solid inventories to meet the demand signals last year. So that impacts your backlog as well. But as I said, some of the markets were softer and that is indicative in the bookings and some of the backlog. Okay. And how are you thinking about net rental adds for 2020 after a couple of years of pretty strong investments? Yes. So our utilization was down, but we expected this. We have been very aggressive on the investments and it takes time. I would say we are midway through the full cycle here before we get into the full disposition component of the model. So it has been a it's a drag right now, but the revenues are up and we were very pleased in the fourth quarter, both on the heavy and the lighter rental services business with the improvement in the revenues in Quebec and Maritimes. So that was good. But still, as we pointed out, there is heavy depreciation costs in there and it takes time to absorb it over the full cycle of the model that we are building. So if we just look at our light equipment rental fleets, Cherilyn, in this year we would have invested in 2019 somewhere around $100,000,000 on a net basis, so net of dispositions. We certainly have put in the financial capital and it was important to do so as we rebalance the fleets basically to make sure that there was allied product that was there to basically fight against seasonality, cyclicality and turn this business into a real full rental services business. As we move now and transition into latter part of that year and move into the next year, we've got good processes in place. The team did a great job of putting the system in place. There will be a lot more focus on people and processes and alignment and getting that stuff deployed, right? So as I talked about in the third quarter call, talked about absorption, which is just the reality of as you invest financially, you have to make sure that you can turn the stuff around in the shop with the people. And as we make the forays into new markets, recognize that we can move a market as well at the same time. So I would see that investment coming down a little bit from $100,000,000 last year to, I don't know, dollars 60,000,000, 65,000,000 maybe this year. Okay, that's helpful. I'll pass the But call on to someone before I do, Paul, I just wanted to wish you our very best on your next stage. Thank you, Cherilyn. Thank you. The next question is from Jacob Bout from CIBC. Please go ahead. Good morning. Good morning, Jacob. Morning, Jacob. Just on the ag equipment, the charge you took, can you just talk about the magnitude and the nature of the charge in the fourth quarter? And then maybe comment on how you are feeling about your ag use inventory position? And is there potential here for further write downs? So as we look at it, it's hard to separate, Jake. What we're dealing with is an industry which has been down for a period of time. And certainly, if you look at some of the public market comparators that are out there, you see that, that challenge spreads across Western Canada. So we took a hard look at it, took a hard look at inventory positions. We certainly wrote some down. We referred to a $4,900,000 year over year drag. Some of that is due to those adjustments, probably $1,000,000 or so. There's other stuff that we just said, look, let's move it out to auctions and clean up the inventory. So that's somewhere sub $1,000,000 or so. And beyond that, revenues were off, right, in that down industry. So that led to some declines in profitability overall as well. So it's a challenging market. It's been challenging to generate returns. We've got good people. We've got good processes. We've got a good business model, but it's just challenging at this point in time. And what is your mix right now of ag overall equipment sales? Mix in terms of what's the contribution of ag itself? Yes. It's sub-one $100,000,000 basically in product support and It's reflective of the markets across Western Canada right now, Jacob. We were aggressive dealing with it. But in this type of environment, you are never comfortable with your inventory. And then the other question I had was just on the construction markets, seeing strong results in the quarter, but maybe talk a bit about the dynamics of between Ontario and Quebec. When we look at the Ontario non res construction data, things appear to be improving. Would that be something you would echo? What we've seen so far is and I look at it through on a full year basis, our Ontario market was softer, but it was the shift in the heavy construction. So what we saw was softer, larger equipment opportunities, okay? So your heavy construction was down, whereas if you look at your general construction markets, it was up slightly. So and I think that's reflective of some of the segments that you're referring to. Quebec was on a year over year basis, it was up slightly three points. But again, it was coming off a very solid year prior. So Quebec was stronger and so that's how it played out for last year. There was a shift to smaller iron. How do you think 2020 shapes up? I don't think this is an environment to speculate in right now. Paul, good luck in retirement. Thank you, Jake. See you on the bay. Thank you. The next question is from Michael Doumet from Scotiabank. Please go ahead. Hey, good morning, guys. Good morning, Michael. Good morning, Michael. Just circling back on the rental. I wanted a little bit of a clarification on softer margins. Now understanding the model generates profits both on rental and dispositions. I want to get a sense if the rental weakness had more to do with the incurring of higher proportional depreciation or softening rental economics, I. E, lower rental rates or utilization? I think the biggest factor is depreciation that we're dealing with, right? So across all of our financial practices, Michael, we maintain a level of conservancy in terms of the selections that we have. So for example, when it comes into rental depreciation, we have simple straight line depreciation. It's not utilization based. It's just if we put it in the fleet, it's there and it's through, right? So at through a period of time in which you're getting that absorbed both internally into our processes and getting it into the marketplace and absorbed from a demand basis, the appreciation gets up. And if you look at it on a year over year basis, I think total depreciation at our light equipment business would have been up $8,000,000 versus the prior year and almost $3,000,000 basically on a quarter to quarter basis. So that's a factor that does come into play. But the rental revenues were we were pleased with our activity in Quebec. I mean the rental services Quebec business, our rental revenue was up 27%. So we were pleased with that activity. It's just as Paul is stating, the infrastructure cost, depreciation costs are a drag. Okay. No, that's interesting. And just from a historical perspective, I mean, lower like rental rates or utilization rates aren't necessarily well off from what you've been trending at historically. There was pressure there in the quarter. They were down slightly. Okay. And the thing to state, Michael, is our convection remains extremely strong in the opportunity that's presented by our Rental Services business. Okay, perfect. And just turning it over to gross margins in the quarter, understanding it was a tough comp, but any way you can break that 120 basis points down into I think you mentioned the revaluation of the ag inventory, but just in terms of equipment margins versus rental margins and where the pressure came from? Yes. So the pressure as we talked about was in the rental and the ag segment, but it was also we had strong new equipment sales. And with it being more weighted to smaller iron that had an impact as well. And so those are the factors and a bit of mix on the parts. Okay, perfect. Thanks guys. And just before turning it over, Paul, congratulations on a very successful career at Toromont. Thank you, Michael. Thank you. The next question is from Devin Dodge from BMO Capital Markets. Please go ahead. Hi, good morning guys. Good Good morning. It seemed to us that the outlook commentary was a bit more positive than what we've seen the last couple of quarters. Was this primarily due to less uncertainty around Ontario Or were there other factors that we should be thinking about? I think we were pretty consistent. I'm not sure anything really changed in there. Nothing intentional. Okay. Fair enough. Let's see. I guess, Paul, how are you feeling about your inventory levels now? You might have I might have missed this in your opening commentary, but we saw a pretty significant drawdown there in Q4. Just wondering if you feel there's more room to go? Or are you satisfied with where inventories are given the outlook in your business? The drawdown that you would have seen would have been the normal seasonal trend, right? So you expect inventories to come down as you close off the year. And then the inventories would naturally increase now as we head into the spring months. So I still think that the inventory levels are high. The management team is very focused on it, making sure that our order boards are adequate and support basically the requirements that are there. But I think we have a little bit too much capital allocated. So I would expect on a year over year basis it to come down. Seasonally and consecutively, you will see that go up a bit as we move into the spring. That's normal buying patterns. We remain focused in there right now on our inventory management, particularly some aging and things of that nature. That's helpful. As well as our RPO was up about 8%, so we are focused on that area as well. Okay, thanks for that. And maybe just to come back rental fleet was significantly larger this year, but Q4 revenues, I mean, up pretty modestly. It seems like you're pointing to time utilization, maybe a little bit less on rental rates. But just can you give us a sense for how much was maybe the overall demand environment versus some of these maybe internal efficiencies that you're going to be going after? And should we expect this drag to kind of ease as we move through 2020? Will this last throughout most of next year? So just an overall comment on the rental services strategy. I'd say we're midway through before you really start to so we're two years in and we won't see that disposition coming through a while. But on the what we saw again, Quebec rental activity was good. We were pleased. We saw some shift and it's tough sometimes when you get into the project work. So there was a shift in project work on the heavy rental side for Ontario Manitoba and that was down. So that was a decline in that environment. Okay, makes sense. Paul, just thanks for all your help over the last couple of years and good luck in your next steps. Thanks, Devin. Take care. Thank you. The next question is from Ben Cherniavsky from Raymond James. Please go ahead. Good morning, guys. Good morning, Ben. Morning, Ben. Can you elaborate a little bit on what's happening both in the markets and with your strategy on the materials handling side? I think now you've sort of been in that business a couple of years. And how has that evolved? Where do you see it going? How has it performed? So we're pleased with how we're performing in Quebec. And we did last year, Ben, it was a full deep dive and we made a lot of changes in there last year, both structurally and how we go to market with our sales coverage. So we feel good we have addressed that. We addressed and identified a lot of opportunities on the service and part site operationally. So I would say we identified the areas that we really need to aggressively pursue now operationally as well as for Ontario market penetration. So I think we are structured right now. Still a ways to go to prove this model out. But Quebec, are pleased with. And so we like where we are positioned, but we have to go execute. I'd say we're still in relatively early innings at this point in time. So we've got the teams kind of aligned and we're at the early stages of identifying the system requirements to enable those teams to better manage their business. And we're gaining an understanding as to what the opportunities are in there. Of the different business components that we picked up in the acquisition 2017, I'd say it's probably the lag as to the focus on the integration. The other area we're focused on there is the rental side, Ben. That we believe strategically represents an opportunity. And so we're just working through that the way we like to run that rental business. Would you be prepared at this stage to give any indication, a range, ballpark figure as to what kind of capital requirements you have in mind for that business to get it to where you think it could be over time? We're going to have our full rental assessment completed in first quarter twenty twenty. And then we will have a real good assessment on what's required there for CapEx. We've got a general idea that we've carried, but I think we're going to be completing this full assessment Q1. Okay. I'll stay tuned. Just on some of the comments on the competitive pressure, maybe you can elaborate on that a little bit, what equipment class you're seeing that in. Is it really just has availability just got a whole lot better and dealers have more inventory now? Is there anything more to it than that? I would say, I always treat this as it's always competitive. And particularly we saw far more activity in the smaller CCE BCP products and that's an awfully competitive environment in there, but we performed well. We were pleased with our performance. But as you know, Ben, it's very, very competitive environment in there with some of those segments and products. Okay. Fair enough. Paul, I would echo what everyone else has said. You've made our job easy over the years. Thanks for that, and best of luck in retirement. Thank you, Ben. Thank you. The next question is from Maxim Sytchev from National Bank Financial. Please go ahead. Hi. Good morning, gentlemen. Good morning, Max. Good morning, Max. Just a quick question, if it's possible to have an update on sort of all the processes integration, eventual ERP harmonization. Just yes, maybe any color on those internal things, if it's possible. Yeah. So we were very pleased with how we integrated the rental services businesses. That was a non event, which is a word we like when we go through these changes. So we'll go through an orderly transition here with and it's not a major go live event across an entire enterprise. We'll do it piece by piece. And so that's where we're on plan. Okay, that's helpful. And then Paul, maybe just a question for you. In terms of, as as you talked about some of the payment terms normalizing, so is it fair to say that we should again be modeling a negative noncash working capital for 2020? Do do you mind maybe just commenting there? That that's a that's a very real possibility. I mean, we we see basically being able to manage this within existing cash balances. Right. And do you care to provide bit of a ballpark or not at this point? I really can't pin it down to that level at this point, Max. Okay. All right. Well, fair enough. And Paul, obviously, all the best. Thank you, Max. Take care. Take care. Thank you. The next question is from Cherilyn Radbourne from TD Securities. Please go ahead. Thank you. Just a couple of quick follow ups for me. Obviously, gold has continued to be strong, and product support has remained quite robust for you. Any thoughts on whether new equipment demand in the gold sector could improve in 2020? Well, we'll just go off what we saw in the fourth quarter. There was some activity in there in the fourth quarter. But obviously I would say in general it's a cautious environment right now. We are pleased we are still weighted well to gold. We look at our entire Eastern Canada portfolio now. But the fleets are active, production is going on. So we are encouraged with that component of opportunity on the product support side, but we will see. Okay. And then just on capital deployment, the balance sheet is really substantially delevered post the Hewitt acquisition. I appreciate that payables are going to normalize over the course of 2020. But would you think about moving to the higher end of your dividend payout range or consider even increasing the high end of that range? Well, certainly ticked up in the range with the increase that we just announced yesterday, right? And typically, the range that we have would have us peaking at about 48%. We continue to believe that that's right. And by 40%, I mean, as a percentage of trailing EPS. The most recent increase would take us up to 36%. Obviously, we're mindful of continued investments that are required to successfully continue this integration. So we're pleased and we're confident and we're moving forward on that basis. Thank you. That's all for me. Thanks, Caroline. Thank you. There are no further questions registered at this time. I'd now like to turn the meeting back over to Mr. Jewer. Thank you, Laurie, and thanks, everyone, for your participation today.