M&A Announcement

Feb 15, 2019

Good day, ladies and gentlemen, and welcome to the Toro Company Acquisition of the Charles Machine Works Inc. Conference Call. My name is Miriel, and I will be your coordinator for today. At this time, all participants are in a listen only mode. We will be facilitating a question and answer session towards the end of today's conference. I would now like to turn the presentation over to your host for today's conference, Heather Hilly, Director of Investor Relations and External Communications for The Toro Company. Please proceed, Ms. Hilly. Thank you, and good morning. The press release announcing our definitive agreement to acquire Charles Machine Works was issued this morning by Business Wire and can be found in com. On our call today are Rick Olson, Chairman and Chief com. On our call today are Rick Olson, Chairman and Chief Executive Officer Renee Peterson, Vice President, Treasurer and Chief Financial Officer Julie Karakas, Managing Director, Tax and Treasury and Nicholas Rose, Director of Business Development and Strategic Planning. We begin with our customary forward looking statement policy. During this call, we will make forward looking statements regarding the proposed transaction, our business and future financial and operating results. You all are aware of the inherent difficulties, risks and uncertainties in making predictive statements. Our press release and the Form 8 ks that we filed this morning as well as our other SEC filings detail some of the important risk factors that may cause our actual results to differ from those in our predictions. Please note that we do not have a duty to update our forward looking statements. Finally, more detailed information concerning the contents of this call are included in an investor presentation available on our company website, thetorocompany.com. With that, I will now turn the call over to Rick. Thank you, Heather, and good morning to all of our listeners. Today, we are pleased to announce that The Toro Company has entered a definite agreement to acquire privately held Charles Machine Works with a portfolio of businesses that include Ditch Witch and other leading brands in the underground construction market. The transaction subject to customary closing conditions including regulatory approvals is currently expected to close before the end of our fiscal 20 19 Q3. With origins dating back to 190 2 and headquartered in Perry, Oklahoma, Charles Machine solutions to cover the full lifecycle of underground pipe and cable from installation and inspection to repair and replacement. The robust portfolio includes horizontal directional drills, walk and ride trenchers, utility loaders, vacuum excavators, asset locators, pipe rehabilitation solutions and aftermarket tools. The company is known as the underground authority for their deep understanding of the structures and systems in the market and the most important needs of underground construction professionals. For calendar year 2018, revenues were about 725,000,000 dollars The transaction is consistent with our capital deployment strategy of investing in value added acquisitions with a specific focus on growing our professional segment, global expansion, water and technology related applications. Charles Machine Works has long been a provider of cutting edge innovations across their portfolio, starting with the invention of the first world's first utility trencher in 1949. From that point on, their focus on the underground structures and systems that move resources across the globe has evolved and grown from natural gas pipelines and high voltage electric lines to water systems and communication networks. These underground infrastructure needs and challenges only grow more pressing as the world advances. Charles Machine Works' state of the art repair and replacement techniques to solve issues and address new opportunities has fueled their continued growth, as have their advancements in robotic applications, line inspection cameras, ground penetrating radar, 3 d imaging, software and mapping systems. These smart technology applications and accompanying expertise will help us accelerate and advance our employees, investments in technology, best in class dealer networks, long standing customer relationships and commitment to community. As an organization, Charles Machine Works aligns well with and we expect it will contribute to our strategic priorities of profitable growth, operational excellence and empowering people. Consistent with our stated M and A strategy, the company expands our business in a meaningful way in a category we know well through our own specialty construction business and in a market that attractive given the need to address both aging infrastructure currently in place and new infrastructure that will be needed to support next generation technologies in telecom and other markets. Culturally, our 2 organizations are also very well aligned, which in our experience has been essential to the success of our acquisition on innovation, brand and channel, while understanding the importance of long term relationships and strong community partnerships. Charles Machine Works has a rich multi generational family legacy, commitment to its employees and market leading position. We have respected and admired the organization for many years. As we have consistently stated, we have a very disciplined approach to acquisitions. Opportunities that align with our stated priorities and will contribute to our financial performance. We establish and foster relationships with potential partners, in many cases, over an extended period of time. When opportunities arise, we have the benefit of an existing relationship and a deep understanding of what is important to them. This acquisition is no exception, and we were excited when joining forces became a possibility. We are confident that together both companies will be stronger, and we expect to accelerate profitable growth and achieve cost synergy opportunities. I'd now like to turn the call over to Renee for a more detailed discussion of the transaction terms and preliminary financial acquire Charles Machine Works for $700,000,000 in cash. We expect to fund the purchase with new debt for which we have already obtained commitments. The purchase price of $700,000,000 represents a multiple of approximately 8x Charles Machine Works' calendar year 2018 EBITDA, inclusive of $30,000,000 of anticipated annual run rate synergies phased in over 3 years. The transaction is attractive on many fronts. Not only is it consistent with our capital deployment strategies, but it is also expected to be immediately accretive to EPS, excluding purchase accounting adjustments and transaction related expenses. It provides a platform for expansion and significant scale in professional end markets such as water, telecom, utilities, oil and gas, rental and construction, many of which are associated with cycles that differ from Toro's existing shareholders. Also, the anticipated cost saving synergies totaling an average annual run rate of approximately $30,000,000 will create additional value. Specific cost synergies that we've identified include overall SG and A leverage and elimination of private company costs. We also believe there will likely be the higher end of our stated target of 1 to 2x debt to EBITDA leverage ratio and is our intent to maintain that target. We expect to prioritize debt repayment in the near term. Obviously, when the acquisition closes, we will update our guidance. I I and leading edge innovations complement and accelerate our product development investments. Together, we are well positioned to our best in class channel networks. Charles Machine Works aligns well with our strategic priorities of profitable growth, operational excellence and empowering people. I am very optimistic about the momentum our combined strength, talents and resources will generate in the future as we drive profitable growth and long term value creation for our shareholders. I will now turn the call over to the operator so that we may take your questions. And our first question comes from Sam Dakaraj from Raymond James. Your line is now open. This is Josh filling in for Sam. Thanks for taking my questions and congratulations on the announcement. Once you combine your existing business with Charles, where will your market position be versus Vermeer? We will be in a market leading position. Vermeer is obviously the other major player in the largest segments that Charles Machine Works competes in. But we will be a leader depending category by category, we will be market share leader or 1 or 2. Got it. And how should we think about incremental margins for Charles? And what's the recent growth rates been like? Yes. When we look at their current EBITDA, which you can impute from the information provided, it's important to keep in mind that this was a private company and managed as such. We do see synergies, as I spoke about, in a number of areas, and we have more work to do in this area as we go through between sign and close. But we see a lot of opportunity to improve, the cost structure really of the combined organization. So we'll look across Toro as well as Charles Machine Works with a focus on sourcing, manufacturing optimization and leveraging SG and A. So like incremental margins on volume as I try and think about what to add on top of the synergies as we look out? Yes. I think we will be providing additional guidance that are updated guidance after close at or after close that will maybe give you more of that information. At this point in time, we're keeping our guidance the same and sharing more of the historical performance from a Charles Machine Works perspective as well as what we would expect to capture through synergies. And recent sales growth rates? Recent sales growth rates have been consistent with what we're seeing in our specialty construction business. We would expect to see that continue in the mid to upper single digit type of growth rate. And again, we'll ensure that when we update our guidance, we include that in our overall sales guidance for Toro. Got it. And do you have a sense of the mix of the debt and cash you'll be using to finance it? Yes. We're anticipating that most of the purchase will be funded through new debt. We will certainly, part of the cash will be associated with that as well. And last one for me. What will the D and A expense be, including the new amortization? Or alternatively, can you quantify initial EPS accretion? At this point in time, we're just indicating it's going to be immediately accretive, excluding the transaction expenses and purchase accounting adjustments. We will be including when we give revised guidance after close. We'll be including further information on how it will fit into the overall Toro cost structure. Our next question comes from Tim Wojs with Baird. Your line is now open. Thank you. So, Renee, you had mentioned that the businesses or the cycles that kind of drive, Charles, are a little different than your core business. Could you kind of break out what the end market exposure is in kind of percentage terms to We could speak to the major exposures. So you We could speak to the major exposures. So you kind of listed them off. Telecom would be the largest at roughly certainly the largest portion of it. Utilities would be another. The rental and construction part of the business. The locating portion of the business, which is more of the technology side of things. So those would be the major ones, communications, utilities. Okay. Okay, great. And then when we think of we think of just kind of how you'll maybe toggle cash usage going forward, would you expect to still do buybacks once you close or would you really focus on reducing the debt? I'm just trying to think of I know you'll probably prioritize the debt, but just given your cash flow, can you do both? Or will you do both? Yes. As we look forward in the short term, because we'll be at the high end of our stated debt to EBITDA ratio, we would certainly focus more on repayment of debt in the short term. If we go a longer period of time, I mean, we would anticipate that we'll have very solid cash flow. And we continue, though, with the same overall capital allocation approach. And keep in mind that as we talk about that, we really start with opportunities for profitable growth, and this fits right into that with the acquisition, maintaining our dividend and growing that as our EBITDA or as our EPS grows. And then share repurchases really is our use if we haven't found a more effective or productive way to deploy that cash. So we would follow that same approach in the future as well. Okay. Okay, great. And then when you look at the $30,000,000 of synergies, should we think of that as kind of ratable realization over the next 3 years? And if you had a bucket that in terms of purchasing and some of the manufacturing efficiencies and some of the SG and A reductions, how would you bucket that, that $30,000,000 Yes. I think thinking about it ratably is So we're going to see probably more in that area just based on where the dollars are. And then SG and A is a smaller amount, but still sizable, that's an area that we'll look at. And as we stated, we do think there'll be synergies that we'll likely capture from a working capital perspective and potentially revenue synergies as well. Okay. Okay. And then I guess the last one I have is just how much is OE versus aftermarket and parts for the business? If they have a sizable parts business, as you can imagine, with the type of products that there are and the wear and tear that it takes. But traditionally, we haven't broken out parts separately for the Toro business just from competitive reasons and would likely do the same from a Charles Machine standpoint. But it's safe to assume as any kind of capital item, the service parts is a significant portion. Important part, but we don't typically break that out. Is it probably fair to assume that it's just given the types of equipment that it's probably higher than the core total business? I can't say that from a I don't have the data to be able to confirm that one way or the other. We will say one of the sub businesses is in the consumables portion of the business. So that is a standalone business actually. The next question comes from David MacGregor from Longbow Research. Good morning, everyone. And congratulations. I know this is something you've been thinking about for many years actually. So it's nice to see you get it done. Thanks. How do we think about the size of the combined rental and specialty construction business? Can you size it for us from a revenue standpoint? Yes. That's difficult to do. So if we size, you're talking about the end market? No. I'm talking about your CMW business plus the existing Toro Specialty Construction business. Just how big is this business kind of revenue wise on a pro form a business? You're picking up $725,000,000 of revenues plus whatever you've got in the legacy Toro business. What does it combine to? So we were we've been a player in this market, but much smaller player than Charles Machine Works. So it would be additive to that. But the largest portion would be the portion that is Charles Machine Works today. Is there any way you can I mean is it half of what CMW is your legacy business? No. David, as Rick had mentioned earlier, some of the bigger pieces are actually in more of the telecom and communications pieces would be probably the biggest single piece of Charles Machine Works. Rental is significant, but if you had to rank it as far as like the order, it's probably 3rd or 4th in the order of magnitude for the Sorry, specific to rental. Yes, the rental piece, specific to the areas of focus from a Charles Machine Works standpoint. Okay. And then it looks like there's about an 8% EBITDA margin here. I'm just wondering how that compares with what you get now in your comparable business? Yes. Our comparable business is certainly a much more focused area overall and in much smaller. So it's really hard to compare the 2 because the product line is not as broad. And as we've stated in the past, we don't break out the specialty construction, but we say it's a fairly small piece of our business. So they're just it's difficult to compare the 2. It is it would be part of our professional business. So it would be in that category. As we've talked about before, there's a range within the professional business, but it would fall into the professional sort of category expectations. Sure. Any acquired debt? No. Okay. And talk about the global dealer network for CMW. How much of the $725,000,000 is U. S. Versus international? And how extensive is that global dealer network? From an international versus U. S. Based, it's similar to Toro's profile. So rough numbers, plus or minus a few percentage, 75 North American base versus 25 international. And I will say one of the things that matches up really well with the 2 companies is our the value that we place on the channel and the relationships with our channel partners. They have an extraordinarily strong channel worldwide. And it has been very early on conveyed the importance of that to Charles Machine Works and their success. And that's a great alignment with how we feel about our channel partners as well. So it's one of the values that we see in the acquisition. Yes. So we will it's really a combination of the 2. So we have key players that will remain in place with Charles Machine Works. The current CEO, Rick Johnson, will stay on board, but he will transition his responsibilities. We will have a Toro person have overall responsibility for the family of companies Toro model in that respect. So it will be a combination. And so and compensation changes would be aligned and consistent with the success of the integration and the synergies. So that's much more to play out on that as we head towards the close, but that's the expectation. And I would just add on the compensation that would be true for Toro as well as Charles Machine Works. So incentives aligned with the success across the organization. Great. Great. Well, thanks very much and congratulations. Thank you. Thank you. Our next question comes from Joe Mondillo from Sidoti and Company. Your line is now open. Hi, good morning everyone. Good morning Joe. Hi Joe. In terms of the synergies, just wondering what sort of upfront and then the 1st few months that you can realize versus sort of the consistent improvement or realization over the 3 years? Yes. We would say some of the areas that we'll look first would be easier probably to execute on would be the purchasing power sourcing type of synergies. Manufacturing optimization, we'll look again across the portfolios. They're not just at Charles Machine Works, but also at Toro, those would take a little bit longer to realize just based on the type of organization. And then some of the SG and A, there's as I stated, some of the private company expenses would go away more immediately. Just an example of that was we both have Boards of Directors. I mean, when we come together as a combined company, we would have 1 Board. And some of the services that are provided like external accounting, things like that would also be very immediate. So there is going to be in the 1st year, we'll focus on some of those quick hits, if you will, really good really good synergy opportunities. Okay. And can you quantify anything, say, 1st couple of months that you can sort of realize? Or is it sort of what you Yes. What we had said is we thought it would be somewhat ratable over the 3 years. And when we give guidance upon closing, we will ensure that we incorporate that into our guidance as well, Joe. Okay. And then one question about the D and A. Just can you say what the D and A of the company is prior to the purchase accounting? Yes. Well, what I can say is that their historical practices have been very similar to Toro from a PP and E perspective, They do have some additional acquisitions that they've done in the past, but it's not terribly different than the Toro profile of what you would see. So as a percentage of sales or could you quantify the depreciation at all or any other guidance you can provide? Depreciation and amortization would be go ahead. Nick, do you have that? Yes. So, this is Nick. Historically, the company has been about 2% or 3% of revenue has been depreciation and amortization before hard to see accounting impacts. All right. And then the interest rate on the debt that you've already secured, what would that be? So this is Julie. We plan to do $500,000,000 of floating bank debt and $200,000,000 of longer term fixed private placement. And we will incorporate that into our guidance as well, but we're still in the process. We have a bridge committed right now, but we're now going to work towards our permanent financing. Okay. And then, Okay. And then one of the last questions I have is, could you talk about the competitive landscape within much of the product categories at the business? Compared to Toro, your strongest businesses, say, golf, you have a couple competitors down to resi, which is much more competitive. So where does the competitive landscape sort of fall within your existing product portfolio? Sure. The analogy to golf, I think, is probably closer than the residential side. As you look at the specific segments that Charles Machine Works competes in, there are different sets of competitors. The most probably the broadest competitor in the largest categories would be, again, Vermeer. So in those categories, it would be somewhat similar to our golf type of market in terms of the competitive landscape. The other categories with the other brands and businesses would have more specific competitors for those markets, But it's closer to a golf type of profile from a number of competitors than it is to certainly to the residential side. Okay. And then just competitive landscape and the market share and such. In the competitive landscape and the market share and such. In terms of your sort of average gross margins, where would this business sort of fall compared to that? Well, initially, the gross margin would be slightly less. But again, if you look overall at overall margins, we feel that post acquisition and post $30,000,000 in synergies, we'll be right back on par with where Toro would be. It certainly falls well within our Professional segment in terms of typical range of margins at this point. We have a follow-up question from Sam Ditosh. This Josh again. I noticed they have a production facility in China in one of the slides. Can you talk about what's made there and if there's any risks around the ongoing trade dispute? Sure. So that is a joint venture with a company in China. It produces products, underground products specifically primarily for the Chinese market. It's not a major portion of the business. And we have we were not aware of any specific issues relative to the trade dispute. One of the reasons is it's primarily for the China market. Got it. Thanks. And Josh, this is Nick. The product portfolio is largely horizontal directional drills. That business is not consolidated as part of the business today. It is accounted for on an equity method. Okay. This concludes the question and answer session. Ms. Hilli, please proceed to closing remarks. Thank you for your questions and interest in The Toro Company. We look forward to talking with you again next week to discuss our fiscal 2019 19 Q1 results and to address any other questions related to the acquisition that you may have. Thank you, and have a good day.