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Good morning. Today is Thursday, July 25, 2019. Welcome to the Toromont to announce the second quarter 2019 results conference call. Your host for today will be Mr. Paul R. Jewer. Please go ahead, Mr. Jewer.
Thank you, Sergey, and good morning, everyone. Thank you for joining us today to discuss the results of Toromont Industries Limited for the second quarter and first half 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&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. And 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 and financial results. Then we'll be more than happy to answer your questions. Scott?
Thank you, Paul, and good morning, everyone. We believe our teams delivered solid results in the second quarter, leveraging the strength of our larger organization. We are now in the second year of our integration plan, embedding our operating philosophies and practices and continuing to gain a much better understanding of the opportunities presented by the expanded territory. We are very pleased with the collaboration and leadership demonstrated by our team and the progress we've achieved together. The integration plan continues, and much work remains. I'd like to highlight a few key developments during the first half of 2019. The team continued to integrate consistent safety practices, rolling out new initiatives. Work continues on the processes and consistency to achieve operational excellence, component rebuild center productivity, consolidation of the S•O•S Lab into one facility and improve sales coverage. We increased the deployment of capital towards the expansion of rental fleets as availability of product improved. Across the entire Toromont CAT business, the growth and product support demonstrate the strength of leveraging the combined organization. The team continues to make positive strides, embracing the value delivered to customers by offering a choice of new, used and rental fleet products. We are encouraged with the improved level of sales activity for larger construction equipment in the Québec and Maritime markets, with an understanding we must continue to prove that the product support service offering will make a difference to our clients. The rollout of our Battlefield Full Rental services model continued with the integration of broader product lines taking hold and contributing to increased revenues in Québec and the Maritimes. During the first half, our Battlefield team was heavily engaged, rolling out our proprietary technology platforms and tools across the Québec and Maritime operations, all while executing the business plan, ensuring our client needs were met. This significant integration went live on June 3, with many of the legacy leaders at the site of 25 facilities that were transitioning to the new system. We are proud to say mission accomplished. We thank our entire Battlefield team and leaders for their exceptional effort, ensuring a successful transition. Undoubtedly, much work remains on the overall integration plan. We thank our entire group, as it's our people and teams who make the difference, while we remain focused on building a strong and sustainable platform. On the business front, consolidated revenues increased 2% in both the quarter and year-to-date on growth in product support and rentals across our businesses, more than offsetting declines in equipment sales. Investment in our rental fleets across Eastern Canada is beginning to yield results. Net earnings were up 14% in the quarter and 15% year-to-date after adjusting for nonrecurring gain recorded in the first quarter. In the Equipment Group, investment in for -- infrastructure projects and broader construction activity continue to present opportunities. The parts and service business has realized significant growth in recent years, driven by the larger installed base of equipment and provides opportunity for future growth, together with increased stability and predictability in variable business environments. Our shops and technicians remain busy, and we continue to hire to address growing demand signals. The increased investment in rental fleets also continues to present opportunities to grow and stabilize seasonality. In the mining sector, activity has been slower to date this year, but production at existing mines is generating meaningful product support opportunities with the potential for incremental equipment sales to facilitate mine expansion. CIMCO's project execution improved in the quarter, but markets remain competitive with tight pricing environments. Strong product support growth continued to bode well for the long-term success. Booking activity and backlog levels, albeit down from last year's levels, are in line with expectations. Across all of our businesses, the diversity of our regions and markets served, extensive product support offerings and financial strength combined with the disciplined operating culture position us well for the long term. I will now turn the call over to Paul to take you through highlights of the financial results. Paul?
Thanks, Scott. Let's put more color on the operating results, starting with the Equipment Group. Revenues were up 2% in the quarter and 3% year-to-date on higher product support, rentals and used equipment revenues. New equipment sales across the group were adversely impacted by softer construction activity in most of Ontario, Manitoba and Atlantic Canada; caution in the mining sector on lower commodity prices; and general economic climate and limited supplier availability of certain models in the power system sector; together with customer project deferrals. Consequently, total new and used equipment sales were down 7% in both the quarter and year-to-date. Sales in the mining markets were down 4% in the quarter and 27% year-to-date against a tough prior year comparator, which included large deliveries. Construction sales were down 2% in the quarter and 1% year-to-date. Good growth continued in Québec, Northern Ontario and the Arctic. Power system sales were down 24% in the quarter and 9% year-to-date. Material handling sales, revenues and sales in the agricultural markets, both smaller market opportunities for us, were down in the quarter and year-to-date. Rental revenues were strong, increasing 15% in both the quarter and year-to-date. We are pleased with the growth arising from our increased investment to expand and diversify the fleets. Product support revenues grew 12% in the quarter and 11% year-to-date on growth in both parts and service in most markets. Gross profit margins increased 50 basis points in the quarter and 40 basis points year-to-date, principally due to a favorable sales mix of product support revenues to total revenues. Selling and Administrative Expenses in the first quarter included a nonrecurring gain, which I'll exclude and not reference for the remainder of the year-to-date remarks. For the quarter, expenses were down 1% and flat as a percentage of year-to-date, translating to lower expense-to-sales ratios. Operating income increased 11% in the quarter and 12% year-to-date on the higher revenues and gross profit margins. As a percentage of revenues, operating income increased 100 basis points in the quarter and 90 basis points year-to-date. Bookings increased 1% in the quarter, but were down 9% year-to-date, reflecting growth in construction orders, offsetting declines experienced in other segments. Backlog of $403 million was 1% lower than this time last year. We expect substantially all of this backlog to be delivered this year. Let's turn now to CIMCO. Revenues were down 5% in the quarter and 1% year-to-date. Package revenues decreased 17% in the quarter and 15% year-to-date. In Canada, lower industrial sales were more than -- more than offset increases in recreational activity in both the quarter and year-to-date. The growth achieved in Atlantic and Western Canada was more than offset by decreases in Ontario and Québec. In the U.S., industrial sales were lower in both the quarter and year-to-date, while recreational sales were up in the quarter but down year-to-date. Product support revenues increased 14% in the quarter and 18% year-to-date to new records for the respective periods in both Canada and the U.S. Gross profit margins increased 360 basis points but were down 20 basis points year-to-date. Package margins increased in the quarter on improved execution but were down on a year-to-date basis. Product support margins were lower in the quarter and year-to-date against a tough prior year comparator, which included good pickups on certain project closeouts. The favorable sales mix of product support revenues to total revenues serves to somewhat mitigate the margin pressures. Sales and Administrative Expenses were up 5% in the quarter and relatively in line year-to-date. As a percentage of revenues, expenses were up 150 basis points in the quarter and 20 basis points year-to-date. Operating income increased 30 basis -- 30% in the quarter to a new second quarter high, and was up 210 basis points as a percentage of revenues. Year-to-date, operating income was down 9% and lower by 40 basis points as a percentage of revenues. Bookings were down 27% in the quarter and 6% year-to-date, largely reflecting lower industrial orders and higher recreational orders. Backlogs of $148 million were down $15 million or 9%, and we expect approximately 2/3 to be realized as revenue this year over the remaining of the year. On a consolidated basis, net earnings increased 14% to $77.4 million in the quarter and 15% to $113 million. Basic EPS was up $0.12 to $0.95 for the quarter and up $0.18 to $1.39 year-to-date. At June 30, we maintained a very strong financial position. Leverage as represented by a net debt to total capitalization ratio was 26% compared to 28% at this time last year. We're also pleased to continue our long track record of superior shareholder returns, delivering increased dividends, a 22.3% trailing 12-month return on opening shareholders' equity and a 22.5% trailing 12-month pretax return on capital employed. That concludes our prepared remarks, and we will be pleased to now take your questions. Sergey?
[Operator Instructions] Our first question comes from Michael Doumet of Scotiabank.
Nice quarter. So the Equipment Group, product support was up across most markets, but demand signals seem to vary region -- or by region and end markets as it relates to new equipment sales. I can fully appreciate that the 2 businesses don't share the exact same drivers, but I'm just trying to get a better sense of what's driving the strong, strong growth in product support, whether it's market demand efficiencies realized from the combination of the platform or market share?
Yes. I think the product support growth is a reflection of the installed base throughout the enterprise. The other trend we're seeing is, again, we continue to see very strong trends along the rebuild of machines. And particularly, this quarter in our Québec and Maritimes, we were really pleased with how the team executed the rebuilds. I think the unit comparative year-over-year rebuilds was up like 150% in Québec and 50% in the Maritimes, so we're starting to get some traction in there with our customers on different value propositions on the product support side. And then we continued to have good strength in the legacy businesses. And of course CIMCO, we're really pleased with the product support trends in there as well.
And what's your visibility on the sustainability of the rebuilt activity there?
Well, I think that all comes down to the value proposition relative to how the customers interpret these offerings. And I think we're improving our quoting activity in this area as well. Our quoting activity is increasing, so we'll see. But so far over the last, I'd say 1.5 years, we see some nice trends in there.
Agree. Okay. And just maybe shifting over here. You highlighted that there was caution in the mining sector due to lower commodity prices. If I remember correctly, a large portion of the Ontario Mining business comes from Gold Mining customers. I would think Québec also is a large precious metal customer base. Any way you can highlight for us specifically which mining end market from a metals perspective you're seeing more bearish market signals from?
Yes, base metals. I mean you're right, the gold prices are still favorable. But we're -- there's a cautious environment there right now. If you look at the industry activity for -- and I'm talking industry activity for mining, it's down year-to-date. But mining is lumpy, so we'll see. There's quoting activity in there. We got to earn the business. And you get that lumpiness in product support, but there was still an uptick there in the quarter.
The next question is from Jacob Bout from CIBC.
The softness you're seeing in the Ontario market. Are you seeing any improvement on the horizon? And in your mind, what is driving this?
A couple -- well, I'll just talk to what we've seen so far. So what we've seen is, when you look across our territory, the softness was in the legacy. I mean overall, when you look at the larger -- the larger [ area ] was down 10%. The heavy construction was down 15%. So -- but we're pleased with our performance in the market, in down markets. So that was good. I think there's been -- there's some grayness still in there, in some of the short-term infrastructure in Ontario. And so we'll see how it plays out. But the -- actually, on the construction side in the quarter we did see a little bit of improvement in the bookings, if you isolate construction.
And on the infrastructure side? I mean is this just quibbling between the provincial and the federal government? Or how are you thinking about that?
I don't want to get into the political arena here. We're just -- there's some grayness.
And then just as far as the margins that you're seeing with QM versus your legacy businesses. How is that gap closing?
Well, we're pleased with the traction on some of our operational excellence, KPI platforms. We -- and obviously, the uptick in the product support helps in there. We also were very pleased with the -- we've done -- we've been aggressive in the first half on the rental fleet uploads. And if you look at our rental stores, I mean, in QM we were up over 40%, 47% revenue growth. So that's very encouraging. And then in the shops, we're seeing some improved consistency with some of the platforms and productivity levels. But it's coming, but we don't want to get too far ahead of ourselves. It's -- we've got a ways to go, and -- but there was improvement.
Last question here is just on CIMCO. So 14% growth in product support sales, but package sales were down 17%. What's driving the disparity there? And are you losing market share on package sales?
No, there's some softer activity. And then again, you can get this timing of work. We're pleased with our quoting activity, particularly in Canada. We were really focused in the last -- or in the first half in particular on improving -- we've had some bumps in our execution. And so we were pleased with some positive trends relative to some changes in how our deal structure works, our approval processes and our execution in the field, so that was a bit encouraging to see some of the improvement in the margins. But the quoting activity is decent. The backlog is still a bit solid, just it's down.
Revenue in any given quarter can be lumpy, Jacob, as you deal with percentage of completion and whether or not we hit our triggers. I mean WIP was up, which mitigates it somewhat. So I wouldn't take anything from a specific quarter.
But the industrial bookings and backlog in Canada and U.S. for CIMCO were down quite sharply.
Yes, they are.
Yes.
They are down ...
What do you attribute that to?
There was some softness in there, and there was some competitive activity. But again, we're -- the quoting activity is strong, so we'll see how it plays out.
And the lumpiness of orders is a reality, right? It's a relatively tight market that you're dealing with, so you can definitely get lumpiness of orders that comes into play here, Jacob.
The next question is from Cherilyn Radbourne of TD Securities.
I wanted to start by asking about the rental business. On the light side, obviously, you've got good growth in the quarter and year-to-date. On the heavy side, you were down in the quarter and kind of flattish for the year-to-date. Could you just give us some color on the different dynamics in both of those market segments?
Yes. So the heavy -- we're just building that platform in QM. But on the legacy side, it was down that, and we'll attribute that to -- we had some favorable project activity last year that had a demand [ signal ] that we were able to fulfill on the heavy rental. And we just didn't see that type of project work in the legacy business in the first half, so that explains really what took place there. The good thing was we got back to being able to work into our model, which we like as the disposition of products. Because if you recall last year, Cherilyn, we were tight on inventory, so we had to shift some of the upload to the retail side. So we got back and the disposition was very favorable in the first half for the heavy rental. In terms of the -- if you look at that rental story, we've been aggressive, uploading, broadening those lines in the QM business and you saw it with tremendous uplift in the revenue streams. I mean our teams were encouraged that we can quote now on larger projects with those broader lines and our participation improved and -- as did the execution side. Now with that, of course, you've got a lot of infrastructure cost in there, higher depreciation, and it's still going to take a while for that to model to fully embed itself over the long term.
Great, that's helpful. On Power Systems, you make the comment that results there were to some degree impacted by limited supplier availability and some customer project deferrals. Like is that kind of a timing issue?
Yes, there was some slippage in there, just some of the products were delayed. But -- so that was the outcome. But again, the backlog is decent and the -- really pleased with the product support growth in there on the Power Systems side throughout the enterprise in the first half.
Okay. And then it sounds like the IT rollout went very well at Battlefield. I wonder if you could just talk a little bit about how you would expect that to benefit the execution in the QM territory going forward.
Yes. So now we get far better visibility with the common platform. And then again, I compliment our teams. They were able to continue to deliver with our customers while this integration was going on, and so what that -- it will do now is bring us better visibility to how we like to assess the fleet activity and the benchmarks we look at on those rental fleets on a consistent basis. So that -- we're really encouraged that -- with that -- those 25 operations transitioning in on a common platform.
We think that our -- Cherilyn, we think our technology platforms are a key part of the success of the Battlefield model that we've had over time. The ability to track assets, the ability to redeploy assets efficiently, the ability to understand the performance of specific assets and maintenance repair on specific assets is a key part of that operating efficiency that we deliver into the marketplace. So we're quite pleased to have that completed.
And then just last one for me. You had $31 million of additions to PP&E in the quarter. Does that just tie back to the technology rollout at Battlefield?
The technology rollout of Battlefield is relatively immaterial, right? So on a -- the total CapEx that we spent on it would be $900,000 and might cap out about $1 million. And in addition to that, we have soft costs of somewhere around $250,000. I mean essentially what you're looking at there in terms of those acquisitions would be land and facilities.
The next question is from Yuri Lynk of Canaccord Genuity.
Just wondering if you could perhaps give us some flavor for the drivers behind the 7% decrease in equipment sales. You mentioned the cautious stance of the mining customers; some softer construction activity; and thirdly, the supplier availability issues. How should we think about those 3 in terms of which ones impacted the sales the greatest?
Well, the availability improved. And so that...
Other than power.
Other than power. But overall, construction availability did improve, and that can impact the backlogs as well. But really, what we're dealing with here is mainly in legacy, the softer market activity levels. But we were pleased with our performance in there. I mean I think this quarter really highlights the importance of the acquisition and what it means strategically that we have far better geographic reach and diversity in there. And I think that was exemplified in the quarter because of the softer activity levels. When you have heavy construction down [ 15% ] as industry activity, I mean, that's reflective of what's going on in there.
And were unit sales in the legacy business down about the same amount as what you experienced?
Yes. I mean with less activity, you're going to have less units sales. But we were pleased with our performance relative to the activity. Teams did a nice job ...
Relative to the industry activity.
The industry activity.
Yes, okay. Second, just switching to the product support side. Can you -- is there a major difference between your parts market share in Ontario versus Québec?
If you break down some segments, there is. And that's -- this presents opportunities. And that's why we're very focused on improving our value position -- propositions with the parts and service. We highlighted that in our comments because that's opportunity for us, and we are starting to see some improvement.
And I assume that opportunity's in Québec?
It's throughout the Atlantic region and Eastern.
And we think -- I mean, broadly, we think there's opportunity for increased [ ops ], which is our parts market share term across, the whole business. But we think that certainly as we embed our approaches to business, we think that the opportunity is certainly great in our expanded territories.
Yes. This is a key strategic area for us, and with the -- getting better data points to benchmark off and -- which highlights some of these opportunities.
Okay. Last one for me. Are there any other IT rollout initiatives we should be expecting in the coming months?
Yes, sure. I mean broadly, we are slowly integrating all of our platforms across the entire business. So as I've often said to many I have engaged with, Battlefield was certainly the quickest out of the mark. They probably would have been a little bit even faster except for the requirement for some French translation for the software that they had. So it was slowly integrated and, as we said, fully launched June 3 of this year. As we progress, we're also progressing on the dealership integration and moving to more fully integrate and deploy some of our proprietary systems across. That will be a slow process that we'll take -- we'll take our time to deal with it. So we'll start to roll out individual applications and address individual areas over the course of the next couple of years and realize the efficiencies related to it.
The next question is from Derek Spronck of RBC.
Just on the QM, which did quite nicely, did you attribute it primarily due to the fact that you're employing your legacy model in QM and you're seeing a nice lift from there? Or is there an actual end market difference between the QM versus the legacy markets?
Well, we're certainly trying to -- that's part of the integration plan is to bring consistencies on the operational excellence side, and that continues, and we're pleased with the progress and we are pleased the Québec markets were far more active, and our teams executed nicely in there as well. But that product support side, the productivity levels, the execution is a key area of focus for us, and we are pleased to see some improvement there in the quarter. But we're not getting too far ahead of ourselves. We're focused on those CRC, Component Rebuild Centers. We're focused on the throughput on the shops.
Would you say the end markets are healthier though in QM relative to legacy as well?
Yes.
Yes.
Okay. And the CapEx spend of $30 million. Was that primarily related to QM? And how should we be thinking about that over the next 2 quarters?
We're investing broadly across the business, right? So it isn't all related to QM. But certainly, in the legacy side of our business as well as we plan for our own requirements, how we should think about it for the whole year is, right now, in our plan. As we've conveyed before, we're looking at a plan of approximately $60 million for PP&E, which is up a bit from $35 million last year. Let's see if we hit the plan or not.
Okay, great. And just on the SG&A front. I mean you've been able to hold SG&A relatively flat for the last several quarters. You've kind of indicated that you are looking to increase hiring, in particular on the technician side. What's resulting to that stable SG&A while, at the same time, you're communicating that you're ramping up hiring? And what -- how should we be thinking about it over the next several quarters as well?
I mean obviously, there is an awful lot of puts and takes that you deal with in an individual quarter, and you can deal with certain components that can go plus or minus as you deal with individual areas. But largely, our focus is on cost control. And as we embed our efficiencies across the business of this larger enterprise, it's our hope that we'll get some -- we'll be able to leverage that a little bit stronger. As we deal with technicians and the hiring of technicians, I mean, clearly those are in cost of goods sold basically, so it's not an SG&A element. And certainly, that's -- it's a different factor there and we continue to focus on it. And on a year-over-year basis, I believe we had an increase of somewhere around 83 technicians in total in Toromont CAT.
So what we look at here by branch is the revenue-producing component of it to help get good ratios in there.
Would you say like the $125 million -- somewhere in and around that absolute level would be a good level to go with out into 2020?
We don't have a target to give you, Derek, at this point in time. I mean we're trying to run the business as best we can to maximize the opportunity that we have, so how that slices down on an individual basis will be seen.
Okay, fair enough. And then just one last question for myself. Are you utilizing third-party vendors for your used equipment sales and/or are you increasingly somewhat indirectly used equipment yourself through your branch network?
We like the direct model, we like to be sticky with our customers and give them good value propositions, and that's what we saw. We were pleased with some of the used sales and particularly the disposition. Those are good offerings.
It's important part of our business model.
Yes.
Is there like a percentage you could provide, like 90% direct, 10% third party or...
You know what? We -- very, very high percentage goes direct. Very rarely will we go third party, only if needed.
The next question is from Devin Dodge of BMO Capital Markets.
So price realization from CAT seemed to be pretty strong in H1, Q2 in particular. Just can you talk about the competitive environment in your markets? Just given with some of the softness you're seeing on the new equipment side? I know the [ MD&A there ] that overall equipment gross margins were up slightly, but this included a shift towards used equipment. Just wondering if you're seeing any kind of gross margin pressure just on the new equipment side?
That's the business we're in, it's competitive. But we -- when you get that -- the rental fleet disposition model going and use that, that helps a bit on the margin. But you know what? It's competitive. It's -- we've been playing in that type of environment for a while.
Always, Devin, the other factor that always has to be taken into consideration is while manufacturer price increases or changes happen on a frequent basis, the other factor we deal with is FX movement. So obviously, that's a dynamic that we deal with, and those always lead to puts and takes and pluses, minuses. It's a -- as Scott says, it's a regular part of our business that we have to manage.
And then maybe a question for you, Paul. But inventory in the equipment group has risen a fair bit so far in 2019. Can you talk about your comfort level with current inventory levels, how do inventory turns look to you right now? And how should we be expecting inventory to trend in the back half of the year?
I'd say we're a little bit long in inventory right now. So we're focused on -- we've had some good success on getting deliveries of product that had been less available a year ago, so we're focused on the level that we have right now. It's up -- in total, inventories are up about $200 million versus a year ago, and we'd like to see that down a little bit.
[Operator Instructions] The next question is from Ben Cherniavsky from Raymond James.
All my questions have been asked. I'm good.
Thank you, Ben. Have a great day.
There are no further questions registered at this time. I would like to turn the meeting back over to Mr. Jewer.
Thanks, Sergey, and thanks to everyone for their participation today. [Foreign Language] That concludes our call. Have a great day.
The conference has now ended. Please disconnect your lines at this time. Thank you for participation.