Titan Machinery Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 31, 2023

There are 11 speakers on the call.

Operator

Greetings, and welcome to the Titan Machinery Inc. 2nd Quarter Fiscal 20 24 Earnings Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded.

Operator

I would now like to turn the conference over to your host, Mr. Jeff Sonnek of ICR. Thank you. Please go ahead.

Speaker 1

Thank you. Good morning, ladies and gentlemen, and welcome to Titan Machinery Second Quarter Fiscal 20 24 Earnings Conference Call. On the call today from the company are David Meyer, Chairman and Chief Executive Officer O Larsen, Chief Financial Officer And Brian Knudson, President and Chief Operating Officer. By now, everyone should have access to the earnings release For the fiscal Q2 ended July 31, 2023, which went out this morning at approximately 6:45 am Eastern Time. If you've not received the release, it's available on our Investor Relations page on Titan's website at ir.titanmachinery.com.

Speaker 1

This call is being webcast and a replay will be available on the company's website as well. In addition, we're providing a presentation to accompany today's prepared remarks. You may access this presentation now by going to Titan's website again at ir.titanmachinery.com. The presentation is available We'd like to remind everyone that the prepared remarks contain forward looking statements and management may make additional forward looking statements in response to your questions. These statements do not guarantee future performance and therefore undue reliance should not be placed upon them.

Speaker 1

These forward looking statements are based on current expectations of management and involve inherent risks and uncertainties, including those identified in the Risk Factors section of Titan's most recently filed Annual Report on Form 10 ks as updated and subsequently filed quarterly reports on Form 10 Q. These risk factors contain a more detailed discussion of the factors that could cause actual results to differ materially from those projected in any forward looking statements. Except as may be required by applicable law, Titan assumes no obligation to update any forward looking statements that may be made in today's release or call. At the conclusion of our prepared remarks, we will open the call to take your questions. With that, I'd now like to introduce the company's Chairman and CEO, Mr.

Speaker 1

David Meyer. David, please go ahead.

Speaker 2

Thank you, Jeff. Good morning, everyone. Welcome to our Q2 fiscal 2024 earnings conference call. On today's call, I provide a summary of our results then Brian Knutson, our President and Chief Operating Officer We'll give an overview for each of our business segments. Bo Larsen, our CFO will then review financial results For the Q2 of fiscal 2024 and conclude with some commentary around fiscal 2024 full year expectations.

Speaker 2

We will also follow-up on the O'Connor's acquisition that was announced yesterday with a high level overview. We carried a strong momentum into the 2nd quarter with revenue increasing 29.4 percent to $642,600,000 This performance reflects double digit same store revenue growth across all three of our operating segments, a combined $86,000,000 Contribution from the Heartland and Pioneer Acquisitions. Our organic revenue growth was also balanced across equipment, Parts and service, each of which performed well and also delivered healthy gross margins. Taken together, We generated a consolidated pre tax margin of 6.5% and diluted earnings per share of $1.38 Which is more than a 25% increase over last year's Q2 earnings performance, which once again demonstrates the strength of our organization and the efficiency by which we are operating the business. Next,

Speaker 3

I'd like to

Speaker 2

provide an update on our equipment inventory. Consistent with our prior expectations, we are seeing some improvement in equipment availability of several equipment categories, but do not anticipate receiving shipments of high horsepower tractors, self propelled sprayers or wheel loaders In excess of customer retail units, we continue to see demand for these products sustained at high levels and expect that to continue into next year. With our suppliers' production capacity is being limited, We do not anticipate replenishment towards targeted minimum stocking levels for these equipment categories until at least The second half of calendar year twenty twenty four. This is undoubtedly limiting our sales levels, but I'm very proud of the team for achieving these record results given all of these constraints. Now as you may have seen last night, we're also very excited about our definitive agreement to acquire O'Connor's, The largest Case IH dealership group in Australia and a market leader in high horsepower equipment.

Speaker 2

O'Connor's has a seasoned management team with a proven track record of driving solid financial performance through a combination of organic and acquisitive growth For over nearly 6 decades, additionally, their operating metrics, core values and customer centric focus highly aligns with our own, making them a great partner for our entry into the Australian agriculture market. In their fiscal year, which ended on June 30, 2023, O'Connor's generated revenue of $258,000,000 and an EBITDA of $21,400,000 which demonstrates the scale of the network they've developed. Combined, the Titan Machinery Enterprise, including the O'Connor's acquisition, Is expected to generate annualized revenue of approximately $2,900,000,000 and approximately 200,000,000 dollars and adjusted EBITDA, which makes us an even more formidable player as a global agriculture and construction equipment dealer. Australia is the largest wheat producer in the Southern Hemisphere and the 3rd largest wheat exporter only behind Europe and Russia. O'Connor's stores are located in Australia's highly productive grain belt, which produces 60% of Australia's wheat.

Speaker 2

The Australian market is benefiting from strong fundamentals that are being driven by enhanced productivity, economies of scale and farmer profitability. O'Connor's focus on high horsepower cash crop production equipment in Australia's Grain Belt region is being supported by Combined farm expansions and increasing adoption of precision ag technology that enhances productivity and crop yields. These trends are very similar to that of Titan's domestic and European agriculture business and coupled with Australia's native English language In comparable legal system, this transaction bodes well for seamless integration that carries over into our shared values and customer centric focus. We believe it also provides Titan with the unique operational synergy opportunities to expand our global customer service capabilities and capacity across the network. The The Australian market is in the early stages of dealer consolidation and through a combined approach where we are able to leverage O'Connor's existing leadership team By bringing Titan's broader capabilities and resources to bear, we believe we are well positioned to capitalize on Continued opportunities to unlock network synergies while driving market share gains.

Speaker 2

Together, we believe we will be able to build upon their presence in the heart of the Australian grain belt and capitalize on operational synergies across our 3 continent footprint consisting of some of the best global agricultural markets generating significant value for our shareholders. We're excited to welcome the O'Connor's management team and employees to the Titan Machinery family and we look forward to a smooth transaction closing and integration process. We expect closing to be completed in Q4 of calendar year 2023. In closing, We remain highly encouraged by the ongoing demand we are seeing in our business and we're working hard to get our customers their equipment as OEM production Delivery schedules allow. Our team is ready to support our customers through the very busy harvest and year end construction seasons in the second half of our fiscal year.

Speaker 2

With that, I will turn the call over to Brian Knutson for his segment review.

Speaker 4

Thank you, David, and good morning, everyone. Today, I will provide a recap of our fiscal 2nd quarter segment drivers and then review some of our high level expectations for the balance of fiscal year 2024 across our respective segments. I will begin with our domestic agriculture segment, which produced strong organic growth with same store sales that increased 10%. As you heard from David, we continue to be acquisitive And the O'Connor's transaction is particularly exciting. Our organic growth in the Ag segment was further bolstered by revenue contributions from our recent acquisitions in our domestic market.

Speaker 4

We are also particularly pleased with our ability to maintain our strong pre tax margin execution, which remain consistent with the prior year period at 7%. Although spring planting got off to a late Start this year in some of our northern markets. Crop progress across our footprint is largely back on track following some timely precipitation. Although this presentation was inconsistent across the upper Midwest, yield potential has improved from earlier this summer, which is encouraging and is helping improve farmer sentiment. Additionally, with the planting delay, We realized some additional parts and service activity that moved from Q1 into Q2, which is also reflected in the strong growth that we reported today.

Speaker 4

As David touched on in his commentary, we are still experiencing tight supply in several of our highest selling equipment categories. Our dedicated inventory procurement team continues to work tirelessly to obtain as many of those units as we can from our OEM partners, Other dealers, lease returns and through the used market. Most other categories of equipment have returned to more normalized levels And this same inventory procurement team has been monitoring inventory trends and have made the appropriate adjustments to purchasing volumes to optimize inventory levels and we'll continue to do so on a forward looking basis. While we remain focused on pre sell, especially for Cash crop equipment. We feel good about where we have landed and are happy to have replenished stocking levels for many equipment categories that we can So we can serve our customers well despite not yet being able to procure enough equipment in our key cash crop product categories.

Speaker 4

We also have a team dedicated to our inventory valuation process in regards to ongoing mark to market as well as determining what price we should offer a customer for a trade in unit. This team also intensely monitors internal and external market trends And is continually adjusting our trade in pricing on a real time basis to ensure healthy margins on future used equipment sales. Our used equipment inventories are in a very healthy position due to our industry leading inventory management processes, which are the result of our scale, decades of experience and continuous improvements. Looking to the balance of fiscal 2024 for our agriculture segment, we remain on track with the modeling assumptions that we laid out at the beginning of the year. Net farm income remains well above historical averages and continues to support demand for equipment purchases.

Speaker 4

Further, with healthy farmer profitability remaining in place, coupled with continued tax incentives surrounding Section 179 and bonus depreciation, The environment is setting up well for a second half strong second half of the year. Although equipment Shortages in cash crop categories are expected to persist. We do foresee an increase in available slots as we move through calendar year 2024. Nonetheless, long lead times coupled with strong fundamentals have our order board consistent with our prevailing expectation That the industry is well positioned heading into next year. Now shifting to our domestic construction segment.

Speaker 4

Construction activity was strong throughout our footprint during our fiscal Q2 and we generated another great performance in all areas of the business With same store sales growth of 18.5 percent and excellent pre tax margin expansion of 60 basis points to 6.2%. We also achieved rental fleet dollar utilization of 30.2% An absorption of 91.2 percent. General construction activity remains strong And Infrastructure, Energy and Agriculture Projects continue to support demand for construction equipment, which has resulted in year to date segment revenue growth of 13%, which is above the initial modeling assumptions we provided at Beginning of the 2024 fiscal year. Although equipment availability is also a limiting factor in the near term for certain types of construction equipment, We continue to see a favorable backdrop as a result and as a result are increasing our full year modeling assumptions for this segment today. Now moving to an overview of our International segment, which represents our business within the countries of Bulgaria, Germany, Romania and Ukraine.

Speaker 4

Same store sales increased 15.9% in the fiscal 2nd quarter and pre tax margin remained very healthy at 6.1%. Conditions varied across our European footprint with excellent growing conditions in Germany and Ukraine, Contrasting with those of Bulgaria, which is experiencing dry growing conditions, which are also present in Southeastern Romania, although to a lesser extent. As a part of our footprint build out strategy in our current German market, we acquired an adjacent 2 store dealership complex in Germany during the second Looking forward to the balance of the year, we are updating our modeling assumptions to reflect somatic conservatism given our Year to date growth of 7.8%, which was at the low end of our prior range. We continue to expect European Ag fundamentals to moderate with flat volumes given the ongoing conflict in Ukraine and the challenges with equipment availability that we see across the other segments of our business. Before I turn the call over to Bo, I'd like to echo David's comments with respect to the O'Connor's team.

Speaker 4

A few months back, I had the privilege of touring all their stores and traveled their entire footprint. Doing so confirm my expectations of their highly productive agriculture landscape and I met a number of Throughout my visit, I was very encouraged by how similar our company cultures are, which is a testament to the focus that their leadership team has brought to their business over the years. We are extremely excited to welcome them to the Titan family and look forward to a smooth integration. With that, I just want to thank all the members of our Titan family for their hard work and dedication to our customers, which have produced fantastic year to date results. Now I will turn the call over to Beau to review our financial results in more detail.

Speaker 5

Thanks, Brian, and good morning, everyone. Starting with our consolidated results for the fiscal 2024 Second Quarter, Total revenue was $642,600,000 an increase of 29.4% compared to the prior year period. Our equipment revenue increased 28% versus the prior year period, led by incremental revenue from our recent acquisitions as well as double digit same store sales growth across all three of our reporting segments, which combined for a 12.1% increase on a same store basis. This growth was also visible across our other revenue streams as well with our parts revenue increasing 39.7%, Service up 27.3 percent and rental and other revenue up 11.6% versus the prior year period. Gross profit for the 2nd quarter increased 29.9 percent to $133,000,000 Gross profit margin increased by 10 basis points to 20.8%, driven primarily by a slight mix shift to higher margin parts sales relative to equipment sales.

Speaker 5

Operating expenses were $88,800,000 for the Q2 of fiscal 2020 compared to $68,800,000 in the prior year. The year over year increase of 28.9% was primarily additional operating expenses due to acquisitions that have taken place in the past year as well as an increase in variable expenses associated with the increased sales. That said, we are pleased to achieve some modest operating leverage of 10 basis points versus the prior year as a percentage of sales. Floorplan and other interest expense was $3,700,000 as compared to $1,600,000 for the Q2 of fiscal 2023, primarily due to higher interest bearing floorplan borrowings driven by higher inventory levels. Net income for the Q2 of fiscal 2024 Was $31,300,000 or $1.38 per diluted share and compared to last year's 2nd quarter net income of $25,000,000 or $1.10 per diluted share.

Speaker 5

Now turning to our segment results for the 2nd quarter. In our Agriculture segment, sales increased 34.4 percent to $469,100,000 This growth was driven by our acquisitions of Heartland Ag Systems and Pioneer Equipment as well as same store sales growth of 10%, which was achieved on top of a strong performance in the prior year period. Despite the strong quarterly performance, 2nd quarter revenues continued to be constrained by the equipment availability of high demand cash crop product categories as already touched on during this call. Agriculture segment pre tax income was $33,000,000 and compared to $24,900,000 in the Q2 of the prior year, which implies a pre tax margin decrease of 10 basis points to 7%. Our construction segment continued its momentum in the 2nd quarter and grew sales to $82,900,000 up 18.3% compared to the prior year period.

Speaker 5

Benefiting from broad based construction activity and improved equipment availability in some equipment categories. Pre tax income was $5,200,000 and compared to $3,900,000 in the Q2 of the prior year. And our year over year Pre tax margin increased by approximately 60 basis points to 6.2%. In our International segment, Sales increased by 16.9 percent to $90,600,000 which reflects a 2.1% currency tailwind on the strengthening euro. Net of the effect of these foreign currency fluctuations, the segment achieved sales growth of 14.9%, which included a modest year over year decline in Ukraine as it remains impacted by the ongoing conflict.

Speaker 5

Pretax income was $5,600,000 and compares to $5,900,000 in the Q2 of fiscal 2023, which implies a pre tax margin decrease of 150 basis points to 6.1 percent. Now on to our balance sheet and inventory position. We had cash of $53,000,000 and an adjusted debt to tangible net worth ratio of 1.0 as of July 31, 2023, which is well below our bank covenant of 3.5. Our total inventory balance at the end of the second quarter was $979,400,000 an increase of approximately $275,500,000 during the 1st 6 months of this fiscal year. This increase came via growth in equipment and parts inventories of $259,100,000 $15,000,000 respectively.

Speaker 5

Of the total increase, dollars 22,000,000 is attributable to the Pioneer acquisition, which was made during the Q1. The primary driver of the increase is the improvement in new equipment availability from our OEM partners As they are largely caught up on production outside of those key high horsepower equipment categories that David and Brian both mentioned, which are still on allocation. Overall, we are still a bit short of targeted stocking levels of available for sale inventory. Driving by some of our ag store locations, the lack of high horsepower display units is clearly notable. To put it in perspective, we have 74 ag dealerships domestically and at today's industry volumes and cost of equipment, We target a combined $7,000,000 of new and used whole good inventory on average per location, Which is the minimum we need to have 1 or 2 stocking units for sale, demonstration or loaner for our highest demand categories.

Speaker 5

Add in a couple of weeks backlog to account for pre delivery inspection work and you get to our target of about $600,000,000 versus the $540,000,000 we are at today for our domestic Ag segment, which implies a shortage of about $60,000,000 However, if you then consider that backlog remains above targeted levels, while we continue to normalize those turnaround times, Our available for sale inventory is actually about $100,000,000 short of targeted levels. As for other segments, While there are still key shortages impacting construction and international, their current inventory levels are more or less aligned with targeted levels. But again do have a few key categories that are still short. Overall, we want to continue to normalize the amount of backlog in inventory and replenish stocking levels of those key equipment categories. Note that these targeted inventory levels take into consideration that we remain focused on presale activities that Brian touched on earlier and presale is an excellent opportunity to provide more visibility into future sales as well as maintaining higher levels of inventory turns.

Speaker 5

With that, I'll share a few comments on our fiscal 2024 full year guidance, We have updated TurtleTalk the year to date performance of our businesses and to include an assumption for the partial year impact of the O'Connor's acquisition, which we expect to report as a 4th business segment. The year to date performance of our agriculture segment has been consistent with our expectations, underpinned by strong organic growth and operating performance. We expect that to continue through the back half of this fiscal year. Our construction segment has been exceeding expectations and we expect construction activity to continue to support that trend for the rest of the year. As for our international segment, it is performing well, but toward the lower end of our previous guidance range.

Speaker 5

As such, we are reaffirming our assumptions for our agriculture segment of up 20% to 25%, Increasing our assumption for construction to be up 5% to 10% as compared to the previous guidance of flat to up 5% And modifying our international segment assumption to be at 5% to 10% as compared to the previous guidance of up 8% to 13%. This adjustment for Europe brings us more in line with industry volume forecast for that region. Before adding the partial year impact of the O'Connor's transaction, We are maintaining our expectation for diluted earnings per share with the midpoint of $4.80 Our first half performance Has added to our confidence in achieving the numbers that we presented at the beginning of the fiscal year and we remain focused on execution for the remainder of the year. With respect to the anticipated partial year impact of the O'Connor's transaction, we expect for it to close in the Q4 of this calendar year. And for purposes of this estimate, we are assuming a closing date of October 1.

Speaker 5

Their results will be reported on a 1 month lag, So these assumptions would result in 3 months of activity being reported in our fiscal 2024 results. With all of that said, we have provided an initial revenue estimate of $70,000,000 to $90,000,000 which translates to a diluted earnings per share contribution Adding the acquisition to our guidance, the ranges arise to $4.60 to $5.25 Seasonality in the O'Connor's business is similar to historical Titan's seasonality in that for O'Connor's About 45% of revenues have historically come in the first half of the year and 55% come in the second half of the year. O'Connor's business for fiscal year ended June 30, 2023 produced revenue of $258,000,000 Pre tax income of $18,700,000 and EBITDA of $21,400,000 adding estimated financing and integration expenses for the 1st 12 months of ownership to these results provides for a run rate pro form a pre tax income of $13,000,000 or $0.40 of earnings per diluted share. We're excited to welcome The O'Connor's team members to Titan and look forward to providing further updates on this business segment on future earnings calls. This concludes our prepared comments and we are now ready to take questions.

Operator

Thank you. At this time, we'll be conducting a question and answer to one question and one follow-up. Thank you. Our first question comes from the line of Ben Klieve with Lake Street Capital Markets. Please proceed with your question.

Speaker 3

All right. Thanks for taking my questions and congratulations on a great quarter and looks like a great acquisition as well. I'd like to start with the acquisition. I'm curious Kind of the genesis of this acquisition, was this a function of you guys actively looking to move into Australia, considering a lot of options or was Conners kind of A kind of unique opportunity that you decided to act on.

Speaker 2

Yes, this is Dave. So I actually got wind a little bit here. I think it's one of these classic situations where you had the 2 family owners, 2 brothers Both retired. They've been out of the business. I know Dennis O'Connor, I think, has been out for 10 years.

Speaker 2

And they put a professional management team in and really didn't have that family succession. So I knew a couple of years ago that they were probably going to be looking for some of that they could Sell their shares of stock to. And I think as you recall, we just last year, we were had Heartland Ag Systems is a pretty important and strategic acquisition and we didn't I didn't really want to convolute those 2 together. But once we Got that completed, got that integrated. I reached out to Dennis O'Connor earlier this year and tried to understand the business a little bit.

Speaker 2

But When you get into that, definitely if you look at the Caseys business in Australia, O'Connor's Was hands down the market leader in high horsepower equipment. Every year all the Australian And New Zealand dealers, they get together for an annual meeting. They have a top dealer award. Well, Connors have won that for the last 5 years in a row. You couple that with operating down on the South Sea, certain part of the country in the grain belt and arguably the best farmland in Australia.

Speaker 2

And I think most important is that proven and experienced professional management team has been in place for over 5 years now. Add all of these together, it really is an old brainer. So we met with the team. Brian went down there and toured the dealership. So It's just uncanny how their metrics or financial metrics or cultures or people, the products, everything just almost identical to ours English language, English based law, low in the corruption scale.

Speaker 2

I mean, it just it was just really made a lot of sense for us.

Speaker 3

Yes, sounds like it. That's very helpful color. Thank you. Follow-up unrelated to O'Connor's, Just kind of general kind of sentiment, farmer sentiment. I appreciated your comments on kind of the state of the state in your backyard and understand the inventory dynamics that you guys are facing.

Speaker 3

But I'm wondering if farmer sentiment and buying patterns are being impacted right now at all by the If you can elaborate on how interest rates over the last especially 6 months are impacting their buying patterns that would be helpful.

Speaker 4

Yes. This is Brian. We're still actually having historically higher amount of cash Transactions right now and then on a lot of these larger ticket items we do have Manufacturers supported programs as well, and especially as you get into some of the lower horsepower or the more Rural Lifestyle Products. And so definitely it's an impact and something our farmers are Producers are watching. It is cutting into their net farm income a little bit.

Speaker 4

It's one of the contributing Factors along with just a lot of other things which have the price up. But urea and fertilizer being down is helping and we're still on pace For a really good year, maybe a lot of different estimates out there around between 15% 20% Below last year's record, depending on where yields come in, but Still on pace for a really good year. They did push a lot of income into this year from last year And there's a lot of tax incentives still in place and we're anticipating that farmers are even going to be pushing income from this year into next year and there was a lot of forward Contracting. So still pretty robust, still a fair amount of cash out there, but yes, interest rates are on people's minds and we do have a lot of different financing Tools to help with that.

Speaker 5

Yes. The only thing I'd add to that too and I think some of the OEMs maybe earlier in this You broke it down pretty nicely. Interest expense is a fairly small portion of the cost when you're talking about the equation for farm income. So while it has increased, it's there's other factors that are much more at play here.

Speaker 3

Yes. No doubt about that. Very good. Well, that's all very helpful. I appreciate you guys taking my questions.

Speaker 3

Congratulations again on a great quarter and I'll get back in queue.

Speaker 6

Thanks, Ben. Thank you, Ben.

Operator

Thank you. Our next question comes from the line of Alex Rygiel with B. Riley Securities. Please proceed with your question.

Speaker 7

Thank you and good morning gentlemen and congratulations on the O'Connor transaction. Good morning, Elvira. Two questions here. You talked a lot about inventory and that was all very, very helpful. But taking a quick step back, Why do you think being at a target inventory level that's comparable to historical levels Is appropriate in this higher rate environment that we're in right now?

Speaker 5

I would Start with saying that the levels we're talking about aren't comparable to historical. So if you want to take it back to a prior Peak, which I think some people are naturally doing and comparing our total inventory level. I think you have to factor in the cost per unit, right? So we're talking about a Significantly smaller number of units per location than we were a decade ago. If you simply ran the math on a 3% increase over a decade, You'd be talking about a like for like equipment being 35% higher.

Speaker 5

And we know with the pricing that we've seen over the past couple of years, it's been much larger So even on a very conservative basis, you're talking about 1 third less number of units out at the locations. And then from there, as we talk about targeted levels, right, we're really focused on our main categories and it's making sure again that we have 1 or 2 That are available for demonstration, loaner or display units. And that's just what you need In order to drive the high volume of sales, right? And so that's really what we're talking about. We're missing out on sales opportunities because we don't have those high horsepower Items on our lots and if we did, our sales would be even higher than they are today.

Speaker 5

So taking a step back, I think it's important to keep all of that in perspective. So We continue to improve our business model and we want to be as efficient as possible and we certainly want to focus on presale activities And all of that is good business practices that we'll continue to do going forward.

Speaker 7

That's very helpful. And then Back in January, you had some delivery delays. I know it's kind of hard to quantify those, but do you think you're all caught up in those delivery delays?

Speaker 4

No, not yet Alex. In fact, Bo spoke to his prepared comments. Our backlog is Actually up a little bit sequentially. So, no, we anticipate Likely at least another couple of quarters before we can get caught up on that. Just our shops are really busy, which is A good thing and we're selling a lot of iron, which is a good thing.

Speaker 4

And it'll just take a little time yet. But Bo anything to add on your end?

Speaker 5

No. Yes, I think that that's right. We talked about our mix in available Sell inventory and wanting to normalize that backlog and we continue to see opportunity to focus on that at the back half of the year.

Speaker 7

Thank you very much.

Speaker 2

And one more comment on that too. With some of the supply side issues and some of the conditions, some of the equipment when Coming out of the factories too, it's taken us substantially longer per unit to get them through our shops right now. And we're seeing that It started to improve a little bit and we do think that's going to be probably back to normal towards the end of the year too. So that will help a lot.

Speaker 6

Thank you.

Operator

Thank you. Our next question comes from the line of Ted with Northland Securities. Please proceed with your question.

Speaker 8

Thank you and good morning. So I'm going to throw my two questions back As it relates to the O'Connor acquisition, and the first one is just maybe a little more color on the Case IH Australian dealer network, can you give us some sense in terms of how many locations there are across Australia? Like kind of maybe the average locations per dealer, kind of like who's the next largest dealer now that you have the largest kind of who's number 2. Just Some metrics to kind of give us a sense with regards to how it compares to the domestic dealer network for Kay's International Harvester.

Speaker 2

So, in our discussions with the management team there, they had a pretty well defined Future growth strategy through acquisitions, look how to identify locations. They've been in conversations with different owners. But I'd say it's much different in United States. You've got you don't have a lot of really big dealer groups at least on the KSIH side, maybe so more so on some of the So, it's a lot of family business, smaller businesses. And I think it's a much more robust consolidation story than what we've even experienced here in United States.

Speaker 2

So and A lot of smaller groups, family owned and I think that's just right for consolidation as you continue All adjacent from where they are now. And I think there's really good relationships between our team and Some of the existing owners and some good camaraderie. And so we just want to do that on a timely and managed approach. But I think That's one of the positives about the story is the future M and A opportunities.

Speaker 4

Yes. And Ted, I would just add on to Dave. I think you asked what's the next largest. And so in O'Connor's footprint in the grain belt there would be There's a CNH dealership with 6 rooftops and then you asked what the average is. And so the average is more around 2 to 3 locations per.

Speaker 8

Okay. And do you have any kind of sense in terms of just, I don't know, like the number of locations there are in Australia? Just out of curiosity, just the kind of the whole size That market at least from like a location standpoint?

Speaker 4

Yes. We know the number definitely in The grain belt and in O'Connor's footprint where we're where our interest level is, There's just as David mentioned, I'll just go back to there will likely be a fair amount of consolidation In that area over time here and we're seeing that with the Deere side as well. RDO equipment that is headquartered out of Fargo here as well that's a very large John Deere dealer, has 25 locations in Australia, As for a long time, I remember way back when they entered the Australian market and they continue to Add locations and continue to build their presence every year in Australia. And then service equipment Large John Deere dealer, just north of us here in Canada has 15 locations. So they're now on Basically either side of us.

Speaker 4

So there is a fair amount of North American presence there now between us and RDO and service.

Speaker 8

My second question just is in terms of O'Connor's revenue mix. When you look at it from sort of equipment parts, Services, rental, etcetera. I mean would you is it a mix that's similar to your business here in ag or is it more like the international business? I mean not that they're that much different, but you have a bit more of a Skew towards equipment relative to some of the higher margin stuff internationally than you do domestically. And so I'm just kind of curious if you could give some color on You're kind of the mix of O'Connor's business and then I'll get in queue again.

Speaker 8

Thanks.

Speaker 5

Yes. It's pretty similar to our domestic Ag business. The Supplemental deck that we posted on our website breaks that down pretty nicely. So looking at a 3 year historical average Their equipment sales mix was 82% versus on the U. S.

Speaker 5

Side, ours is more like 77%, 78%. So a couple of percentage points different, But very similar and that's just one of the many similarities that their business profile and metrics have to our domestic ag business.

Speaker 8

Okay. Congrats on the quarter and the acquisition.

Operator

Thank you. Our next question comes from the line of Daniel

Speaker 9

This is Reid on for Daniel. Just a couple of questions on margins here. As you noted, we're seeing a lot lower inventory, which should translate to better gross margin And that should benefit your SG and A to gross margin ratio. Is this a sustainable ratio going forward assuming Inventory stays low or how should we be thinking about that?

Speaker 5

I mean, talking about back half of the year And our expectations, we touched on the fact that we do expect some moderation in the gross margin But from an operating expense perspective, we expect to remain in line or below prior year as a percentage of sales. And For the full year that same story would be true at this point is to be in line or probably a little bit below last year's percentage of sales from those operating expenses.

Speaker 9

Okay. Thank you. And on the O'Connor's acquisition, it looks like last fiscal year they Thanks with gross margin slightly below you all. Do you all expect to see some synergies uplift at gross margin? Or can you touch on maybe some margin synergies?

Speaker 9

Just a little more color there would be great.

Speaker 5

Yes. So And the financials that we provided in the supplemental deck, they had gross margin of 18.7%. I think that's what you're referencing, slightly below Ours and then actually had a pre tax margin of 7.2%. So the profitability of their business is one of the many things that really attracted us To the management team and their operating model. That margin, if you factor in the fact that they are a little bit more skewed to equipment sales, Makes a lot of sense and is pretty similar to us.

Speaker 5

In terms of synergies, I mean, what we're really looking at is Focused on a consolidated executive leadership team looking at the business from a global perspective, we want to continue to support that Senior management team to execute on the growth strategy that they had in front of them. And then there's some unique opportunities from Service model perspective and being able to provide customers 20 fourseven type support as we look at the different time zones that we're now operating in as well.

Speaker 9

Thank you all for the color.

Operator

Thank you. Our next question comes from the line of Mig Dobre with Baird. Please proceed with your question.

Speaker 6

Good morning and thank you for the question here. Good morning, Mick. I want to go back The inventory discussion and I'm sort of curious as to how you think inventories will progress for you for the remainder of the year. It sounds like you'd like more inventory if available. So as the supply chain And it's getting better for the OEM.

Speaker 6

Are you sort of inferring here that you're going to continue to build inventories through year end? So I guess that's part number 1. And then related to this, given that so much of your business is now pre sell, can you comment at all about Your pre sell activity on model year 2024 equipment in North America? And then I'll have some follow ups. Thank you.

Speaker 5

Yes, I'll maybe start with the inventory question and then Brian might touch on the presale. So from an inventory perspective, we Would expect the inventories probably will increase sequentially in the Q3 and then come down a little bit from there in the Q4. We Typically see that to be the case. We did mention that largely speaking from a high horsepower perspective that most Of everything that we're going to receive is retailed to customers. Of course, we need to turn that around with pre delivery inspection.

Speaker 5

So again, we'll see What we're able to do with normalizing that backlog and those are really the factors that are at play. But from a bigger picture perspective in terms of That we've seen year to date versus what we would expect in the back half of the year. The back half should be a lot Less than what we saw in the first half. And again, the first half is kind of very welcome to see get us replenished levels on some of these other categories. Back half, a smaller modest increase and again focusing on normalizing that backlog.

Speaker 4

Yes. Mig, this is Brian. I would just As you know, we're definitely trying to be really clear that we are short in certain Key product categories, and those are the areas that we're looking to get more in. But as you know, there are other product categories where We're finally feeling pretty good about where we're at. We've been running low for quite a while now.

Speaker 4

And then there are a couple of other product categories that we talked about last call that we have a little bit Excess of your smaller tractors in some of those. And so I think you see it implied in our guidance is Us being proactive about just in the second half here, cleaning up that mix a little bit. So we're positioned really well for You're in hopes that some of these key product categories will open up. And so, we're proactively addressing these Few smaller categories where we're a little long and that's what you see in the anticipated margins that we've got reflecting. Most dealers that I know they wouldn't do that.

Speaker 4

They wouldn't be feeling the pressure yet that stuff isn't aged. And so we really just want to Are cognizant of our healthy mix and are being proactive there. And to your pre sell question, as you know that the OEMs are keeping the Order book is really tight here. They're not out very far. These key product categories are on allocation.

Speaker 4

And so as Bo said, where We just finally are out into 2024 now. And with our first tranche of early orders there, we've got We've got names on all those key product category units.

Speaker 6

But again, Do you get a sense that volumetrically demand for model year 2024 is up relative To 23 and ask the question because it matters within the context of inventories building on your balance sheet and in the industry more broadly.

Speaker 4

No, I would say demand is still very similar to how it's And those key product categories, but importantly demand has been outpacing supply now for a long time on those. But and then normalized in the other product categories. So, yes, I don't see demand increasing here as we've got a little bit lower net farm incomes and likewise on the construction side. But demand is still strong. And again, as I mentioned, our order boards in those key product categories, we're still selling everything we can get for the allocation We have so far.

Speaker 2

Thank you. Yes, this is Dave. And I'll just reiterate my comment. I don't see us getting Self propelled sprayers, wheel loaders or forward drive tractors, but in any quantities of stock until at the earliest the second half of twenty twenty four. That's all tight it is.

Operator

Thank you. Our next question comes from the line of Larry De Maria with William Blair. Please proceed with your

Speaker 10

Thanks. Good morning. Hey, first question, let's just pick up where we left off there. On the early order programs and presales, what is the message that you're we're still seeing On calendar 2024, I mean, I understand that obviously there's orders and there's short supply. So first Are there any cancellations out there that we're seeing?

Speaker 10

And to BJ's question about point about demand not getting stronger, are we Seeing I don't know, are we talking about a flat calendar 2024 at this point? What's the specific messaging on what the order programs are telling you about next year?

Speaker 4

Yes, I think so, Larry. So to answer your first question, no cancellations still. And yes, 2024 is a long ways out at this point and but that's Flattish is kind of our anticipation at this point for demand perspective. But again, You got to work in the fact that we need production availability to increase in these key product categories and we haven't been able to keep

Speaker 2

Okay. Thank you. Maybe what you're asking a little bit, I'd say farmer's sentiment might be tempered a little bit. Like you say, there's a lot of noise out there, there's interest rates, things like There was so much demand before in the production levels were so much below previous peaks that The demand is still good, but maybe farmer settlement might be off a little bit, but I've We've been dealing with farmers for over 40 years as they're always pretty negative. But there are there is some noise out there in that, but still the demand is still All pacing supply and high horsepower.

Speaker 2

Yes, good point, Dave.

Speaker 10

Okay. Thank you. And then can you give us some color on the second half? Obviously, Good quarter. Construction looking stronger, international a little lower.

Speaker 10

It seems like the core guide ex O'Connor Should be going up, not staying flat for the year, which would imply probably be a lower second half than the expectations in the consensus numbers. So can you talk about Your expectation in the second half, is there a deceleration? Or is it just really about not getting production or not having confidence in production? And then a fiscal 3Q versus 4Q sales split. Thanks.

Speaker 5

Yes. And a couple of pieces of commentary on that, right? I'd say From a top line perspective, if you look at same store sales growth on our domestic ag business, it's been about 7% in the first half of the year. We expect something similar in the second half of the year. Then you layer on any growth expected From a Heartland perspective, which given some of the commentary about sprayer production, we'd expect their growth to be north of those levels.

Speaker 5

Mathematically speaking, from a margin perspective, we've been touching on it, right? But that's where some of the math comes into play to get to the results. So the top line It's very much what we've been discussing and reiterated the guidance. And gross margin moderation It's something we've been talking about since the beginning of the year. So year over year in Q3 and Q4, We would expect margins to be lower than they were in the prior year.

Speaker 5

And that would be for a number of reasons, including what Brian was touching And then from a split perspective, we would expect Q3 to be our highest quarter And Q4 to be a little less than that, but more than what we just saw in the Q2. So that's also consistent with expectations that we had put out there previously. The other thing just to help you out in doing your math and getting to where we Come out to you from an expectation perspective is you did see other interest expense Higher in the second quarter and we would expect that in the 3rd Q4 as well, certainly as Comparing to the prior year period. So put all that together and take a step back, what we're really doing is reiterating a guidance midpoint of $4.80 which is outside of the O'Connor's acquisition, which is on top of last year's record results. And if you really zoom out and talk about where we're at today with our earnings power versus where we were in the prior peak, we were talking about $2 per share looking good.

Speaker 5

So Again, we've spoken this year about higher confidence in achieving average pre tax margins north of 5% through the cycle. The reasons why we have confidence in getting there, focusing on our organic growth through market share gains and continuing to execute on our pipeline. So for us and I hope you hear it, we're nothing but excited about how the rest of the year shapes up and how we're going to be well positioned

Operator

Thank you. Our final question this morning comes from the line of Steve Dyer with Craig Hallum Capital Group.

Speaker 6

And I guess when you say Q3 highest, is that the core business excluding the acquisition you just made of O'Connor's? Or is that all in Q3 will be the highest revenue?

Speaker 5

Yes. No, that's a great point and thanks for allowing me the opportunity to clarify that. That was our expectation Excluding the O'Connor's acquisition. So then we'd layer the O'Connor's acquisition on top of that. So appreciate that.

Speaker 6

Good. And then just a quick follow-up. Did you realize any manufacturing incentives in Q2? And then what are your

Speaker 5

Yes, another opportunity for me to clarify there. So last year, we started to accrue for manufacturer incentives in the Q2 to the tune of $2,600,000 This year, we haven't yet done that. Just aligning again with the cadence of production that we're expecting and for that to continue to increase in the back half of the year and we just talked about Our expectations in the second half from a volume perspective, I. E, the second half being larger than the first half. So we definitely expect To recognize similar levels overall for the year, it'll just fall in the back half of the year as opposed to starting incrementally last to recognize that $2,600,000 figure in the quarter.

Speaker 6

Great. Thanks, Paul. Good luck, guys. Thank you.

Operator

Thank you. Ladies and gentlemen, that concludes our question and answer session. I'll turn the floor back to Mr. Meyer for any final comments.

Speaker 2

All right. Thanks everybody for your participation and your interest in Titan Machinery and we look forward to updating you on our progress on our next call. So have a great day.

Operator

Thank you. This concludes our conference today. You may disconnect your lines at this time. Thank you for your participation.

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Earnings Conference Call
Titan Machinery Q2 2024
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