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Edited Transcript of TITN earnings conference call or presentation 26-Nov-19 1:30pm GMT

Q3 2020 Titan Machinery Inc Earnings Call

WEST FARGO Dec 2, 2019 (Thomson StreetEvents) -- Edited Transcript of Titan Machinery Inc earnings conference call or presentation Tuesday, November 26, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David Joseph Meyer

Titan Machinery Inc. - Co-Founder, Chairman of Board & CEO

* Mark P. Kalvoda

Titan Machinery Inc. - CFO & Treasurer

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Conference Call Participants

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* Lawrence Tighe De Maria

William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure

* Mircea Dobre

Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research and Senior Research Analyst

* Steven Lee Dyer

Craig-Hallum Capital Group LLC, Research Division - Co-President & Senior Research Analyst

* John Mills

ICR, LLC - Managing Partner

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Presentation

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Operator [1]

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Greetings, and welcome to the Titan Machinery Inc. Fiscal Third Quarter 2020 Earnings Call. (Operator Instructions) Please note, this conference is being recorded.

I will now turn the conference over to your host, John Mills, Managing Partner at ICR. You may begin.

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John Mills, ICR, LLC - Managing Partner [2]

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Great. Thank you, Daryl. Good morning, ladies and gentlemen, and welcome to the Titan Machinery Third Quarter Fiscal 2020 Earnings Conference Call. On the call today from the company are David Meyer, Chairman and Chief Executive Officer; and Mark Kalvoda, Chief Financial Officer.

By now, everyone should have access to the earnings release for the fiscal third quarter ended October 31, 2019, which went out this morning at approximately 6:45 a.m. Eastern Time. If you have not received the release, it is available on the Investor Relations page of Titan's website at ir.titanmachinery.com.

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 the presentation now by going to Titan's website at ir.titanmachinery.com. And the presentation is available directly below the webcast information in the middle of the page.

You'll see on Slide 2 of the presentation our safe harbor statement. We would 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. 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-K. 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.

Please note that during today's call, we'll discuss non-GAAP financial measures, including results on an adjusted basis. We believe these adjusted financial measures can facilitate a more complete analysis and greater transparency in the Titan's ongoing financial performance, particularly when comparing underlying results from period to period. We've included reconciliations of these non-GAAP financial measures to their most directly comparable GAAP financial measures in today's release.

The call will last approximately 45 minutes. And at the conclusion of the prepared remarks, we will open the call to take your questions.

Now I'd like to introduce the company's Chairman and CEO, Mr. David Meyer. Go ahead, David.

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David Joseph Meyer, Titan Machinery Inc. - Co-Founder, Chairman of Board & CEO [3]

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Thank you, John. Good morning, everyone. Welcome to our third quarter fiscal 2020 earnings conference call. On today's call, I'll provide a summary of our results and then an overview for each of our business segments. Mark will then review financial results for the third quarter of fiscal 2020 and conclude by reviewing our updated modeling assumptions for fiscal 2020.

If you turn to Slide 3, you will see an overview of our third quarter financial results. Our third quarter revenue was $361 million, with adjusted pretax income of $14.5 million and adjusted earnings per diluted share of $0.44, which is a $1.6 million improvement over the prior year period.

Prior to getting into the more detailed discussion of our segment performance, I wanted to share a few high-level comments. First, for the third quarter in a row, we experienced another solid quarter of growth in our important parts and service business. This growth was led by our domestic Agriculture segment, which also performed well on equipment sales in a challenging environment.

Second, we are happy to announce the October 1 closing of the acquisition of the Uglem-Ness CaseIH dealership located in Northwood, North Dakota. The Northwood dealership is contiguous to our existing stores in the Northern Red River Valley and has a legacy of strong sales of high-horsepower equipment, backed by superior parts and service support for their customers. In addition to this acquisition, we have seen the M&A pipeline for domestic farm equipment dealerships start to heat up. We are engaged in discussions with owners of quality North American ag dealerships. I expect these efforts to yield additional acquisition opportunities.

Finally, while we had a profitable third quarter in our International segment on reduced revenues, the financial performance overseas did not meet our expectations, which I will discuss in greater detail in a few minutes.

I will now provide additional detail for our 3 operating segments consisting of our domestic Agriculture and Construction segments and our International segment.

On Slide 4 is an overview of our domestic Agriculture segment. To say the least, 2019 has been a very challenging year for our farmer customers. Spring planning was abnormally late followed by a cool, wet summer, continuing with late season rain and snowstorms, saturated fields and a wet harvest. Fortunately, the delayed killing frost dates in our footprint allowed crops to reach reasonable levels of maturity and respectable yields. But September and October rain and snow have delayed harvest and have created some very difficult harvest conditions. The corn is being combined at high moisture levels requiring drying. There are serious propane shortages in the Upper Midwest, which is causing further harvesting delays as this year's crop needs to be dried and propane is the main fuel used by on-the-farm grain dryers.

While there are pockets of preventative plant and drowned-out crops, the yield reports for the fields that reached maturity have been good with the highest yields coming from growers in Iowa followed by Nebraska. We anticipate the completion of the corn harvest in Minnesota, North Dakota and South Dakota extending into Q1 of calendar 2020 due to the extreme conditions, propane shortages and the high corn moisture levels.

Farmer sentiment is being impacted by the late harvest, along with the uncertainty with trade issues and its effect on exports and commodity prices. USDA market facilitation payments have been a shot in arm for our customers. In addition, some of our growers took advantage of the spike in commodity prices in June and July by selling carryover crops, and locking in good prices on this year's crop.

As the age and hours of the farmer equipment fleets continue to increase, we believe that replacement demand, along with farmers' desire for upgrades in technology and equipment performance and the year-end tax buying, will support our new and used equipment revenues. As I noted above, we have 3 consecutive strong quarters in domestic parts and service fueled by the Ag segment. We anticipate continued growth in our aftermarket parts and service business due to the aging of our customers' equipment fleet along with parts and service needs associated with tough harvest and field conditions.

Turning to Slide 5, you'll see an overview of our domestic Construction segment. The strong economy continues to positively impact the construction equipment industry. Continued stable oil prices is creating demand for construction equipment for oil-related activity. Federal, state and municipal infrastructure projects are creating work for large construction contractors and smaller subcontractors. While we are seeing stronger demand in the metro areas, the rural construction equipment markets continue to be negatively impacted by the depressed farm commodity prices since farmer customers represent an important outlet for our construction equipment.

Our rental -- our fleet rental business continues to improve, supporting our CE bottom line. The operational improvements we have implemented in our construction stores are producing positive results. Although there are some industry comments that the CE equipment industry is softening, we believe the mid-range product segment that we focus on will continue to be healthy. And we are confident in our full year modeling assumptions that construction revenue will be up 5% to 10%.

On Slide 6, we have an overview of our International segment, including our markets within the countries of Bulgaria, Germany, Romania, Serbia and Ukraine. This is the third year in a row of our International segment is producing positive contributions to our bottom line. However, both Q2 and Q3 of our current fiscal year have performed behind the prior year second and third quarters. While our Q3 year-over-year variance is an improvement over the Q2 year-over-year variance, we have updated full year revenue modeling assumptions to be flat for our International segment compared to our prior year guidance that assume being up within the range of 2% to 7%. Yields of late season crops are average to above average across most of our international footprint, but softening global commodity prices are impacting customer sentiment.

Calendar 2020 will be the final year of the 5-year European Union [subvention] fund program. This program is administered by the participating EU countries, which include our markets of Romania and Bulgaria. Romania used all of its funds in the first 3 years of the program and was without funds in calendar 2019. Bulgaria has unused funds, which is causing Bulgarian farmers to speculate that the unused funds will become available in calendar 2020, the last year of the program, which is creating a wait-and-see situation on equipment purchases.

With approximately 30% of the world's black soil in the Ukraine, we look at doing business in this country as a long-term opportunity. The sale of farmland is currently forbidden in the Ukraine. President Zelensky is actively promoting land market reform and has pledged to lift the long-standing ban on the sale of farmland. We believe that land market reform would be a boost to our business and has the potential of injecting billions of dollars of capital into the Ukrainian economy, providing an improved credit environment for the financing of farmer purchases.

We expect improved returns in this upcoming year from our German dealership based on continuous improvement initiatives, particularly in our parts and service businesses we have in place for these stores. In line with our strategy of growing the aftermarket parts and service business in our International segment, parts and service revenue grew year-over-year in the third quarter. We continue to invest in people and processes as we work to improve operations in these developing markets in Eastern Europe, Ukraine and the Black Sea region.

Before I turn the call over to Mark, I want to thank all our employees for their efforts in supporting our customers during this very critical fall season. It's a privilege to work with such a great team.

So with that, I'll turn the call over to Mark to review the financial results in more detail.

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Mark P. Kalvoda, Titan Machinery Inc. - CFO & Treasurer [4]

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Thanks, David. Turning to Slide 7. We generated total revenue of $361 million for the fiscal 2020 third quarter, which was flat compared to last year. We experienced modest revenue growth in our Agriculture and Construction segments, which was offset by a decline in our International segment revenue. Our higher-margin parts and service businesses performed very well during the third quarter, increasing 9.6% and 11.3%, respectively. We were able to drive parts and service growth in each of our 3 segments in this seasonally strong quarter, reflecting our increased focus in these areas, a difficult harvest environment and a customer fleet that is continuing to age.

As David noted, our equipment business within our Agriculture and International segments continues to be impacted by ongoing macroeconomic uncertainty and challenging weather conditions in certain areas of our markets. Equipment revenue decreased 3.1% in the quarter versus the prior year period. Rental and other revenue was down 6.2% primarily due to lower inventory rentals but offset by increased dollar utilization of our rental fleet. The dollar utilization of our Construction segment rental fleet improved 160 basis points to 30.4% for the current quarter compared to 28.8% in the same period last year. The higher utilization of the fleet positively impacts revenue, but also the incremental revenue helped enhance margins by 460 basis points in the rental and other category as fixed depreciation costs have been covered, and therefore, more revenue contributes to bottom line performance.

On Slide 8, our gross profit of $72 million for the quarter was an increase of 3.3% compared to the same period last year, primarily driven by the change in revenue mix toward our higher-margin parts and service businesses. This is apparent in our gross profit margin, which increased by 60 basis points to 19.9% versus the prior year period. Our operating expenses increased by $4.9 million to $58 million for the third quarter of fiscal 2020. The increase was primarily the result of $2.1 million of ERP transition costs incurred in the quarter and higher costs associated with the increased business in our Agriculture and Construction segments, including 1 month of additional costs associated with the operation of our newly acquired Northwood store.

These higher expenses, combined with lower equipment sales particularly in our International segment, negatively affected our ability to leverage our fixed operating costs. As a result, our operating expenses as a percent of revenue increased from 14.8% in the third quarter last year to 16.1% in the third quarter of fiscal 2020. Excluding the ERP transition costs in the third quarter of fiscal 2020, the increase in operating expenses was $2.8 million or 5.3% versus the prior year period. Floorplan and other interest expense decreased 31.4% to $2.4 million in the third quarter of fiscal 2020 compared to $3.5 million in the same quarter last year. Most of the decrease was due to the lower interest expense resulting from the May 1, 2019, retirement of the remaining balance of our convertible notes along with the decrease in our level of interest-bearing inventory in the third quarter of fiscal 2020 compared to the same quarter last year.

In the third quarter of fiscal 2020, our adjusted net income increased 9.2% to $9.9 million compared to $10.9 million in the prior year. Our adjusted earnings per diluted share for the quarter was $0.44 compared to $0.49 in the third quarter of last year. Our quarter-over-quarter adjusted net income and EPS were negatively impacted by a higher effective tax rate of 33.8% in the current year, which was 18.2 percentage points higher than the comparable quarter in the prior year representing about an $0.11 impact on our adjusted EPS comparison.

Our current year third quarter was higher due to foreign currency gains that created a higher taxable income than book income in our Ukraine business. These foreign currency gains caused our effective tax rate to increase by approximately 7 percentage points which negatively impacted our adjusted diluted EPS by $0.04 for the current quarter. With the assumption that the Ukrainian currency remains relatively stable for the remainder of our fiscal year, we would now expect a full year effective tax rate of approximately 33%. This rate can move for a variety of reasons such as the Ukrainian currency impact I just described as well as changes in profit-and-loss mix between our various tax jurisdictions as well as adjustments in valuation allowances on our deferred tax assets, including net operating loss carryforwards, among other items.

For the third quarter of fiscal 2020, adjusted EBITDA was $21.8 million compared to $21 million in the third quarter of last year. You can find a reconciliation of adjusted net income, EPS and EBITDA to their most directly comparable GAAP amounts in the appendix to this slide presentation.

On Slide 9, you will see an overview of our segment results for the third quarter of fiscal 2020. Agriculture revenues were $214 million, an increase of 2.1%. The revenue increase was the result of strong double-digit growth in parts and service revenue. The higher mix of parts and service revenue drove a 4% increase in adjusted pretax income to $10.3 million for the quarter compared to $9.9 million in the prior year period.

As a reminder, on October 1, the company closed on its acquisition of Uglem-Ness Company, which consists of 1 CaseIH agriculture dealership location in Northwood, North Dakota. In its most recent fiscal year, Northwood generated revenue of approximately $25 million. We expect the acquisition to be accretive to earnings within a year.

Turning to our Construction segment. Revenue increased 1.3% to $78 million compared to the prior year period. Revenue results were similarly driven by solid parts and service growth. The segment's adjusted pretax income decreased to $400,000 in the current quarter due to higher operating expenses and increased floorplan and other interest expense. This bottom line performance was below expectations and will likely fall short of achieving profitability in fiscal year 2020. However, we are optimistic about future improvement in this segment as we build off of the initiatives we have focused on over the past 2 years, which we believe will help us achieve sustained future profitability in this segment.

In the third quarter of fiscal 2020, our International segment revenue was $69 million, a decrease of 7.3% compared to the same quarter last year. The decline was primarily the result of lower equipment revenue resulting from the industry conditions David discussed earlier. The lower equipment revenues negatively impacted income before income taxes, causing a decrease of $500,000 compared to the prior year third quarter.

Turning to Slide 10. You see our first 9-month results. Total revenue increased 5.8% compared to the same period last year. For the first 9 months of the 2020 fiscal year, equipment sales increased 4.7%; parts increased 9%; service revenue increased 13.5%; and revenue and other revenue decreased 2.4%.

Turning to Slide 11. Our gross profit for the first 9 months was $190 million, a 7.8% increase compared to the same period last year. Our gross profit margin increased by 40 basis points year-over-year to 19.9% for the first 9 months of fiscal 2020. The higher gross profit margin was a result of a changing mix with a greater percentage of revenue generated by our higher-margin parts and service businesses as well as improved rental and other gross profit margin due to our year-to-date dollar utilization of our rental fleet, which improved 150 basis points to 25.5%. Our operating expenses increased by $17.9 million or 12.1% for the first 9 months of fiscal 2020 to $166 million.

In addition to the reasons I discussed for the third quarter increase in expenses, we also incurred increased operating expenses in the first 6 months of fiscal 2020 relative to the prior year 6-month period due to our German acquisition early in the third quarter of fiscal 2019. Floorplan and other interest expense decreased $3.8 million or 34.2% to $7.3 million in the first 9 months of fiscal 2020, largely due to the interest expense savings resulting from the repayment and retirement of our senior convertible notes. The decrease in our interest-bearing inventory in the first 9 months of fiscal 2020 as compared to the same period last year also contributed to the lower level of interest expense.

Our adjusted diluted earnings per share was $0.77 for the first 9 months of fiscal 2020 compared to $0.71 in the prior year period. Our effective tax rate was 31.3% for the current 9-month period compared to 22% for the comparable prior year period.

On Slide 12, we provide our segment overview for the 9-month period. Overall, our adjusted pretax income increased 22.1% to $24.3 million for the first 9 months of fiscal 2020 compared to $19.9 million in the same period last year. This improvement is primarily the result of higher parts and service revenues across all 3 segments and lower overall floorplan and other interest expenses. These results were partially offset by higher overall operating expenses as well as a reduced contribution from our International segment.

On Slide 13, we provide an overview of our balance sheet highlights at the end of the third quarter of fiscal 2020. We had cash of $52 million as of October 31, 2019. Our equipment inventory at the end of the third quarter was $544 million, an increase of $127 million from January 31, 2019, reflecting a $160 million increase in new equipment, partially offset by a $33 million decrease in used equipment. Equipment inventory turns were 1.7 versus 1.8 in the prior year period. I will provide a little more color on our inventory on the next slide.

Our rental fleet assets at the end of the third quarter increased to $115 million compared to $111 million at the end of fiscal 2019. We still anticipate decreasing our fleet size to around $110 million by the end of the current fiscal year. As of October 31, 2019, we had $446 million of outstanding floorplan payables on $660 million of total floorplan lines of credit. Subsequent to the end of our quarter, we increased our floorplan line with our primary supplier by $50 million, resulting in current floorplan lines of credit totaling $710 million, which is ample capacity to handle our equipment finance needs.

Our total liabilities to tangible net worth ratio is a healthy 2.1. As a reminder, this ratio was impacted by the adoption of the new lease accounting standard, which went into place in the first quarter this year and will continue to influence the year-over-year comparisons for the balance of fiscal 2020. Importantly, the ratio of 2.1 is well below 3.5, which is the leverage covenant requirement of our larger bank facilities. We expect this ratio to strengthen as our equipment inventory levels and associated plant payables decreased in the fourth quarter.

Turning to Slide 14. The amount of new and used equipment inventories are reflected in the size of the red and blue bars on this slide. The third quarter amounts include approximately $11 million of equipment inventory associated with the October 1 acquisition of our Northwood location. Although down sequentially and including the acquired store inventory, our current level of inventory is higher than we had planned, primarily due to higher levels of equipment purchases as well as lower international equipment sales. We now anticipate an ending inventory for fiscal 2020 around $485 million, excluding additional acquisitions. This represents about a $60 million reduction in our equipment inventory from current levels.

Although inventory levels are elevated, the quality of our inventory remains healthy as evidenced by good equipment margins and a high percentage of noninterest-bearing inventory, which is reflected in the black line on the graph. The primary driver of the improvement in this metric is the reduced aging of our inventory as a result of our ongoing life cycle management efforts as more of our inventory remains under interest-free terms with our suppliers. This improvement has been the primary reason for a reduction in floorplan interest expense over the past few years.

Slide 15 provides an overview of our cash flows from operating activities for the first 9 months of fiscal 2020. The GAAP reported cash flow used for operating activities for the period was $8.3 million. As part of our adjusted cash flow used for operating activities, we include all equipment inventory financing, including nonmanufacturer floorplan activity. Our adjustment for nonmanufacturer floorplan payables was $62 million for the first 9 months of fiscal 2020. We also adjust our cash flow to reflect the constant equity in our equipment inventory, which enables us to evaluate operating cash flows, exclusive of changes in equipment inventory financing decisions.

The equity in our equipment inventory decreased to 18% as of October 31, 2019. And the adjustment for constant equity and equipment inventory represents an $89 million use of cash. The decrease in equity in our inventory is primarily due to the stocking of new equipment inventories in the first 9 months of the fiscal year and the higher level of floor plan financing available on such inventories as well as borrowing more on our floor plan lines in connection with the repayment of the outstanding balance of our convertible notes which occurred on May 1, 2019.

After all adjustments, our adjusted cash flow used for operating activities was $35 million for the 9-month period ended October 31, 2019, compared to $2 million of adjusted cash flow provided by operating activities for the same period last year. Cash generation is down due to the higher levels of equipment inventories compared to the prior year. We expect to generate significant cash in the fourth quarter as we anticipate a substantial reduction in our equipment inventory levels.

Slide 16 shows our updated fiscal 2020 annual modeling assumptions. We are maintaining our revenue modeling assumptions for our Agriculture and Construction segments but are reducing our International revenue modeling assumption from up 2% to 7% to flat. We are also tightening our diluted EPS assumptions to the lower half of our prior expected range to reflect the challenges within our International segment as well as an expected higher consolidated effective tax rate of approximately 33% that I discussed earlier.

Although our International business underperformed to our expectations, our Ag business, which is our largest segment, continues to perform well in difficult market conditions. Despite lower current quarter profitability in our Construction segment, we are pleased with the broader internal improvements we are seeing with this -- within this segment as we drive towards sustained future profitability.

Operator, we are now ready for the question-and-answer session of the call.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Steve Dyer of Craig-Hallum.

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Steven Lee Dyer, Craig-Hallum Capital Group LLC, Research Division - Co-President & Senior Research Analyst [2]

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Just was hoping you could talk a little bit more about sort of the acquisition strategy going forward. It was -- did a lot of it a number of years ago, and then there was some rationalization. Are you thinking -- maybe what's different this time? Are you thinking there's different regions? Is it going to be primarily ag-related? Maybe what's pricing that guys are asking? What's the lay of the land there going forward?

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David Joseph Meyer, Titan Machinery Inc. - Co-Founder, Chairman of Board & CEO [3]

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Well, like I -- Steve, like I said on the call earlier that there's a lot of interest. It's all -- it's heating up. There's a lot of dealer principals looking for a succession solution out there. So we're fully engaged with that. And I guess what we're really focused on right now is this North America production agriculture areas. Quality Case IH dealerships is our preference right now for doing acquisitions.

So it's a good pipeline. I think what you're seeing from a lot of dealers, it's an aged dealer principal owner group. There's increased demand from the OEM. There's requirements on the capital side of the business: the fleets out there, the sophistication it's taking to support these. In many cases lack of succession is driving a lot of these acquisitions.

So like we said in our comments, we hope to have some future announcements based on a lot of our efforts we're doing and working a lot of this potential. And I guess it's -- we like this Upper Midwest area production agriculture. And we understand that we've got a lot of experience and contiguous to our existing footprint is also a deal.

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Steven Lee Dyer, Craig-Hallum Capital Group LLC, Research Division - Co-President & Senior Research Analyst [4]

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Got it. Okay. And then just what are you hearing from growers sort of into the end of the year here, just around tax purpose buying of equipment? Is that -- do you expect some of that this year? Or is it more a little bit sitting on the hands, given some of the spotty harvest and some of the trade stuff?

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David Joseph Meyer, Titan Machinery Inc. - Co-Founder, Chairman of Board & CEO [5]

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Well, growers, they're really focused. I mean they've got a really tough grind in the harvest here. So they really try and focus. There's still some beans out there, and there's quite a bit of corn. And they really -- they want to get some fall tillage done if at all possible. So they're really focused on that. There was some good selling of carryover crop done in late June, early July with actually some pretty decent commodity prices. So there were some crops sold on that.

And most of our farmers are on a cash accounting system. So I think there will be some purchasing based on the ones that are not only able to sell like share of the crop but also lock in some of this year's crop with some better prices. That, in addition to the payments from the Market Facilitation Program, that's going to be taxable income. So to combine that, I expect some tax buying. I think -- overall, I think a lot of the growers are probably seeing better yields than what they probably were expecting back in late July, early August. So the main thing is get the crop off, but I do think there will be some tax buying yet this year.

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Operator [6]

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Our next question comes from the line of Mig Dobre of Robert W. Baird & Co.

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Mircea Dobre, Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research and Senior Research Analyst [7]

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I've got several questions here but maybe starting with where you just left off. I guess I understand the potential for tax buying in the fourth quarter. All of that makes sense. But knowing what we know today, how should investors think about your fiscal '21, calendar 2020? And I'm asking about the North American -- the U.S. Ag business specifically. Can we see growth next year based on what's currently going on in the farm space? Or should our expectations be a little more modest than that?

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David Joseph Meyer, Titan Machinery Inc. - Co-Founder, Chairman of Board & CEO [8]

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Well, first of all, Mig, we're working off of some pretty low comps and pretty low industry numbers, so -- at these levels. So we saw some positive things out there. I think as you look at these long-term yield trends even this year, I mean as difficult as things were, some pretty respectable yields out there. So year after year, with the seed genetics and some of the farming practices and some of the in-farm decisions out there, the tillage practices and all these guys -- some of the precision out there, these guys are year after year just putting up some better yields.

So I think, long term, I think that's something that we can all be excited about. But I think we have to straighten out some of the trade issues. We have to get some decent prices up there. It'll be great if the USMCA got passed. I think too, is this replacement demand is not going away. Every year, the equipment, the fleets are getting more hours on them, more age on them. And so we've got the replacement demand. And I guess for the growers that don't trade, I mean as you get that kind of hours in the duty cycle, that parts and service is really evidenced by -- look at this last year, I think a lot of it was driven by age and hours. And some of these really tough conditions, field conditions and harvest conditions our growers been going through is driving that part of the business. So I think definitely that's -- I think that's key to some of our strategies is that aftermarket business.

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Mircea Dobre, Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research and Senior Research Analyst [9]

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Well, right. I mean on parts and service, I guess what I'm wondering is how much of this is an older fleet versus some unusual things with weather that might have driven parts and service, which I guess, in essence, could establish some tough comps for you as we look forward to...

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David Joseph Meyer, Titan Machinery Inc. - Co-Founder, Chairman of Board & CEO [10]

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I'd say both, Mig. I'd say as difficult as last year's harvest was, I think the general consensus of most of our growers is this one is not only much more widespread but I'd say even more difficult than last year. Even a lot of our very best farmers out there today where a year ago would have had all their corn combined, today they still have corn out in the field. So I'd say as you look into next year, I don't see any pullback on all of that parts and service business based on what we're seeing.

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Mircea Dobre, Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research and Senior Research Analyst [11]

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Got it. Got it. Okay. And in terms of equipment orders that you guys might be taking in now for delivery into fiscal '21, I guess I'm just wondering how that's trending versus your expectation or versus, say, last year at this time.

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David Joseph Meyer, Titan Machinery Inc. - Co-Founder, Chairman of Board & CEO [12]

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I'd say maybe on that, we're consistent with last year. Let's say had slight improvement of where we've got that, I guess we'll call it presell on that order book for retailers to be delivered into next year.

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Mircea Dobre, Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research and Senior Research Analyst [13]

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So slight improvement. Okay. Then I want to ask a couple of margin questions. If I look at your equipment gross margin, 10.8% in the quarter. It ticked down a bit sequentially. It was a little different, frankly, than the way we model, but I guess I'm wondering here how should we think about the fourth quarter versus the third. And was there anything unusual from a mix standpoint that might have impacted the third quarter?

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Mark P. Kalvoda, Titan Machinery Inc. - CFO & Treasurer [14]

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Yes. From the margin -- from equipment margin standpoint, one of the things that affected us was the tougher conditions in International this quarter. That did have an impact that probably made up a good chunk of that sequential reduction in kind of the quarter-over-quarter where last year was at about that 11 1 in the third quarter.

In regards to the fourth quarter, the fourth quarter is typically when we have some of these tax-buying decisions. These tend to be some larger deals that tend to have a little bit thinner margins to them at the end of the year. I do -- we do anticipate that it's going to be a little better than last year and not down to the level that we achieved in fourth quarter last year but certainly sequentially down from what we just saw here in our third quarter. So all of that kind of leads to around a similar to maybe a slight improvement in full year equipment margins compared to the prior year.

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Mircea Dobre, Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research and Senior Research Analyst [15]

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Okay. That's very helpful. And in terms of either used equipment pricing or maybe some of the things that you have to do to move new equipment, I guess the question is, is the pricing environment getting tougher? Or would you say it's sort of pretty much what you expected or what you've seen thus far this year?

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Mark P. Kalvoda, Titan Machinery Inc. - CFO & Treasurer [16]

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I would say what we saw in the third quarter was tougher on the international side, where international was a stronger headwind than what we saw earlier in the year and similar, similar -- expectations are similar on the new ag side. So we saw some of that pressure throughout the first, second quarter, that continued into the third quarter this year. Used still looks good.

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Mircea Dobre, Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research and Senior Research Analyst [17]

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Got it. A couple more and then I'm done. One on the acquisition itself. I guess I'm looking to clarify something here. You said accretive within a year, I heard you on the call. That to me implies that it's not accretive in the near term. And maybe Mark, you can remind me here. Do you have like an inventory step-up or something of the sort that is impacting your financials in the near term? It's been a while since you've done one of these larger acquisitions.

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Mark P. Kalvoda, Titan Machinery Inc. - CFO & Treasurer [18]

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So to your first question, yes. We typically talk about the first year of operations because there's -- can be some level of disruption or whatever as we get into the first month of an acquisition with the implementation -- or the integration and that type of thing. We've actually got -- this is modeled to be accretive day 1.

I think the other thing to remember is we are getting into a -- when you get into the fourth quarter and the first quarter, those are the seasonally low periods where there isn't near as much parts and service as there is in that second and third quarter. So we like to talk about it in the full year. That way, the timing of the acquisition really doesn't play a part in kind of that -- the outlook for that particular store when we're talking about that acquisition.

So this is a good acquisition. I think that from a revenue standpoint, that's actually about $25 million. It's about twice the size of kind of our average store out there, which makes for good metrics at a well-run store.

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Mircea Dobre, Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research and Senior Research Analyst [19]

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No, for sure. I'm just looking to clarify if you have some deal-specific or whatnot costs early on that we need to sort of be aware of in factoring to our model.

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Mark P. Kalvoda, Titan Machinery Inc. - CFO & Treasurer [20]

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No. No, nothing to that regard. And I think your second question was -- I think it was on like inventory levels related to the new acquisition and the...?

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Mircea Dobre, Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research and Senior Research Analyst [21]

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No, inventory step-up. The inventory step-up, I was asking about. If you have one of those on some inventory you're acquiring.

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Mark P. Kalvoda, Titan Machinery Inc. - CFO & Treasurer [22]

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Yes. So the inventory we acquired is in our numbers right away. We purchased it between the manufacturer and dealership. It's all onboard. And it's -- the impact was about $11 million to us here in October.

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David Joseph Meyer, Titan Machinery Inc. - Co-Founder, Chairman of Board & CEO [23]

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So it was an asset deal and not a stock deal. So basically, it would have been the purchase accounting at the price we paid for the inventory, there wouldn't be -- if you're referring to that.

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Mircea Dobre, Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research and Senior Research Analyst [24]

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I was referring to exactly that. Thank you for the clarification. Okay. And then last question is on the other segment, the rental business. You commented on the gross margin improvement as your depreciation-related expenses are coming down. So I guess what I'm wondering about is given the way you're thinking about the fleet into year-end, right? If in fiscal '21, we just have flat rental revenues, what would gross margins look like for this business?

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Mark P. Kalvoda, Titan Machinery Inc. - CFO & Treasurer [25]

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With flat rental revenues on a similar-sized fleet, the margins would stay the same if the mix stays the same. So the other component that you're seeing in that line is those inventory rentals. But if all else is equal, the mix is equal, utilization is the same, the margin should be the same as well.

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Operator [26]

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(Operator Instructions) Our next question comes from the line of Larry De Maria of William Blair.

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Lawrence Tighe De Maria, William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure [27]

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A few questions. First, obviously, you guys noted you have a pretty good pipeline for, I guess, Case IH dealers in North America. And you noted principally -- well, mostly it's the principal dealers that look for succession. Just curious -- is there any stress in distribution channel, given what's going on this year and over the last few years? Just curious if some of the opportunities are arising because of maybe some financial stress.

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David Joseph Meyer, Titan Machinery Inc. - Co-Founder, Chairman of Board & CEO [28]

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Yes. I think -- I don't know if you want to call it stress really, but I think the capital needs are going to start increasing. And in some of these dealer groups, say they expanded from, say, 3 stores to 6 stores. Your capital needs exponentially increase as you bring in trade-ins and that much more inventory out of the stores, the reconditioning, the people, the shop tools, the equipment. So yes, I think potentially, there could be some capital needs. And it's -- I think most of the dealerships are in pretty good shape. But it takes a lot of capital to run these things.

So I wouldn't say you might be looking at a problem dealership. But other than the fact that say, hey, the age of the dealer principal, a lot of work to sophistication and say all of sudden, now they're looking at higher levels of credit, more exposure, more personal guarantees. Some of those types of things is going to drive them and make them say, hey, maybe it's time that we start spending our winters in Arizona and Florida and things like that.

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Lawrence Tighe De Maria, William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure [29]

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Okay. That makes sense. And as it relates to MFP payments, was this -- update us on the timing of when farmers received it and if that is directly translating into orders or it's more on the comp. Just curious how that's flowing, if it's more discussions or guys -- people are receiving the checks and going out to spend it.

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David Joseph Meyer, Titan Machinery Inc. - Co-Founder, Chairman of Board & CEO [30]

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They received the first tranche of this stuff. So basically about 50% of their allocation, they would have received that probably back in that September-October time frame. Okay. Now the second tranche has been released, and it's -- they should receive that payment if they haven't already pretty quick here. I think I've heard talk even yesterday. Some of those showed up in the mail yesterday. So they should -- those should be before the end of the year.

Then as far as -- and that would be about 25% of the allocated amount. And that fourth -- or that third payment would be the last 25% payment. That hasn't been 100% authorized or approved yet. I think they're still waiting to see what post-harvest soybean prices end up being and stuff.

So -- and I'd say it's a shot in the arm. I guess it's one of these safety net things. But I would say, standing by itself, that's not going to tend to make people go out and buy a whole bunch of equipment. I think it's helped to support some of these depressed soybean prices predominantly, and a little bit of a shot in arm to get those back up to maybe some levels of profitability for the people that raise a lot of soybeans.

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Lawrence Tighe De Maria, William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure [31]

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Got you. And as it relates to Ukraine, I guess I wasn't expecting to hear Zelensky on this call. But can you give us maybe a little bit further color on what the timing of these reforms, it sounds like they're pretty optimistic for that market, and how material that might be for obviously Ukraine equipment market?

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David Joseph Meyer, Titan Machinery Inc. - Co-Founder, Chairman of Board & CEO [32]

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Well, yes. Well, we've been hearing on-and-off discussions over -- ever since we've gone there to Ukraine. The fact that the growers are -- they don't own the land. And the land, it's forbidden to sell it. And then that becomes difficult to who's -- to financing, so that's nonexistent. So you can imagine right now if the farmers in the United States weren't allowed to use land as part of their balance sheet, part of their security for their operating notes and stuff.

So if you go in and you read about the land reform in Ukraine, well, there's just a lot of discussion on it. There's a lot of interest in it, like people say, Ukraine doesn't need -- A, they just have a tremendous amount of this black soil, this chernozem soil. They've got more of it than any other country in the world right now. And that subsoil is really high in humus, phosphoric acids, phosphorus, ammonia. And it's just really hyper productive. It retains moisture really well. And well, that's just a huge asset there. And if all of a sudden, farmers can own that land or people invest in that land, create some good basis for equipment financing for the balance sheet.

So I think that's a huge positive. And I think there's just a lot of -- you hear comments that they'd like to get some stuff done by next April, by the end of the year. There's just a lot of ongoing -- but there again, it's -- you get into that political arena and what's going to actually happen. I mean there's definitely some level of -- it's aspirational thoughts, but boy, there's just a lot out there on that, Larry. And hopefully, I think for the best interest of that area that, that happens. I think it's going to be good for the farmers in that region.

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Lawrence Tighe De Maria, William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure [33]

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Yes. Sounds good. And my last question. You talked about aftermarket parts and service, I guess, being pretty stable. Replacement demand being pretty stable. I mean from a very high level, I recognize you don't have guidance. So is it the base case then for next year, we can think about North America being flattish based on those comments? Is that the implication? Recognizing that obviously trade gets pushed down and stuff.

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David Joseph Meyer, Titan Machinery Inc. - Co-Founder, Chairman of Board & CEO [34]

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Well, so as I look at -- right now, the equipment next year is going to be another year older and it's having -- the tractor is going to have another 300, 400 hours; combines, you're going to have another 300, 400 hours on them. But I'll tell you like right now, if you go out and watch these combines out working in these fields right now where they're getting stuck and they're getting to -- it's frozen ground, and it's muddy ground. And the headers are running on the ground. And they've got to bring them in at night and thawing them out. I mean you've got big ruts in the field and tractors are getting stuck and they've got tow cables on them. And I mean -- and the sieves are plugging up. And I mean things are freezing up and you're starting this equipment up in sub-freezing temperatures out in the middle of the field. So that is tough on equipment, Larry. So we're seeing that.

If you look at our parts and service this year, a lot of that was attributed to that, I think, some really tough harvest conditions and fuel conditions last fall. And again, now -- I mean it's not even -- it's wider. And I think it's much more severe this harvest than it was last harvest. So I don't see any reason at all in the combination of both replacement demand and that really, that tough duty cycle that we're going to see -- I'm very confident we're going to see a continuation of that parts and service business going into next year.

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Lawrence Tighe De Maria, William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure [35]

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Fair enough. And would you say the same about the replacement demand of OE equipment? Or is that much more of a maybe jump all depending on trade crops or...

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David Joseph Meyer, Titan Machinery Inc. - Co-Founder, Chairman of Board & CEO [36]

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Actually, I'd say -- definitely, I'd say we're working off of some really low industry numbers. And a lot of this equipment needs to be replaced. So that's not going away.

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Operator [37]

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We have reached the end of the question-and-answer session. I will now turn the call back over to David Meyer for any closing remarks.

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David Joseph Meyer, Titan Machinery Inc. - Co-Founder, Chairman of Board & CEO [38]

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Okay, good. Well, thank you for your interest in Titan Machinery. We're looking forward to updating you on our progress on our next call. So have a good day, everyone.

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Operator [39]

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This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.