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Titan Machinery, Inc. (NASDAQ:TITN)

F4Q10 Earnings Call

April 15, 2010 8:30 am ET

Executives

John Mills - ICR

David J. Meyer - Chairman of the Board & Chief Executive Officer

Peter J. Christianson - President, Chief Financial Officer & Director

Mark Kalvoda - Chief Accounting Officer

Analysts

Robert J. Evans - Craig-Hallum Capital

Paul Mammola – Sidoti & Co.

Rick Nelson – Stephens Inc.

Jeff Osher – Harvest Capital

Robert McCarthy - Robert W. Baird & Co.

Brent Rystrom – Feltl and Company

Operator

Welcome to the Titan Machinery Incorporated fourth quarter fiscal 2010 conference call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. John Mills with ICR. Please go ahead sir.

John Mills

Thank you. Good morning ladies and gentlemen and welcome to our conference call. On the call today from the company are David Meyer, Chairman & Chief Executive Officer, Peter Christianson, President & Chief Financial Officer and Mark Kalvoda, Chief Accounting Officer.

By now everyone should have access to the earnings release for the fiscal fourth quarter ending January 31, 2010 which went out this morning at approximately 7:00 am Eastern Time. If you have not received the release, it is available on the investor relations portion of Titan’s website at www.titanmachinery.com. This call is being webcast and a replay will be available on the company’s website as well.

In addition, we are providing a slide presentation to accompany today’s prepared remarks. We suggest you access the presentation now, by going to Titan’s website and clicking on the Investor Relations tab and the presentation is directly below the webcast information in the middle of the page.

Before we begin, 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 on them. These statements are based on current expectations of management and involve inherent risks and uncertainties including those identified in the risk factor section of Titan’s most recently filed 10-K which was filed this morning. These risk factors contain a more detailed discussion of the factors that could cause actual results to differ materially from those projected in the forward-looking statements. Titan assumes no obligation to update any forward-looking projections that may be made in today’s release or call.

With that, I would like to turn the call over to the company’s Chairman and CEO, Mr. David Meyer. Go ahead David.

David Meyer

Thank you, John. Good morning everyone and welcome to our fourth quarter 2010 conference call. On today’s call, I will provide an overview of our fourth quarter results, provide a general update on our business environment and then our strategy for fiscal 2011 including recent acquisitions. Then Peter will review the financial results for the fourth quarter and provide our fiscal 2011 outlook. I will then provide some closing remarks and then we will open up the call to take questions.

As John mentioned, to help you follow today’s prepared remarks we provided a slide presentation which you can access on the Investor Relations portion of our website at www.titanmachinery.com. If you click on the Investor Relations tab on the right side of the page, you will see the presentation directly below the webcast in the middle of the page. I will pause for a few moments to allow you to access the presentation on your website.

Now turning to slide two we have an overview of the fourth quarter. We are pleased with the top line growth we achieved for the fourth quarter which exceeded our expectations. However, our net income was lower than we previously expected primarily due to the results of our construction business segment. As you can see on our press release and on this slide this quarter we are introducing segment reporting for our agricultural and construction businesses in order to provide more insight and detail on our segments and our business overall performance.

Overall revenue for the fourth quarter increased to $252 million, up 34%. Looking at our results by segment the revenue generated from our agricultural business in the fourth quarter increased 33% to $227 million primarily driven by organic growth. Revenue generated from our construction business increased 39% to $32 million driven by our prior year acquisitions.

Our pre-tax income for the quarter was $6 million, up 13%. Pre-tax income for our agriculture business was $8.2 million and pre-tax loss for our construction business was $2.3 million. Despite the weakness in our construction business we achieved earnings per diluted share of $0.19 in the fourth quarter compared to $0.18 per share last year.

Turning to slide three you see our full-year results. Revenue for the full-year fiscal 2010 increased 22% to $839 million. Revenue from our agricultural segment increased 20% to $751 million and revenue from our construction segment was $116 million, a 32% increase reflecting our increased footprint in the construction segment. Our pre-tax income for fiscal 2010 was $27 million. The segment results will enable you to better understand the results for fiscal 2010.

Looking at our pre-tax income by segment, our agriculture business generated a pre-tax income of $36.1 million in fiscal 2010 and our construction business generated a pre-tax loss of $6.8 million in fiscal 2010. Diluted earnings per share for fiscal 2010 were $0.88.

On slide four you can see we added nine additional stores in fiscal 2010. Seven of these stores were Ag acquisitions and two of these stores are new store openings comprised of an Ag dealership in Albert Lea, Minnesota and a construction dealership in Minot, North Dakota.

Let me now review our two most recent acquisitions, both of which closed early in the fourth quarter of 2010. Combined, these acquisitions generated approximately $27.3 million in revenue in our most recently reported fiscal years. First we acquired Oskaloosa Implement Company which consists of two Case IH branded agriculture equipment dealerships located in Pella and Oskaloosa, Iowa. In its most recent fiscal year ended December 31, 2008 the two dealership generated revenue of $16.8 million. We also closed on the acquisition of Valley Farm Equipment which was one Case IH brand agriculture dealership in Milbank, South Dakota. It’s most recent fiscal year ended February 28, 2009 Valley Farm generated revenues of approximately $10.5 million.

In addition to the recent acquisitions during the fourth quarter we opened a new Ag equipment dealership in Albert Lea, Minnesota, representing a new market for Titan Machinery. The areas surrounding Albert Lea in Southern Minnesota and Northern Iowa have consistently produced large industry unit sales resulting from generations of prosperous farms that are operating on highly productive [inaudible] soils. We are excited about the opportunity for this store.

Yesterday, we announced we entered into a purchase agreement to acquire Hubbard Implement in Iowa Falls, Iowa. Hubbard is a Case IH brand agriculture equipment dealership and is well situated in the fertile farm land in central Iowa and is strategically located contiguous to Titan Machinery’s existing locations in Grundy Center and Waverly, Iowa.

In its most recently reported fiscal year, Hubbard Implement generated revenues of approximately $7.9 million. The acquisition is expected to close on or around June 1, 2010.

Now I would like to update you on our segment industries. On slide five you can see the U.S. farm cash receipts have trended upwards over the past ten years which has resulted in the current strength of our agricultural industry. Farmers continue to enjoy balance sheets which we feel will continue with their current strength with the USDA forecast of year-over-year increase in gross farm receipts. Our customers continue to have many different options to receive financing and we have not seen our customers face difficulty receiving credit when they decide to finance equipment.

C&H capital continues to ride an array of attractive equipment finance and lease options. There are also several local and regional banks and farm credit affiliates in our markets that we believe are really very healthy and continue to provide capital for land, operating expense and equipment purchases. An interesting event taking place in our industry is the January 1, 2011 Tier 4 emissions requirements for tractors. We expect this to result in an increased level of demand for the remaining inventories of current Tier 3 models which will drive the sales of current models throughout the end of this year.

We are also excited about the anticipated new technologies and increased operating efficiencies associated with the Tier 4 tractor rollout forecast for January 2011 which we believe will create pre-sell activity in Q4 of our current calendar year.

In the construction side of the business it is important to keep in mind that the regions in which most of our construction stores are located are not dependent strictly on the housing sector. The influence of infrastructure, energy, mining, ag and commercial growth in our markets have tempered the effects of the recession on our construction equipment business which is reflected in our last year’s results with our comp store sales around 20% and the industry being down much more.

As we look into 2011 and beyond we are confident that the construction equipment stores will be an important contributor to the growth of Titan Machinery brands and our top and bottom line performance. A bright light in our construction business is the oil boom created by oil activity in Northwest North Dakota which has doubled in the past three years, surging to 80 million barrels in 2009. North Dakota is now the country’s fourth largest oil producer behind Texas, Alaska and California.

Now I would like to take a moment and discuss our strategy for 2011. On the ag side of our business we plan to continue improving organic same store results and we believe we will be able to continue acquiring additional locations throughout the year.

Turning to our construction segment, one of our primary goals is to improve our top and bottom line results in this business. Although we believe we have seen a bottom in the construction equipment industry we have taken several key actions that we believe will drive improved results for our construction business in this fiscal year.

Turning to slide six you will see an outline of some of these steps we have taken. First, we re-right sized our rental fleet. Our rental fleet has been under-utilized over the past year and had a negative impact on our margins. Second, we made some key improvements in our construction segment personnel. We are closing an underperforming [fees] store Columbia Falls located in the Kalispell, Montana market. Not only does this market have overall low industry unit potential, it is primarily a residential construction market which is currently significantly over-built.

Lastly, we are working diligently to fully implement our Titan strong store operating model in the construction equipment dealerships we acquired in fiscal 2009. If you look on slide seven, the map represents our construction equipment footprint. The gold states represent the fiscal year of 2009 construction acquisition stores and the blue states represent our core locations. Last year our group of core CE locations were profitable significantly outperforming our more recently acquired stores. As we fully integrate our operating model into our acquired stores we anticipate an improvement in the results in line with historical improvements of our core locations.

It is important to remember that the price we paid for these acquired dealerships took into account the challenging environment and continue to represent the opportunity for a strong return on investment in the construction equipment business. Strategically, we believe acquiring these stores was the right, long-term decision. We believe our current construction store base has the potential to generate strong earnings growth.

While any improvements in the overall industry would certainly benefit our results, we believe the steps we have taken to manage the controllable aspects which I just outlined will enable us to generate improved results even if the overall industry does not improve.

Regarding future acquisitions, we continue to see a long runway of potential ag and construction acquisition candidates in the upper Midwest. We are currently in discussions with a number of single store and multi-store dealership groups. In addition to the current high level of industry consolidation, we are seeing increased seller activity in 2010 which we believe is due to the current 15% capital gains rate that is legislated to change in 2011.

In summary, as we begin fiscal 2011 we are confident in our ability to continue delivering solid results. We believe our ag business will remain strong and we are confident that the changes we made to our construction business will result in improvements in profitability in that area of our business. With that, I would like to turn the call over to Peter to review our financial results in more detail and provide you fiscal 2011 guidance. Peter?

Peter Christianson

Thanks David. Turning to slide eight, our total revenue for the fiscal 2010 fourth quarter was $252.3 million. We experienced increases in all three of our main revenue streams. Equipment sales increased 32.7%. Parts sales increased 38%. Service sales increased 28.9%. The abnormal harvest during the quarter had an adverse effect on our service revenue which contributed to our less than anticipated earnings per share.

On slide nine, our gross profit for the quarter increased 13.8% to $37 million which was less than our revenue growth of 34% reflecting lower gross profit margins. Our change in gross margins reflects lower equipment margins due to lower manufacturer program incentives, last year’s tight equipment supplies and a return to a more traditional supply condition.

Our operating expenses as a percentage of net sales decreased 200 basis points to 11.8% in the fourth quarter versus 13.8% in the fourth quarter of the prior year. This is driven by the higher ag sales in the fourth quarter generating great fixed operating expense utilization. Our pre-tax income was $6 million or 2.4% of revenue compared to $5.4 million or 2.8% of revenue in the fourth quarter of last year. The compression in our pre-tax margin reflects the previously mentioned lower gross profit margins.

Net income for the fiscal fourth quarter of 2010 was $3.4 million compared to net income of $3.2 million in the fourth quarter of last year. Earnings per diluted share for fiscal fourth quarter 2010 were $0.19 compared to $0.18 per diluted share.

Now turning to our full-year results, on slide 10 our total revenue for fiscal 2010 increased to $838.8 million compared to $690.4 million in fiscal 2009. Our equipment growth lagged our parts and service revenue primarily due to a weak construction equipment market. On slide 11, gross profit for fiscal 2010 increased to $141.1 million. Gross margins in fiscal 2010 were 16.8% compared to 17.4% in fiscal 2009.

Our recurring parts and service businesses contributed 52% of gross profit in fiscal 2010 compared to 46% in fiscal 2009. As was the case during our fourth quarter our change in gross margins was primarily due to lower equipment margins and a decrease in margin for our “other” category which includes our construction rental equipment due to a lower utilization of our rental fleet that resulted from a weak construction industry in the year.

Our operating expenses as a percent of net sales were 13% in fiscal 2010 versus 12.6% in the prior-year period. This increase in operating expenses as a percentage of revenue was primarily driven by the larger concentration of construction stores in fiscal 2010 which have a higher operating expense as a percentage of revenue as well as lower revenue in fiscal 2010 as compared to fiscal 2009 due to the challenging construction environment.

Pre-tax income was $27 million compared to $30.5 million. On a segment basis, our ag pre-tax income was $36.1 million and we have pre-tax loss from our construction segment of $6.8 million. Our pre-tax margin was 3.2% compared to 4.4% of revenue last year. This change was primarily driven by our lower gross margins.

Earnings per diluted share for fiscal 2010 were $0.88 on approximately 18 million shares outstanding compared to $1.08 per diluted share on approximately 16.8 million shares outstanding in the same period last year. The 7.1% increase in share count was due to our May 2008 follow-on offering.

Slide 12 shows our same store sales results for the fourth quarter of fiscal 2010. Our same store sales increased 22.1% which exceeded our expectations. Looking at same store sales by segment, our ag store same store sales increased 25.1% driven by strong equipment sales while our construction same store sales declined 1.9% reflecting the weak construction market. Based on the different margin levels of our revenue stream, we believe the same store gross profit is the most useful measure for our business. For the fourth quarter our same store gross profit increased 4% year-over-year. Our ag dealership same store gross profit increased 7.7% reflecting our lower equipment margins while our construction same store gross profit decreased 16% reflecting compressed equipment margins.

Turning to slide 13, you can see our full-year same store comparisons. Our overall same store sales increased 4.9% in fiscal 2010 ahead of our most recent expectations of flat same store sales comparisons for the year. Ag same store sales increased 8.2% while our construction same store sales decreased 26.8% reflecting the challenging environment for our construction business. It is important to remember that although our construction business was down 26% the national construction industry was down to a much greater percent.

Turning to same store gross profit, our overall company same store gross profit increased 1.7% with ag increasing 3% and construction decreasing 9.4%. When reviewing same store comparisons, I would like to remind you our group of core construction locations was profitable, outperforming our more recently acquired construction stores. For modeling purposes it is important to recall that we calculate same store sales by including stores that were with Titan for the entire period to which we are comparing. In other words, the only stores that were part of Titan for the entire three months of the fourth quarter of fiscal 2009 are the ones that are included in our fourth quarter same store comparison. A total of 19 locations were not included in our fourth quarter same store results; 9 ag stores and 10 construction stores. For full-year results, 31 locations are not included; 14 ag stores and 17 construction stores.

On slide 14 we give an overview of our balance sheet highlights. We continue to have a very strong balance sheet with cash and cash equivalents of approximately $76 million or approximately $4.23 per share in cash to pursue future acquisitions and fund working capital and general corporate purposes. As we have discussed on previous calls fiscal 2009’s extremely strong global equipment market reduced inventories to very low levels which is reflected in our fiscal 2009 year-end inventory levels.

Our fiscal 2010 inventory returned to historical stocking levels to support our forecasted sales and ensure we are maximizing our business. Our inventories decreased to $349 million at January 31, 2010 compared to $357 million at the end of our third quarter and $243 million at the end of fiscal 2009. We expect our inventory levels throughout fiscal 2010 to be similar to our level at the end of fiscal 2010. This level will support our expected sales throughout the year and market share goals.

Working capital and the end of fiscal 2010 was $159 million. Long-term debt including current maturities and advances was $29 million at the end of fiscal 2010. As of January 31, 2010 we had $107 million available of our $365 million total floor plan lines of credit. In addition we have a loan agreement with Bremer National Bank which provides for a $25 million revolving operating line of which the entire $25 million is available.

In summary, we continue to have a strong balance sheet, enabling us to invest in our business and growth opportunities as we see fit. Slide 15 gives an overview of our cash flow statement. When we evaluate our business we look at our cash flow related to inventory net of floor plan activity which is reported on our statement of cash flow as both operating and financing activities. When considering floor plan our fiscal 2010 net cash flow used for our seasonal increase in inventories was $13.5 million. This cyclical cash requirement illustrates the importance of our strong cash position on our balance sheet.

On our statement of cash flow, the GAAP reported net cash used for operating activities was $47.7 million primarily due to our increase in inventory. We believe including the non-manufacturer floor plan proceeds and the advances in contracts in transit as part of our operating cash flow better reflects the net cash flow of our operations. Making these adjustments, the net cash provided by operating activities during fiscal 2010 was approximately $4.5 million. A reconciliation of this non-GAAP measure is contained in the slide show which is posted on our website.

Turning to slide 16, you will see our full-year fiscal 2011 outlook. For the year, our revenue outlook is in the range of $920-980 million. We expect to generate net income between $17.2 million and $19.9 million and earnings per share of $0.92 to $1.02 based on 18.1 million weighted average diluted share count. When modeling our business for the 2011 forecast we expect our ag same store growth to be in a range of flat to 5% growth. We expect our construction same store growth to be in the range of 15-20%. We also expect a 50% reduction in our construction lots.

In addition to our annual guidance I would like to provide some color on our fiscal 2011 first quarter. This quarter is historically a seasonally soft quarter and we expect this quarter to be similar to the previous year. It is important to remember that weather does affect our quarterly results and this is why we provide annual guidance.

Turning to slide 17, you see our net income analysis for the past six years. Based on our outlook for fiscal 2011 our bottom line will continue to grow at a steady pace. Following an extremely strong year in fiscal 2009 fiscal 2010 results and fiscal 2011 projections are in line with our long-term net income trend.

Now I will turn the call back over to David for closing comments.

David Meyer

Thanks Peter. We are pleased we were able to deliver top line growth in a challenging construction environment. We believe this is a testament to our strong Titan operating model. In fiscal 2010 we made several key acquisitions and further established Titan Machinery as a leader in the industry. As I stated earlier, we continue to see a long runway of potential ag and construction acquisition candidates.

As we enter fiscal 2011 we believe the improvements we are implementing in our construction business will enable us to achieve improvements in this business segment and enable us to achieve top and bottom line growth in 2011. Before we take your questions I would like to conclude by thanking our employees for all of their hard work and thank our valued customers for their continued support.

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

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Robert J. Evans - Craig-Hallum Capital.

Robert J. Evans - Craig-Hallum Capital

On your last comment on the Q1 guidance similar to last year I assume you are talking about earnings versus revenue?

Peter Christianson

Right. Yes.

Robert J. Evans - Craig-Hallum Capital

Obviously your guidance for the year is up a fair amount. Can you give us some sense of how we should think of revenue in Q1 this year versus last year? Sequentially I think you were down last year around 12% or so.

Peter Christianson

I will come back to that. I will give you some color on that. I just want to get a range.

Robert J. Evans - Craig-Hallum Capital

On your guidance can you comment on your 920-980, how much acquisition revenue is assumed in that?

Peter Christianson

On our modeling what we do is we model in how much we look at our same store sales and we thought we would be able to give you a lot more insight by going to segment reporting. So given the modeling we put out there I think you can pretty well come up with the acquisition being the final piece of our revenue. You need to remember on the acquisitions as you are calculating into the models there are two parts of the acquisition revenue. One of them is the annualization of last year’s stores that we acquired and then the other one is the new store acquisitions for this year. This year that is dependent a little bit on our timing. So going back to look at last year we have the list of the stores we did. When we do our press releases we give their historical revenue and the timing throughout the year and so I think you can pretty well back into that.

Robert J. Evans - Craig-Hallum Capital

Going through your guidance it would assume, I haven’t done all the math yet, but it would assume gross margins remain somewhat depressed. Is that true? Given the revenue guidance and the fact you are going to have construction I think you said a reduction in the loss by 50% which is around I think $0.12 per share it would appear you are still looking for depressed gross margins and I am wondering for color on that.

Peter Christianson

The only color I would give you is what you have to keep in mind when you talk about our equipment margins is 2009 was an extremely strong year and we had the tightest global supplies we had in recent history on equipment sales. So if you look at really how we ended up this year where we ended up with an annual 10.1% equipment margin versus last year’s 11.5% that 10.1% is much more in line with what our historical equipment margins have been. For modeling purposes we use that number from last year. We were in that range because we think that represents more of the historical results and that is why we say we are kind of back to a traditional supply side of a competitive selling environment.

Robert J. Evans - Craig-Hallum Capital

Can you talk a bit more on gross margin in terms of the biggest…I just want to make sure I am clear on what the biggest impacts were in Q4 this year say versus Q4 of last year. The biggest buckets of difference.

Peter Christianson

Could you repeat that again?

Robert J. Evans - Craig-Hallum Capital

The biggest buckets of Q4 gross margin this year versus last year. Dealer incentives I think are a part of it but if you can elaborate on the 2-3 things that are the biggest change.

Peter Christianson

The biggest things when you look at it quarter-over-quarter was that some of the manufacturers have annual program incentives and they fall into the fourth quarter. If you recall last year on our fourth quarter call we had a large manufacturer incentive that we entered into our pricing on our equipment margins. This year we didn’t realize that. We also this year are returning like I said to more of a traditional selling environment where there is traditional supply. It is just more competitive so you have that return to the historical equipment margins. Just about half of that difference is incentive pricing on whole goods and then the remainder of that would be the competitive nature of the environment we were in going into the fourth quarter.

I guess what I would add to that is we did maintain our sales velocity. We were able to keep that revenue stream rolling and capture the sales.

Robert J. Evans - Craig-Hallum Capital

You mentioned Tier 4 emission standards should be strong for the industry. Can you elaborate on that?

David Meyer

This is a pretty major change we haven’t seen in a long time in our industry. With the Tier 4 by our customers there is an anticipated price increase that may come with the Tier 4 emissions with the January 2, 2011. With that, understanding I think there is a high level of satisfaction with what the current engines in our tractors and the fact that this change and the unknown with change and the fact they like what they have right now and they know what the price is right now. They don’t know what the price in 2011 is going to be with the Tier 4. This is going to drive business with these current Tier 3 models on the ground. So we think from now to the end of the year there is going to be a big demand for the existing Tier 3 engines.

At the same time from learning about the Tier 4 engines is the new technologies that increase efficiencies we have another group of customers that will be lining up for those and taking advantage of the Q4 pre-sell programs to lock in those engines and those tractors that will be basically producing the first quarter of calendar year 2011. It is kind of a win/win and an exciting time for our industry. If you do some reading on this there is a lot of jockeying going on between John Deere and Case IH. The C&H engine family is going to come out with the SCR technology as opposed to Deere has been talking about the EGR technology. It is going to be interesting. We think we have the best solution to the Tier 4 Emissions and we are looking forward to selling and retailing all of the existing Tier 3 models this year and then the opportunities with the increased efficiencies coming out with the Tier 4 engines in calendar year 2011.

Peter Christianson

For a little color in the revenue in the first quarter that would follow in the same range of what we were looking at last year along with the earnings.

Robert J. Evans - Craig-Hallum Capital

You are saying sequentially down 11-12% you mean? I am not sure what you are saying.

Peter Christianson

What I am saying is that last year we had in that vicinity of about 19-20% of the revenue split out in the first quarter.

Operator

The next question comes from the line of Paul Mammola – Sidoti & Co.

Paul Mammola – Sidoti & Co.

First on the shifting of some of the parts and service revenue associated with the late harvest, where does that land? Will it be in the next quarter or could you see some of these guys bring their combines in the summer?

David Meyer

We talked a little bit on our last quarterly earnings call and the question then was do you feel like the parts and service business because of the abnormal harvest was going to be pushed into the fourth quarter and at the time we really didn’t have good visibility to it because the harvest wasn’t done. In fact, lots of the harvest was just finishing up here within the last month. Really what has happened as we have gone forward now and we do have our results in for the fourth quarter, as I talked about in our script was that we didn’t realize that service.

The parts thing it seems like kind of tracked on about with our anticipation of what should happen but the service side of the equation never did come in and could very easily just never happen. Looking at our results for the fiscal year ending in January we would have just not realized that piece of that revenue stream of that service because of the fact they didn’t get their crops harvested. To the extent they didn’t get them out we didn’t get a chance to work on those machines. That is what we see happening. We think we are pretty well done in the fourth quarter our parts tracked about right and our service was off and didn’t come in as we anticipated it. We are not really banking on a lot of that coming back to us in the first quarter.

Paul Mammola – Sidoti & Co.

Understood. You talked a little bit about Columbia Falls. Are there any charges in the fourth quarter or first quarter associated with closing down that store?

Mark Kalvoda

We just announced the closing of it so we didn’t have any fourth quarter charges. We do anticipate some first or second quarter charges but they will be relatively immaterial.

Paul Mammola – Sidoti & Co.

If I can take you back to guidance would it be fair to call it conservative to the extent that we understand you are pulling in the gross margin in terms of equipment sales if you lessen the pre-tax drag from CE that is almost $0.20 right there. If you have ag up 5%, again I understand the gross margin drag, I would expect maybe if things go according to plan could end up in the $1.05 to $1.15 range. So I guess the question is could you call what you put up there initially conservative?

David Meyer

We like to give you the best outlook we can in our business and just exactly like I showed on the slide looking at our outlook we model our business between 0-5% on our same store on the ag side and 15-20% on the construction side. We did use that equipment margin assumption based on more of the historical equipment margin levels. We feel like our guidance has given you a good insight on what our expectations are.

Operator

The next question comes from the line of Rick Nelson – Stephens Inc.

Rick Nelson – Stephens Inc.

I would like to ask you about the CE side of the house and the guidance you are providing for 15-20% same store growth and the reduction in the loss. What gives you comfort in the recovery?

Peter Christianson

I will take kind of the first part of that answer and then David can follow on, but one of the things is we have worked very diligently over the last 12 months to fully integrate our Titan operating model into those stores. What we have seen is we did the same thing in the core stores we have in the Dakotas and took them from being unprofitable stores to being profitable. We grew their revenues and we grew their margins. What we see as our compensation and our operating model drives increased revenues and we feel confident we are going to be able to get results because of the implementation of our model in and of itself.

In addition to that, David can comment on the industry and the effect we see on that.

David Meyer

We buy some used equipment and some distressed used equipment from the East Coast or West Coast and down in the South and bring them back into our markets which are a little stronger than the rest of the industry. We have seen a little uptick in that used equipment pricing somewhere between that 5-15% just in the last two months. That tells me we are seeing a bottoming out and we are seeing some upward trends. You have to keep in mind for those recent acquisitions we did in the last fiscal year in Iowa, Nebraska, Montana and Wyoming, we bought those at fairly conservative prices. This was a small…we are going to see a fairly high return on our investment on that. It doesn’t take much of a turnaround considering the price at which we bought those deployed assets.

So we think we see some opportunities. We made some comments on the oil business in northwest North Dakota and also the fact in most of our markets we have the ag influence, energy, mining, it is somewhat tempered from the rest of the construction business in North America. We think this is going to take a few years to completely get back on board but we think we have hit the bottom and it is starting to move in the other direction.

Rick Nelson – Stephens Inc.

If I could also ask you about the pipeline given the recovery you see in the construction side of the business, preference for ag versus construction in terms of acquisitions.

David Meyer

We think there are some good opportunities right now in construction equipment store acquisitions. If there happened to be one available that was strategic to us I guess we are seeing if you can buy some of these at the bottom of the market and long-term projections look good long-term for construction we are not going to shy away from those. At the same time we feel really good about ag store acquisitions right now. I am talking to a number of people right now. We have some single stores. We have some multi-store groups. A lot of different geographies in the upper Midwest.

The 15% capital gain we have this year is going to really weigh heavily on a lot of these sellers and we are getting a lot of momentum picking up right now because they are watching the calendar and the clock and a lot of these ag stores are making really good money right now but the 15% capital gain is really important to them and a lot on the fundamentals that is really driving acquisitions in this industry. The lack of succession, the increased sophistication of equipment, the huge barriers to entry, some of the increased capital needs out there. They are still strong and like I said I am talking to a lot of people and a lot of dealers of a lot of different dealerships on acquisitions right now.

Rick Nelson – Stephens Inc.

Given that pipeline how much revenue do you think you could absorb? I know your target is 10-15% but given those dynamics could you swallow more than that? Would C&H approve more than that?

David Meyer

First of all, the people we have in place in Titan and our transition team and our training people and our ability to go into the stores and bring them on board to our model, we have put a lot of investment and a lot of resources into that group of people. We feel confident we can do a number of acquisitions. Sometimes current with each other, multi-acquisitions at one time. I think we have the internal resources here to make that happen and do it very effectively. We continue to work hand in hand with C&H. As you understand the industry, the manufacturers know there is going to be consolidation taking place.

If you look at a lot of the things that Titan has done when they have gone in and done acquisitions. Our past track record with very satisfied customers. We are able to retain employees. We are growing market share. We are investing in facilities. Like I said we continue to meet regularly with the C&H folks and really manage our growth hand in hand with both the Case IH and Case construction people. We continue to anticipate moving ahead similar to the fashion we have done in the past.

Rick Nelson – Stephens Inc.

Same store revenue, how you see that unfolding as the year progresses. I know you have more construction stores coming into same store sales early this year. Is that in fact additive early in the year or do you see that more of a second half recovery?

Peter Christianson

When you talk about same store sales it is important to realize all of our construction stores will be included in that right now because the final acquisitions were closed I believe at 12/31, December of 2009, so we will include those stores for the full-year and that was part of that forecast assumption we made when we said the 15-20%. I correct myself, the last acquisitions were in December 2008.

Rick Nelson – Stephens Inc.

So they were all in the fourth quarter? The construction stores?

Peter Christianson

Yes. So they will be part of our same store calculation for the entire year.

Rick Nelson – Stephens Inc.

Was that also the case in the fourth quarter?

David Meyer

The Midland acquisition in Iowa and Nebraska, that happened earlier in 2008. That was more mid-year 2008. Then the Montana Wyoming was September 2008 in the fourth quarter.

Rick Nelson – Stephens Inc.

So you would have more construction rolling into comps in the first quarter than you had in the fourth quarter?

David Meyer

That is correct.

Rick Nelson – Stephens Inc.

That 15-20% same store lift you are looking for from construction, how do you see the cadence of that during the year?

Peter Christianson

We are really not going to that level on our outlook. One of the things that is important is we now have had those acquisition stores for a full 12 months so we have our operating model pretty well fully integrated into them and that is why we see a full-year effect on that outlook coming through there.

Operator

The next question comes from the line of Jeff Osher – Harvest Capital.

Jeff Osher – Harvest Capital

Just to try and condense some of the questions you received, simply put if revenues at the midpoint of your range, call it $960 million if you grow revenues year-over-year something closer to $300 million the contribution margin would effectively be nil if you are able to recapture half of your construction loss, call it $3.4 million. That gets you on the $15.7 million you did in net income in fiscal 2010. You recapture $3.4 million that gets you closer to $19 million or the high end of your net income guidance and that assumes no incremental revenue as a zero percent contribution margin. Maybe you can just help people and me specifically reconcile that?

Peter Christianson

You went through a lot of stuff there.

Jeff Osher – Harvest Capital

Let me simplify it. If you did $15.7 million of net income in fiscal 2010 and you pick up $3.4 million from the construction loss that gets you to $19 million right there. Your revenue guidance is for incremental $300 million. On the incremental revenue guidance call it $250 million of incremental guidance on the top line…

Peter Christianson

I think the first thing you have to change in your assumptions is when you talk about the $3.4 million you are taking that into all of these calculation that is pre-tax you are talking versus after-tax. The other thing is when we did the range I think you just made a misstatement, you were stating an additional $300 million or something and I don’t know…

Jeff Osher – Harvest Capital

$250 million call it.

Peter Christianson

If you take it from the range and you look at our total sales this year coming in where they were at I don’t know where that $250 million is. It was [inaudible] this year and the midpoint is 960 so that is…

Jeff Osher – Harvest Capital

Sorry I was looking off of 2009. Call it $110 million assumes zero contribution.

Peter Christianson

I can tell you this if you do go through it and do the math and just be sure you don’t get yourself confused between pre-tax and after tax, we have given the assumptions and I am sure if you work that through your model it will work.

Jeff Osher – Harvest Capital

So the $6.8 million you quoted for fiscal 2010 you are telling us now that was pre-tax? For construction loss.

Peter Christianson

That is correct. Our segment reporting is before eliminations and before tax.

Operator

The next question comes from the line of Robert McCarthy - Robert W. Baird & Co.

Robert McCarthy - Robert W. Baird & Co.

Can I first ask you about your rental fleet liquidation? I gather that generated revenue in the fourth quarter. Is that right?

Peter Christianson

You are speaking to when we right size our rental fleet?

Robert McCarthy - Robert W. Baird & Co.

Yes.

Peter Christianson

We did that primarily in the first quarter and the third quarter.

Robert McCarthy - Robert W. Baird & Co.

So no impact to the fourth?

Peter Christianson

Correct. That is right. To the extent we did that, what we do is we didn’t reclassify that from being part of our capitalized rental fleet over to being in our inventory held for resale. We don’t necessarily have that. We aren’t doing it because it is pre-sold. We are just saying that we are going to use the discipline when we manage our rental fleet so we have a fleet that is right sized so we can drive the right utilization and that also contributes to our inventory on the construction side of the business.

David Meyer

That rental fleet too we inherited that from the Montana Wyoming acquisition so in January we recognized that right away. That is not something from our core stores. It is more from the acquired stores we did a year ago.

Robert McCarthy - Robert W. Baird & Co.

Of course. I was just trying to understand whether it had any impact on fourth quarter gross margins.

David Meyer

No.

Robert McCarthy - Robert W. Baird & Co.

The actions you are taking to reduce your losses on the construction side of the business I gather one way to measure the savings you expect is half of the loss from this year. How much of that would be the benefit from closing the store? What does that save you?

Peter Christianson

That store probably would be looking at about $600,000 pre-tax.

Robert McCarthy - Robert W. Baird & Co.

That just gives us a sense of how big the challenge will be to accomplish the rest of…

Peter Christianson

It was about $600,000. To reiterate again those are all pre-tax numbers for our business on a segment basis.

Robert McCarthy - Robert W. Baird & Co.

Of course. The improvement in CE personnel you were referring to, this is really just moving new Titan trained people into running the acquired businesses right?

Peter Christianson

What we have been doing is we have been really strongly recruiting people. As we see that we need talent right now you can imagine with the construction industry being where it is at on its cycle there are a lot of very qualified people out in the marketplace. So we felt like it was the time for us to really look at who we have in these acquisition stores and make sure we recruit the top notch people. So we have been doing that in the last 12 months.

Robert McCarthy - Robert W. Baird & Co.

Are we primarily talking I gather about store managers, sales managers?

David Meyer

We are talking about store managers. We brought some machine control specialists in with the GPS precision aspect of the business. We found some really good people on that side. We have some department managers in some of the stores we have got. Also two region managers we have done. So pretty intensive and most of this is taking place in the acquired footprint.

Robert McCarthy - Robert W. Baird & Co.

You made an interesting remark when you were talking about inventory levels. You said you thought they would stay roughly flat through the year because you are up to more normal levels I gather. If the market is going to be strong enough to drive 15-20% improvement in CE same store sales growth, obviously then you are not going to fill that kind of growth from inventory. I guess what I am trying to get to is I am surprised you believe you need to carry this level of inventory to support this level of sales. Could you talk about that a little?

Peter Christianson

We are comfortable with where we are at with how much inventory we are carrying. Of course we all need to remember that still 80% or about, last year it as about 85% of our business was ag related, and if we look at what the stocking levels are relative to that and how that has kind of gotten back to a more traditional stocking cycle. A good point you bring up on the construction segment of our business. Our inventory turn is not where we would like it to be. We haven’t broken that out but it isn’t where we would like it to be on the construction segment. So when we talk about improving our sales we think that is going to drive us into a lot better inventory turn on the construction side of the business. We are pretty comfortable with how we see that rolling out through the year.

Robert McCarthy - Robert W. Baird & Co.

That makes sense. I understand your construction same store sales growth really could benefit from sales that are specific to Titan and your ability to generate sales in your territory. What do you think the underlying growth rate for the industry is going to be compared with your up 15-20?

Peter Christianson

David spoke to that earlier. We think the construction business is on the bottom side of the cycle. What we really wanted to do was we want to take actions that David went over on our action plan so we felt we could influence our results on our same store sales regardless of the industry. We really do feel like we modeled 15-20% and if the industry stays flat we want to do 15-20% in our plan.

Robert McCarthy - Robert W. Baird & Co.

So it is fair, if I quote you as saying you are assuming the industry will be flat? That would be okay with you?

Peter Christianson

We really don’t know for sure but right now the things that we see it looks like it is probably flat and maybe if there is any uptick to it that could be in the back half of the year. Everybody is still kind of looking to see how that is going to rollout.

Robert McCarthy - Robert W. Baird & Co.

So a source of potential upside. What are you expecting in terms of pricing for the current year? Generally stable or do you think you can get some price in the markets you are in?

Robert McCarthy - Robert W. Baird & Co.

On the construction and ag side or just the construction?

Robert McCarthy - Robert W. Baird & Co.

Yes and new versus used. Please talk about what you are seeing David.

David Meyer

I think we are seeing a little bit of an uptick in used construction values. As far as new construction values I don’t see we are going to be able to get much more pricing out of this market right now. It is still very competitive. There seems to be a little bit of a glut of machinery out there. I see the manufacturers under-producing retail. So that all tells me you are not going to see a lot of pricing there. I think our main thing would be to minimize interest bearing inventory and try to liquidate as much of our existing inventory we have right now. Increase the turns and increase the velocity of equipment through on the construction side.

On the ag side we still see uncertain levels on some used tractors and stuff that there is still a high demand for good late model equipment. I see a definite interest by a lot of customers to get their hands on some of this late model, Tier 3 type engines. So that remains very stable in that business. There still remains a lot of competition between C&H, Case IH and John Deere, so this competition I think is going to keep that business fairly stable and it all depends on what the effects of this Tier 4 and the changes with the model year 2011 models and that will be for the fourth quarter of this calendar year. Then the actual Tier 4 engines produced after January 1 is going to add a little bit of dimension out there that could have some increased pricing because of the Tier 4 technology.

Robert McCarthy - Robert W. Baird & Co.

I thought you might go there. Peter in your segment breakdown at the end of the release where you report income loss before taxes for agriculture and construction there is a line for shared resources, the expenses that aren’t being allocated out to the segments. In the fourth quarter that number was down considerably from the prior year. As a matter of fact, it really doesn’t look anything like a run rate when you consider the full-year number was a little above $2 million. So I am kind of wondering if there was something you got a little help from in the fourth quarter to offset some of the expenses?

Mark Kalvoda

Yes. It was down this year versus last year on unallocated expenses. What happened in the current year is we didn’t have a manufacturer financing incentive. If you look on our other income line that did come through that we didn’t pass down to the stores. That didn’t go out to the segments. The benefit of that stayed at the shared resource center.

Robert McCarthy - Robert W. Baird & Co.

Is it fair to say then that the difference between the number from this year and the number from last year is a rough estimate of how much larger those incentive payments were in this year’s fourth quarter?

Mark Kalvoda

It would be somewhat larger than that. The difference, if we hadn’t had it the shared resource number for this year would have been somewhat higher.

Robert McCarthy - Robert W. Baird & Co.

There is a lot of debate as I am sure you are aware in the marketplace about SCR versus EGR. For us laymen out here it seems the need to actually have some inventory of urea even though it is a relatively small amount and the complication of making sure you always got some in the tractor, etc. would be a distinct negative compared to EGR. I gather that Cummins and Case IH are talking about some offsetting benefits and I kind of wonder if you could talk about that a little bit?

David Meyer

I am sure there are a lot of people on this phone if we start talking about EGR and SCR they are going to be a little bit lost so I am going to try and simplify this as much as I can. Your SCR what they are doing is adding a compound to the exhaust and if you look at the over-road semi trucks they are experiencing this right now. All of the over the road semi trucks out there for the most part are running the SCR technology. So they have a tank of urea when they go to the fuel stop and fill their tank with fuel they put in urea which gets used at about a 2% rate. So for every 100 gallons of fuel they are using they are using 2 gallons of the urea and most of the truck stops have this urea there so it is not a big issue.

What they are seeing is probably 4-6% savings in fuel economy. So that much more offsets what the cost of urea is. It is very simple. It is an add on outside of the engine. There is not a lot of R&D involved with that and it is a pretty easy entry into the marketplace and that is the direction C&H is going.

On the other hand with EGR what that is doing is they need to cool the temperature of the exhaust and add filters after the fact that capture these particles. All of a sudden there you are talking about major internal changes to the engine in order to do this. If you take the off-road equipment as compared to the semi trucks if you take a combine or a large 4-wheel drive tractor and you need to cool that exhaust all of a sudden you are talking about bigger radiators. You are talking about horsepower loss. You are talking about a lot of issues that are going to take horsepower and increase your fuel consumption. You are looking at some of these byproducts that could maybe even be a fire hazard out there when you start getting these particles.

So we really think the SCR technology is the way to go. I actually think people with EGR are really going to struggle with that. I feel really confident that C&H is picking the right direction with the SCR technology.

Operator

The next question comes from the line of Brent Rystrom – Feltl and Company.

Brent Rystrom – Feltl and Company

What were your goals for ag and construction business segments when you talk about the fourth quarter missing on the construction side was your miss in the quarter entirely there or was there a miss on your segment goals?

Peter Christianson

It was on both sides of the business. Our equipment margins came in a little bit less than what we had anticipated. We were able to exceed on our revenue. As you are very well aware on the ag side of the business there is just a tremendous amount of year-end buying from our customers at the end of December. What happened, and it shows in the numbers, what happened was we were able to capture sales and we exceeded our expectation on the revenue side but the market would only allow X amount of pricing in there and that is reflected in our equipment margins. At the same time we would have liked to pick up a little bit more on our construction we thought maybe from year-end buying there. But, it fell a little behind.

Brent Rystrom – Feltl and Company

We poll a lot of dealers and when we did our poll in January 11 of the dealers and most of the dealers we poll are independents and they told us that the fourth quarter sales literally half or a little over half of the business in their fourth quarter ends typically in December came as that year-end tax buying. Basically the tone coming out of the fourth quarter and again the December quarter was that conditions were pretty sloppy at quarter end.

Since then on subsequent polls what we are hearing from people if you X out the weather impact which is the brutal January/February and people are just not doing anything as you know in your dealerships down in Iowa in January you couldn’t even walk in the parking lot because they were covered with ice. X out that and sales trends have actually been improving the last two months or so. Would you say that is reasonable compared to what it was in the fourth quarter kind of tone?

Peter Christianson

Our fourth quarter like I said we exceeded our revenue expectations and when we mode this year and talk about our first quarter we feel that our first quarter is traditionally our softest quarter and that is why…I want to give you a little color on our first quarter and just let you know we see it kind of tracking like what last year did.

David Meyer

If you look at what the manufacturers forecast last December for the first quarter even in calendar year 2010 I think the first quarter industry results in combines, 4-wheel drives and 100 hp plus tractors has far exceeded what even the manufacturers anticipated back in December.

Brent Rystrom – Feltl and Company

That is what I am kind of seeing. It kind of felt like the things were going to get kind of sloppy here in the first quarter. Oddly enough they firmed. Obviously not necessarily too hugely firmed but my point is it felt like it was going to fall off the cliff [in the November] post-year term, business has maybe stabilized a bit?

David Meyer

I think the industry numbers are holding true and I see if I hear what John Deere is saying and what C&H is saying they are increasing production to meet the increased demand out there. As we said in the call there are a number of factors; the farmer’s strong balance sheets, the demand for Tier 3 engines and I think a lot of these things…if you look at the USDA they are talking about increased gross farm receipts up from last year levels. So I think the combination of strength in the livestock markets and I think a lot of this corn that was in the fields is now coming off too and all of a sudden some of these farmers have a lot more money to spend. So there is a lot of positives out there.

Brent Rystrom – Feltl and Company

Cash is finally coming in. Combine sales, any thoughts on recent things there? Again, another recent survey we are kind of seeing that peak up as probably the area where people are most concerned with dealers? Any thoughts on combine sales relative to overall sales?

David Meyer

Again the industry is up for combine sales. We are getting combine business with some new models out there. Again, there is definitely an interest out there for tractors and combines to grow the business. Traditionally I guess it would be a little more of a seasonal business. I think a lot of growers like to see their crop come out of the ground and see where the markets are at and some things like that and also you see in some places probably some deliveries of units where the deals were actually made in the fourth quarter back in November and December and they are being delivered now too and you are starting to see some of that. The pre-sell business the deliveries are actually being made and that is actually being reflected and that is in some of the industry numbers.

Brent Rystrom – Feltl and Company

2010 comps you did phenomenally compared to the industry. What drove that? What was the big driver that pushed your sales above what the industry was seeing on the ag side?

Peter Christianson

I think we track not too far off of the industry and if there was a differentiating factor it probably would be the aggressive nature of our processes and our tightened operating model and the way we comp our field marketers and just the way our whole system is set up with this strong store operating model. That would be a differentiator in helping us achieve that.

Brent Rystrom – Feltl and Company

The 0-5 comps for the ag side and the 15-20 I would assume you would sequentially kind of build that? Or do you see that kind of straight line across the year for each segment?

Peter Christianson

No one has total visibility into that. As we look at our business really what we are going to do is we gave you some color on the first quarter on this call and we will update you on our next earnings call and look at how this weather pattern plays into our customer production cycle because that can influence this thing as far as how their buying habits, which quarter they fall into and we will keep you updated on that.

Brent Rystrom – Feltl and Company

How was the weather pattern? I drive across central Minnesota and Wisconsin and Northern Iowa and I have seen a lot of field work that wasn’t getting done last year at this time. I am assuming you are wetter on your Dakota side?

David Meyer

I think right now I think most of these farmers are way ahead of where they were last year.

Brent Rystrom – Feltl and Company

Even in the Dakotas?

David Meyer

Right. Fields are drying out. I think there was some wheat getting planted right now. I think if you look a lot of the corn in southwest Iowa a lot of the corn is already in the ground.

Brent Rystrom – Feltl and Company

You look at the old planting and stuff it is 37-38% versus 7 last year so you have huge, huge favorable trends there.

David Meyer

It is in good shape.

Operator

That does conclude our question and answer session. For closing remarks and statements I would like to turn the call back over to our speakers.

David Meyer

Thank you for listening to our call today. We look forward to speaking to you again when we report our first quarter results in June and as I say again any calls or questions make sure you get a hold of us and we would be happy to talk to you. Have a great day.

Operator

That does conclude today’s conference. Thanks for joining.

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Source: Titan Machinery, Inc. F4Q10 (Qtr End 01/31/10) Earnings Call Transcript
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