Titan Machinery's (TITN) CEO John Mills on Q4 2016 Results - Earnings Call Transcript

| About: Titan Machinery (TITN)

Titan Machinery Inc. (NASDAQ:TITN)

Q4 2016 Results Earnings Conference Call

April 13, 2016 08:30 AM ET

Executives

John Mills - IR, ICR

David Meyer - Chairman and CEO

Mark Kalvoda - CFO

Analysts

Steve Dyer - Craig-Hallum

Mig Dobre - Baird

Rick Nelson - Stephens

Neil Frohnapple - Longbow Research

Joe Mondillo - Sidoti & Company

Tyler Etten - Piper Jaffray

Larry De Maria - William Blair

Operator

Good day everyone and welcome to the Titan Machinery Incorporated Fourth Quarter and Full Year Fiscal 2016 Conference Call. Today’s event is being recorded.

I would like to turn the conference over to Mr. John Mills of ICR.

John Mills

Thank you. Good morning, ladies and gentlemen. Welcome to the Titan Machinery fourth quarter fiscal 2016 earnings conference call. On the call today from the Company are David Meyer, Chairman and CEO; and Mark Kalvoda, Chief Financial Officer. By now, everyone should have access to the earnings release for the fiscal fourth quarter ended January 31, 2016, which went out this morning at approximately 6:45 am Eastern Time. If you’ve not received the release, it is available on the Investor Relations tab of Titan’s website at 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 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. 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. The statements do not guarantee future performance and, therefore, undue reliance should not be placed upon them. These 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 disclosure report.

These risk factors contain more detailed discussion of the factors that could cause actual results to differ materially from those projected in any forward-looking statements. 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 into Titan’s ongoing results of operation, particularly when comparing underlying results from period-to-period. We have included a reconciliation of these non-GAAP measures for today’s release.

The call will last approximately 45 minutes. David Meyer will provide highlights of the Company’s fourth quarter results and a general update on the Company’s business, then Mark Kalvoda will discuss the Company’s financial results and the fiscal 2017 annual modeling assumptions. At the conclusion of our 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.

David Meyer

Thank you, John. Good morning, everyone. Welcome to our fourth quarter fiscal 2016 earnings conference call. As John mentioned, to help you follow today’s prepared remarks, we provided a slide presentation, which you can access on the Investor Relations tab at our website at titanmachinery.com.

If you turn to slide three, you will see a quick overview of our fourth quarter and full year financial results, which came in as I expected from the preliminary results we announced with our pre-release a few weeks ago. Revenue was $335 million, primarily reflecting lower agricultural equipment sales in North America as this segment continues to face prolonged industry headwinds.

The adjusted pre-tax loss was $45.4 million, which included the inventory impairment charge previously discussed in our pre-release. For the full year, we generated revenue of $1.4 billion. Our adjusted operating cash flow was $44.3 million and adjusted pre-tax loss was $43.7 million. For the fourth quarter and full year, our financial results were impacted by continued headwinds in the ag and energy industries.

Throughout the year, in order to successfully navigate the challenging environment and have us well positioned as the industries recover, we’ve continued executing on our equipment inventory reduction plan and our corresponding floorplan payables. In addition, we expanded the inventory reduction plan in the fourth quarter to include the marketing of the certain aged equipment inventory through alternative channels rather than our normal retail channels. As a result, we recorded an inventory impairment charge of approximately $27 million or $0.77 per diluted share, related to the expanded equipment inventory reduction plan, which Mark will discuss later as well as provide additional color on our financial results.

Slide four lists the discussion points for today’s call. First, we will discuss the headwinds we are facing in our agricultural segment as well as provide an update on the construction industry; next, we will provide an update on international segment; Mark will then review financial results and will provide an update on our expanded equipment inventory reduction plan as well as our modeling assumptions for fiscal 2017.

Now, I’d like to provide some more color for you today on our agriculture, construction and international markets in which we operate. On slide five is an overview of the agriculture industry. Spring planting is expected to be on schedule; however, timely rains will be required to support ongoing crop development throughout our footprint. USDA recently reported prospective planning for this year and reflected a combined increase of corn and soybean acres with a decrease in wheat and other crops. Lower commodity prices reflected the increase in projected production and ending stocks. USDA report, which was updated in February projects calendar year 2016 net farm income to be $54.8 billion, which represents the 3% decrease from projected net farm income in calendar 2015 and a 43% decrease from the five-year average. We believe the continued lower projected net farm income will result in continued lower end user demand for new and used equipment. In addition, high industry supply will continue to pressure equipment prices and compress margins.

For the past few years, because of the late reinstatement of Section 179 and extended bonus depreciation, many farmers were not able to plan their equipment purchases in order to take full advantage of this tax incentive. This year, farmers know that Section 179 and extended bonus depreciation are in place, and this will benefit many farmers in their purchasing decisions. As a reminder, Section 179 and accelerated depreciation was made permanent at $500,000 and bonus depreciation was extended through 2019.

In summary, the agriculture industry continues to face a number of headwinds including lower commodity prices. We believe that we have taken the appropriate steps to navigate through the current climate and will be well-positioned when the industry recovers. We’re focused on managing the controllable assets of our business including inventory and debt levels as well as operating expenses. We remain confident in the long-term agriculture industry as farmers continue to carry strong balance sheets and the underlying macro trends are projected to continue driving the long term demand for agriculture commodities.

Now, I’d like to turn to the construction segment of our business. On slide six, we provide an overview of the construction industry and our markets. Low oil and natural gas prices and overall decreased energy activity continue to negatively impact equipment and rental demand in our energy markets in surrounding regions. In addition, lower commodity prices are impacting purchases of construction equipment by customers in the agriculture industry. Offsetting some of the lower energy and agriculture demand is improved residential, commercial, and transportation infrastructure activity. Our footprint is experiencing stronger demand in large metro areas, and improved rental demand in these areas is partially offsetting the impact from reduced energy activity. We are seeing new equipment inventory levels beginning to stabilize as demand and production by manufacturers are enabling new inventory to be in line with anticipated demand. As I mentioned in our ag industry overview, the reinstatement of Section 179 on a permanent basis and the extension of bonus depreciation at the end of our calendar year 2015 should also help the construction equipment customers plan their purchasing decisions throughout the year.

Overall, we believe our construction segment revenue will be flat in fiscal 2017 with improved profitability as we begin -- as we benefit from the operating -- inventory initiatives we have put in place.

On slide seven, we have an overview of the industry in our international segment, which includes stores in Bulgaria, Romania, Serbia and Ukraine. Winter crops are in good condition and spring planting is underway in all of our markets with adequate moisture levels to support early crop development. Lower global commodity prices continue to impact customer sentiment and income in all our international markets, similar to North America. Offsetting the lower commodity prices and resulting farm income, the European Union subvention funds continue to be available in the Romanian and Bulgarian markets. As you recall, the subvention funds are monies that the European Union has budgeted over a five-year period to support investment in agriculture production in developing markets of Eastern Europe, providing 50% to 70% of the cost of qualifying new equipment purchases.

Ukraine market continues to experience challenging geopolitical and financial conditions. High interest rates and restricted credit availability are impacting end-user demand. Local currency is trending weaker versus the dollar adding financial pressure on the end-users. We continue to see a steady demand for parts and service to repair existing equipment and expect that to continue for the foreseeable future.

We are pleased with the operational improvement of our international segment during fiscal 2016. These improvements position us for profitability in fiscal 2017. Even though we continue to face headwinds in many areas of our overall business, because of the improvements we have made to our cost structure and inventory reduction and due to the continued positive cash flow, we bought back $30 million or 20% of total outstanding senior convertible notes with $25 million in cash, and we’ll recognize a pre-tax gain of approximately $2 million during the first quarter of fiscal 2017. This repurchase is in line with our strategy to use positive cash flow for delevering our balance sheet and better position the Company for future opportunities.

Now, I would like to turn the call over to Mark Kalvoda, our Chief Financial Officer to discuss our financials. Mark?

Mark Kalvoda

Thanks, David. Turning to slide eight, our total revenue for the fiscal 2016 fourth quarter was $335 million, a decrease of 31.6% compared to last year. Equipment sales decreased 37.4% quarter-over-quarter, which was impacted by the headwinds in the ag industry that David discussed. The decrease in equipment revenue was higher than the overall decrease in revenue as equipment revenues are more affected by the current market conditions compared to our more stable and higher margin parts and service business.

Our parts sales decreased 5.4% in the quarter while service revenue decreased 6.2%. The softness in this quarter’s parts and service revenue was primarily attributed to a decreased amount of customer preventative maintenance and continued lower warranty and pre-delivery service work, as a result of lower net -- lower new equipment sales.

Our rental and other revenue decreased 23.1% in the fourth quarter, primarily due to the lower utilization of our rental fleet. Our rental fleet dollar utilization was 22.5% for the current quarter compared to 24.5% in the same period last year. The decreased utilization was primarily due to the lower oil prices reducing rental demand in our oil producing markets, partially offset by increased rental demand in our non-energy markets.

On slide nine, our gross profit for the quarter was $16 million and our gross profit margin was 4.8%, a decrease of 910 basis points compared to the same quarter last year. The decline was primarily due to the $27 million impairment charge related to our decision to market certain aged equipment inventory through alternative channels rather than our normal retail channels as part of our expanded equipment inventory reduction plan. I will be providing more information regarding this plan in a few moments.

Exclusive of the inventory impairment charge, the decrease in gross profit is primarily due to our intensified efforts to sell aged equipment inventory in the current challenging market. Our operating expenses as a percentage of revenue in the fourth quarter of fiscal 2016 was 16.3% compared to 13.2% for the same quarter last year. Although, our operating expenses as a percentage of revenue increased due to the lower revenue in the current quarter, we decreased our operating expenses by $10 million or 15.9% on an absolute dollar basis, primarily reflecting the impact of our first quarter and fiscal year 2016 realignment and other initiatives including our international segment cost reduction implemented during the fourth quarter of last year. Our reduced operating expenses better align our cost structure with the current market conditions.

The non-GAAP adjustments of $7.2 million in the fourth quarter primarily reflect $6.7 million non-cash charge related to impairment of long lived assets within the agriculture and construction segments. In the fourth quarter of fiscal 2016, we recognized a non-cash charge of $31 million primarily related to the impairment of goodwill and other intangible assets within the agriculture segment.

Floorplan and other interest expense increased 40 basis points as a percent of revenue, which is primarily due to lower revenue. Floorplan and other interest expense decreased $1.4 million or 15.9% on an absolute dollar basis, reflecting a decrease in our average interest-bearing equipment inventory and reduction in our long term debt compared to the same period last year.

For the fourth quarter of fiscal 2016, adjusted EBITDA was a negative $36 million, which compares to positive $6 million in the fourth quarter of last year. The decline in adjusted EBITDA was primarily due to the equipment inventory impairment charge, our intensified efforts to sell aged equipment inventory in the current challenging market, and reduced revenue. You can find the reconciliation of adjusted EBITDA in the appendix to the slide presentation.

Adjusted loss per diluted share was $1.31 for the fourth quarter of fiscal 2016, which excludes certain non-GAAP items as outlined in the reconciliation table in the appendix of the slide presentation. This compares to adjusted loss for diluted share of $0.20 in the fourth quarter last year.

On slide 10 you’ll see an overview of our segment results for the fourth quarter. Agriculture sales were $204 million, a decrease of 42.4%, reflecting the headwinds discussed earlier. Ag adjusted pre-tax loss was $26 million, which included equipment inventory impairment charges of $11 million dollars compared to income of $2.4 million in the prior year period. The primary factor impacting our ag segment results were low equipment sales due to the challenging market and lower margins due to our aged inventory reduction plan.

Turning to our construction segment, our revenue was $91 million which is 6.5% lower than the prior year period. The primary factor in the lower revenue was related to the soft energy and ag markets, partially offset by improvements in residential and commercial markets in our metro areas as well as transportation, infrastructure activity.

Adjusted pre-tax loss for our construction segment was $20 million, which included equipment inventory impairment charges of $16 million compared to an adjusted pre-tax loss of $5.1 million in the same period last year. The equipment inventory impairment charge included $4.6 million related to exiting the Terex haul truck product line.

In the fourth quarter of fiscal 2016, our international revenue was $40 million, which is 4.6% increase compared to the prior year period. Our adjusted pre-tax income was $0.3 million compared to an adjusted pre-tax loss of $3.6 million in the prior year period. We are very pleased with the improvement in our international operations and the turnaround we are experiencing in this segment. Our better aligned cost and asset structure contributed to better bottom line performance in addition to improved revenue. In our appendix, you’ll see the corresponding same store sales results, which are in line with our segment’s performance as we had minimal change in our store count year-over-year.

Turning to slide 11, you’ll see an over view of our full year revenue results. Total revenue decreased 28% compared to last year, primarily due to lower equipment sales, which were impacted by the challenging industry conditions in our ag segment. Over the course of the full year, our parts were down 9.2%, service was down 13.5%, and rental and other was down 17.7%.

On slide 12, our full year gross profit was $206 million, a 33.2% decrease compared to the prior year period, primarily due to lower equipment revenue and equipment gross profit margin. Our gross profit margin decreased 110 basis points to 15.1%, primarily reflecting the impairment charges recognized on aged equipment inventories. Equipment gross profit margin was also negatively impacted by challenging ag and construction industry conditions. Operating expenses declined by over $50 million or 19.3% for full year fiscal 2016 compared to last year.

Operating expenses as a percentage of revenue were 16.2% compared to 14.4% in the same period last year. The increase in operating expenses as a percentage of revenue was due to the decrease in total revenue in fiscal 2016 as compared to last year, which negatively affected our ability to leverage a reduced fixed operating cost. We implemented realignment during the first quarter of fiscal 2016, which enables our cost structure to be better positioned as we enter fiscal 2017 and will benefit from a full year of these cost reductions.

In fiscal year 2016, we recognized $13 million in non-GAAP adjustments, primarily consisting of a $6.9 million impairment charge relating to long lived assets.

Adjusted floorplan and other interest expense increased 50 basis points as a percent of revenue, which is primarily due to lower revenue. Adjusted floorplan and other interest expense decreased $3.7 million or 10.7% on an absolute dollar basis, reflecting a decrease in our average interest-bearing equipment inventory and a reduction in our long-term debt compared to the same period last year. Our adjusted diluted loss per share was $1.25. This excludes $0.51 per share for the non-GAAP charges I just mentioned. At the end of our slide presentation, we have included a reconciliation table to help illustrate the adjustments to our GAAP results.

Turning to slide 13, you will see our segment results for the full year fiscal 2016. Ag revenue was $865 million, a decrease of 35.8% compared to the same period last year and adjusted pre-tax loss was $25 million, compared to adjusted pre-tax income of $19 million, which included $11 million of equipment inventory impairment charges in fiscal year 2016.

Construction segment revenue decreased 12.5% and adjusted pre-tax loss was $23 million, compared to an adjusted pre-tax loss of $9.2 million last year. The fiscal year 2016 loss includes $16 million of equipment inventory impairment charges. Our international revenue was relatively flat at $162 million and our adjusted pre-tax loss decreased to $0.5 million compared to an adjusted pre-tax loss of $10 million in the prior year period, reflecting the turnaround in this segment I discussed earlier.

Turning to slide 14, here we provide an overview of our balance sheet highlights at the end of the year. In light of the prolonged headwinds we are facing in the ag and construction industries, improving our balance sheet was and remains one of our key areas of focus. We had cash of $89 million as of January 31, 2016. Our equipment inventory decreased to $591 million, compared to equipment inventory of $772 million as of January 31, 2015. The inventory change includes a decrease in new equipment of $126 million and a decrease in used equipment of $54 million from the end of fiscal 2015. $180 million inventory reduction in fiscal 2016 reflects $153 million from the execution of the equipment inventory reduction plan during fiscal 2016 and also includes $27 million in impairment charges.

In a few minutes, I will provide an update on our inventory outlook for fiscal 2017. Our rental fleet assets at the end of the fourth quarter were $138 million, compared to $148 million at the end of fiscal 2015. We anticipate maintaining a similar fleet size for fiscal 2017. As of January 31, 2016, we had $445 million of outstanding floorplan payables on $1 billion line of floorplan lines of credit. We reduced our total discretionary floorplan lines of credit this month to $950 million reflecting lower current and expected equipment inventory levels. The reduced floorplan levels combined with lower long-term debt at the end of fiscal 2016 has improved our total liabilities to tangible net worth ratio to 2.1 as of January 31, 2016 from 2.6 as of the end of the prior year. I’ll provide some additional commentary on this metric in a moment.

Because of continued positive cash flow and our strong total liabilities to tangible net worth, this month we bought back $30 million or 20% of our total outstanding senior convertible notes with $25 million in cash and will recognize a pre-tax gain of approximately $2 million in the first quarter of fiscal 2017. This gain is not considered in the modeling assumptions I will discuss in a moment as we consider it an adjustment to our GAAP results. This transaction is in line with our efforts in utilizing positive cash flow to delever our balance sheet and also generating a financial gain for our shareholders.

Slide 15 provides an overview of our cash flow statement for the full year fiscal 2016. The GAAP reported cash flow from operating activities for the period was $232 million, primarily reflecting the successful efforts in reducing our inventory. We believe including all equipment inventory financing, including non-manufacturer floorplan activity as part of our operating cash flow better reflects the net cash flow of our operation. Our adjustment for non-manufacturer floorplan net payments shows a reduction of $222 million. We are using a portion of our operating cash flow and cash on our balance sheet to reduce our floorplan payables and other debt.

To accurately reflect cash from operating activities, we adjust our cash flow to reflect the constant equity in our equipment inventory. By providing this adjustment, we are able to show cash from operating activities exclusive of changes in equipment inventory financing decisions. The equipment -- the equity in our equipment inventory increased 5.8% during the full year fiscal 2016 and represents a $34 million use of cash. In line with our cash strategy, we will continue to increase our equity in equipment inventory, reduce other debt as we generate operating cash flow. Making these adjustments, our adjusted cash flow provided by operating activities was $44 million for the full year fiscal 2016, a decrease of $27 million compared to the same period last year. This decrease was primarily due to our fourth quarter aged equipment inventory reduction plan.

Slide 16 provides additional color for our expanded marketing plan of aged inventory that was discussed in our pre-release. We have been pleased with our inventory reduction efforts during the past two years. However, given the significant decline in end user demand for our equipment inventory and the challenging market conditions in both ag and construction, we have identified certain aged pieces of equipment totaling $74 million that we have decided to market through alternative channels such as online and onsite auctions. As a result of this decision, we are required to value these units consistent with an auction value as opposed to the values they would have through our normal retail channel. Based on this change in value, we incurred an inventory impairment charge of $27 million in our fourth quarter results.

Graph on this slide provides an overview of the $74 million of aged inventory, identified in our extended marketing initiative. Looking at it by segment, there is $36 million of ag equipment, $29 million of construction, and $9 million related to the exiting of the Terex haul trucks. Breaking it down by new and used, there is $28 million of new equipment and $46 million of used equipment. The $28 million of new equipment includes ag equipment, primarily made up of non-core short line products such as specialty combine heads, grain carts and grain handling equipment. In addition, there is also construction new equipment primarily consisting of non-core products such as aggregate units, scraper units, and products used in the oilfields including generators and heating products.

The majority of our remaining new equipment inventory are core products, which are sold through normal retail channels and our supported by manufacturer retail programs and therefore we have limited valuation exposure on our remaining new inventory.

The $46 million of used equipment includes ag equipment, primarily made up of products such as tractors, combines, combine heads, and planters. In addition, there is also construction equipment consisting of all trucks, aggregate units and various non-core products. The remaining used equipment identified to be sold through normal retail channel has more exposure to potential changes in the ag and in construction industry compared to new equipment. However, we believe we have accounted for this valuation exposure in our equipment margin modeling assumption.

At the bottom of this slide is the planned timing of the marketing of the $74 million of aged equipment to be sold through alternative channel. As you can see in the first quarter, we anticipate marketing 30% of the expanded aged inventory reduction. We will be providing quarterly updates on our progress throughout the year on the status of this reduction plan.

Turning to slide 17, I would like to provide you an update on our long-term equipment inventory initiative. Similar to what we’ve provided in the past, you will see a chart outlining our ending equipment inventory position for five years, including our any inventory target for fiscal 2017. The chart shows that we reduced year-end equipment inventory for fiscal 2016 by $180 million compared to the end of fiscal 2015. The reduction reflects $153 million as a result of our equipment inventory reduction plan and also includes the $27 million inventory write down in the fourth quarter. The amount of our inventory reduction for fiscal 2016 represents a significant improvement and met our goal of $150 million reduction for the year, despite lower than expected equipment revenue.

We anticipate an additional $100 million reduction of equipment inventory in fiscal 2017 and expect the quarterly inventory stocking trend to be similar to that of fiscal 2016 with most of the reduction occurring in the back half of the year and particularly in the fourth quarter. We were able to decrease our used inventory in fiscal 2016 and will continue to focus on moving used equipment in fiscal 2017. By the end of fiscal 2017, we expect to have reduced our equipment inventory by approximately $450 million or 48% compared to the end of fiscal 2014, representing a major improvement in our balance sheet.

Tuning to slide 18, you will see a chart showing our total liabilities to tangible net worth ratio for a five-year period, including our target for fiscal 2017. This chart shows a notable improvement in this ratio from a high of 3.1 in the fourth quarter of fiscal 2014 to 2.1 at the end of fiscal 2016. Based on a consistent level of tangible net worth, we expect to further reduce the ratio to approximately 1.6 at the end of fiscal 2017. The improvement in our fiscal 2016 total liabilities to tangible net worth ratio primarily reflects our cash generation and the use of this cash to reduce inventory, financing and other debt that I spoke about previously.

Given the current market conditions, particularly in the ag segment, we believe generating cash to delever our balance sheet and reduce our interest expense, positions the Company to capitalize on long term opportunities.

Slide 19, shows our fiscal 2017 annual modeling assumptions. We are reiterating the same assumptions that we previously provided to you in our pre-release last month. We expect our ag same store sales to be down 13% to 18%. This primarily reflects lower anticipated results from our equipment revenue as well as a slight decrease in our parts and service revenue. We expect both our construction and international same store sales to be flat. On modeling assumption for equipment margins for the full year is projected to be in the range of 7.7% to 8.3%. This range reflects continued margin pressure from the industry headwinds we discussed earlier on the call. We expected adjusted diluted EPS to range from a slight loss to breakeven for fiscal 2017. This assumption does not include the $2 million pre-tax gain we will recognize in the first quarter of fiscal 2017 from the repurchase of $30 million of our senior convertible notes, which we acquired for $25 million in cash.

This concludes the prepared comments for our call, operator we are ready for the question-and-answer session of our call.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from Steve Dyer from Craig-Hallum.

Steve Dyer

Thanks. Good morning, guys. As it relates to the permanency of Section 179, do you anticipate that’s going to change the seasonality of the business at all, just given that it’s been waiting until the last minute the last few years?

David Meyer

No. Steve, I think it’s going to give the customers little bit of chance to plan their business. And some of the seasonality is reflected in presales and all that, and I think all that continues to be the same.

Steve Dyer

Okay. And then, as it relates to the inventory, I know you are going to parse it out over the next several quarters in terms of how you are going to get rid of it. Is the impairment on the income statement, is that -- do you anticipate that’s a one-time event?

Mark Kalvoda

Yes. So, what we did at the end of the year is all of this $74 million, we took that, we took that impairment charge all in our fourth quarter. So everything that we’ve identified, the flow through, those alternate channels, we’ve hit the P&L here in the fourth quarter. So, we brought it down to a level where that’s the requirement from GAAP is to bring it under a level where we can achieve some reasonable margins going forward.

Operator

We’ll go next to Mig Dobre of Baird.

Mig Dobre

Good morning, guys. Maybe we can talk a little bit about how you’re thinking about capital deployment, especially in light that you bought back some of your convertible bonds and I guess a few things here. We obviously are seeing the equity component of equipment inventory financing continue to go up. What do you view as the new normal here; how big of a drag is this going to be in fiscal ‘17, if you would, to cash? And then in terms of capital deployment, I understand that you’re looking to delever, but with the stock trading below book value, isn’t that sort of an attractive way to deploy capital as well?

Mark Kalvoda

I think, we’re looking at all alternatives. We looked at for capital and allocation decisions like that. I think especially since -- we obviously are indicating we haven’t seen the bottom of the ag as we’re indicating revenue is going to be down this year. We feel that it’s prudent to take down our debt, to continue take down our debt, especially with the convert where we can take it down at a discount and basically get a 17% discount for paying it back at this point in time. But certainly as we move further through the cycle, I think it does open up some other opportunities for capital allocation as well, and we’re looking at all of those alternatives.

Mig Dobre

Can you talk about the equity and equipment inventory?

Mark Kalvoda

Sure, yes. The equity and equipment inventory, so that did go up to 25% by the end of the year. Now, when we do, do things like the converts that actually will cause us to go to pull from that someone where that equity and equipment will come back down because we’re deploying that to pay off the convert. But we do anticipate over time baring any other capital allocation decisions that that will continue to creep up through the year, as we generate more cash from selling our inventory and paying down some of that floorplan.

Mig Dobre

But do you have a specific target? I’m sorry to keep pushing on, but do you have a specific target in mind when are you looking as to what the optimal amount of equity in inventory should be?

Mark Kalvoda

No, not particularly; it’s not like we’re shooting for a 35% or 40% or anything like that. We’re not really targeting a specific amount. I think we’re looking more at the timing and with the cycle and what’s our best alternative for the cash that we are generating at that point in time. So no, there is not a specific target that we’re looking to hit.

Mig Dobre

Okay, then two more from me. In light of the challenges that you’re outlining and the fact the revenues are going to be down again in ‘17, how should we think about the SG&A run rate; do you have any plans to continue to work this number down going forward?

Mark Kalvoda

As far as SG&A goes, we made a lot of -- we did a lot of work last year where we brought that down $53 million last year, year-over-year. We don’t have anything near the level that we talked about last year at this time with the realignment plan. I would say, it’s a combination of smaller initiatives to bring that down. We do expect SG&A to be lower than that of this past fiscal year but not a material change, like we had in the past. Other line items, certainly with inventory being reduced, our floorplan interest expense will continue to come down nicely. And as we pay off some of this convert, our other interest expense, so our financing costs become a good but less than what we had last year but SG&A is not going to move near to the level that it did last year.

Mig Dobre

Great, appreciate it. Thank you.

Operator

We’ll go next to Rick Nelson of Stephens.

Rick Nelson

Thanks. I’d like to ask about the bad covenants. I know you amended your credit agreement I believe in October. Were there additional amendments more recent and where you sit today versus the covenants?

Mark Kalvoda

Yes. Hey Rick, Mark here. As far as the different covenants that we have, I think I’ll just walk through them real quick. Wells Fargo, our bank syndicate has based on an excess availability, so there is no direct financial covenant. We’re sitting fine. There are no issues; no at all any kind of question as far as amendment. As far as the other two major lines that we have there with CNH and DLL, we just got clarification from them, either through amendments or through clarification letters that we’ll be adding back or they will be adding back this $27 million impairment. So that creates no issue there and also both of them we now have kind of in line for fiscal 2017 that the tangible net worth ratio -- I’m sorry, the debt service coverage ratio is greater than 1.1 that used to be out 1.25; now it just needs to be greater than 1.1. So, we don’t foresee any problems with that. A couple of these amendments, the DLL and CNH that will be part of the 10-K that’s filed later today.

Rick Nelson

Thanks for that. Your guidance assumes a narrowing in the loss for the full year. How are you thinking about the quarter? Is it going to be more back-end loaded; is the inventory and some of the floorplan starts to come down, or you think each quarter you can show year-over-year improvement?

Mark Kalvoda

No. We do expect it to progressively get better. There’s of course seasonality that’s involved with our third quarter. Our third quarter, we anticipate to kind of be our best quarter given the harvest that’s going on in the higher level of equipment purchases at that time than maybe what happens in the plant time of the year. And then, I think just looking back at some of the same-store comps that we had in previous years, the back half of the year, so last two years have been really beaten up, meaning very negative same-store sales in the back half of the year, where the front half has hung in better. So, I think this first half will definitely be more difficult than the back half of the year. And also I think also with that as we move further through this inventory, some of this aged inventory, there is less of that pressure I think in the back half of the year than what we’ll see in the front half.

Rick Nelson

I know you’ve done some store closings and have had sales here over the past year or so, are you contemplating more of that?

David Meyer

Well, we continue to look at our footprint optimization, Rick, and that’s an ongoing effort that we -- from both our board and management continue to look at the opportunities there.

Rick Nelson

Great. Thanks a lot. And good luck.

Operator

We’ll go next to Neil Frohnapple of Longbow Research.

Neil Frohnapple

Hi, good morning. Starting with the construction segment, you mentioned improved operating profitability this year. So, excluding the $16 million of equipment inventory charges, I think pre-tax losses was around $7 million for FY16. So, on flat sales, would you expect the losses to narrow or do you expect the segment to return to profitability in FY17?

David Meyer

I think with some of the efforts that we made and we did see a big kind of downturn in the rental, which we’re starting to see signs of that picking up. But what’s really kind of cleaning out the inventory through this impairment charge or this initiative on the aged, we do feel good about construction even with flat sales. So, we are confident that -- we are very optimistic that it will return to profitability in fiscal ‘17.

Neil Frohnapple

Alright. And then follow-up Mark, on the rental business, I mean, could you just talk about your expectations for dollar utilization this year and whether you would expect rental rates to increase or decrease?

Mark Kalvoda

I think this year we ended up around that 25%, 26%, something like that. I would just indicate that we expect something north of that, call it a percent or two would be some nice improvement. As you know, for every dollar that you get over that depreciation, 85% or 80% goes right to the bottom-line. So, any percent improvement is a big help to the bottom line.

Neil Frohnapple

Okay. And then, are you able to quantify how much of your used equipment sales were sold at auction in Q4? And just really trying to get a sense of how these initiatives compare to your historical mix of auction versus retail?

Mark Kalvoda

Neil, we really haven’t broken out anything for like fourth quarter. What we determined to do is we’ve identified this 74 and we’re going to provide good kind of reporting to you guys on how that progresses. But yes, it wasn’t close to the $74 million obviously in the fourth quarter, but we’ll give you good updates going forward on the progress on this $74 million throughout fiscal ‘17.

Neil Frohnapple

Great. Thank you. I will pass it on.

Operator

[Operator Instructions] We’ll go next to Joe Mondillo of Sidoti & Company.

Joe Mondillo

Good morning, guys. I was surprised to hear about a third of the written down equipment was new equipment. Could you just provide a little more information on why that risk was involved in some of the new equipment? I think it’s about 6% of your 3Q book value on new equipment.

David Meyer

Yes. What it was is like we indicated was a lot of non-core short line product that’s been seating around for a period of time or has been really negatively impacted by the oil conditions, the oil industry, particularly in the in the Bakken here. So, I would say that there are a lot of kind of specific non-core items that we, I think cleaned up pretty well here now, and I think there’s limited exposure to that going forward in the new equipment that’s remaining on our books.

Joe Mondillo

Okay. And then the used equipment, how confident are you that we’re not going to see anymore deterioration in the book value, at least compared to the write down that you saw in the fourth quarter? And then also if you could talk about pricing on what you’re seeing on the used equipment side of things.

Mark Kalvoda

I’ll answer that first part of the question as far how confident we are. First of all there is, in our used, that’s where we have the risk as market changes that those used values do fluctuate. So, we will always have some level of lower cost to market adjustments, as you know from the past. But to have it at that level where we’ve identified a certain percentage of our inventory, rather sizeable percentage of our inventory to go to auction, we don’t foresee that happening anytime soon barring any type of large macro event that may occur or something like that. So again, we do always have those lower costs to market adjustments in our used. And I would say you know we have some of that budgeted into our margin assumption. As you know, our margin assumption prior to this cyclical downturn has been up around close to like 11-11.5%, probably averaging closer to 10 and we’re still guiding toward more of an 8% margin for the first year. So that definitely has some of that lower of cost to market write down in it.

David Meyer

Just to answer your question on pricing, we’re seeing I think some stabilization right now and there’s been some -- actually some positive moves and some of the lower horsepower tractors. I’d say the biggest challenge that you’re going to see is the high horsepower combine tractors as our planters, self propelled sprayers, specific to the corn and bean areas but still relatively stable compared to what we probably see the downward trends that we experienced in the fourth quarter.

Joe Mondillo

Okay. And then also, I guess just lastly, I just was wondering last couple of years the weather has been extremely favorable for growing conditions. At this point in time in the year, I know it’s still early, but what is your sort of thoughts on how weather has been trending in terms of implications for later this year and how things play out?

David Meyer

Well, you’re seeing some drought trends out there but over the week and now there is some pretty good rains in some of your wheat growing areas, as a result I think some of the wheat prices took a hit because of that. So, as we said in our comments, I think we’re going to need seasonal rains throughout the year, the yields, I think one thing right now a lot of the land’s going to be farmed, lot of the slews or -- there’s not overabundance of moisture out there, so most of the land, farmers are being able to get into. With that said, you hear a lot about the rain coming in later and later in the year and depending on -- if it comes in earlier June, July, August or it’s later in the year, could have some potential impact. So, we’ll just have to wait and see, but there will be needed some timely rains I think to get us through this whole crop this year.

Joe Mondillo

Timely rains meaning that will provide a good crop or not so much? I mean it seems like timely rains would provide a really good crop, which would put more pressure on crop prices. So, isn’t that not what you would want?

David Meyer

In our markets that’s the way we like but if we want to see higher commodity prices worldwide, it’s going to take a fairly big weather event in some of your larger growing areas of the world, that’s going to make prices drive. Without that, yes, it’s going to be a challenge on the supply side, which depresses the commodity prices.

Operator

We’ll go next to Larry De Maria of William Blair.

David Meyer

Larry, are you there?

Operator

And apparently he stepped away. We’ll go next to Tyler Etten of Piper Jaffray.

Tyler Etten

Good morning, guys. Thanks for taking my question today. I was wondering if you guys could talk a little bit about -- you said there’s stabilization in the market pricing. Does that mean that auction activity has slowed down? And do you expect that -- if so, do you expect that to pick up in pressure prices later in the year?

David Meyer

I think there is some, there is quite a bit of auction activity towards the end of December. I would see you’re seeing a higher frequency; you’re starting to see some retirement sales, which we haven’t seen in a long time, some of probably not as many large consignment sales as you maybe saw here a couple of months ago. But I think you’re going to see sales, both consignment sales and online auctions, and onsite auctions, retirement sales, you’ll probably see those throughout the year, but I think they’re sensitive to the best timing of when they have those sales and when you’re going to get the biggest return for your equipment, which time of the year that’s going to be. But you’re not going to see them go away this year.

Tyler Etten

Okay. So, the reduction will continue to pressure margins. Where do you bridge the gap if your guys’ margin guidance is the same as it was last year?

Mark Kalvoda

Well as far as, I mean what we do for all of our retail inventory is we bring it to a retail value each year. So, we market from a retail basis every year. So, it’s more -- so even though that it continues to go down this year, the overall market conditions, it’s just kind of relative to where we left off from last year, if that makes sense. So, it’s not like it’s been down for two years, so it’s going to be a bigger hit in the current year. It’s just a year-over-year kind of progression. And we constantly bring in used equipment at current market conditions. So, when we’re bringing in that used, we’re valuing appropriately given the market conditions. So, the fact that it’s going down and we still have lower than average equipment margins is kind of in line with what we would be expecting. If it would level off, and we wouldn’t have like further erosion and going down like that, we would have equipment margins that would start going back up to more historical levels which would be at what I indicated earlier, closer to that 10%.

Tyler Etten

Got it, that makes sense. And then for a follow-up, what is your guys’ expectation per acreage following the USDA crop report, which was much more bullish on corn acres than many were expecting?

David Meyer

Yes, I think in a lot of our markets, we’re seeing corn acres, the intentions are consistent what the USDA is saying but I think depending on the weather and what happens to soybean prices, there could be a few farmers switch from corn to beans as given the planting timeframe here.

Tyler Etten

Great, thanks guys.

Operator

We’ll go next to Larry De Maria of William Blair.

Larry De Maria

Hi, sorry about that before. Curious as for the remarketing of used, we’re over two thirds of the way through the first quarter I guess. So, can you just give us an update on how the auctions have gone, according to plan, worse, better et cetera? And does it contemplate a decrease in the used prices as we go out through the year? Just trying to obviously gauge the risk and get a sense of what’s going in real time. Thanks.

Mark Kalvoda

Yes. As far as the first part of the question, I’d say that our -- we’ve been progressing on our plan. At this point, I would say that it’s on plan. I don’t think there’s anything materially different, one way or the other. So, we are progressing. And as we’ve indicated that’s the largest percent of targeted inventories in that first quarter. So, I’d say that’s a good sign.

Larry De Maria

And throughout the year, do you have decreases in the value of the used implied or is that, in other words, we expect the run rate to stay the same on the average pricing?

David Meyer

It’s earlier, Larry, and I think we’re seeing some stabilization in there. In old machinery, Pete, he’s getting to be the voice of used machinery values. And he’s showing this overall index rating at what 6.6 now and he’s seeing that slightly improving and there again I think the biggest challenge is going to be in your high horsepower equipment which you might see down slightly in Q2 over Q1.

Larry De Maria

Okay. And then, as far as prevent plant acres in your territory, maybe remind us how much were there and if we’re going to see those come on line, which would imply possibly an increase in acreage in your area, specifically just your color on the prevent plant acres in your territory.

David Meyer

I think we’re going through some fairly major wet cycles in some of those lands; farmers weren’t able to get into some of those acres. I think there’s a much of improvement there. So, I see less of that and I see a lot of the land being able to be farmed.

Larry De Maria

Okay, and would that be reflected in the USDA or could that be a change?

David Meyer

No, I think it’s probably reflected.

Larry De Maria

Okay. And then if I could just ask one more question. You talked about obviously construction, weakness in energy but improvements in transportation and residential, I think you called out. Can you just talk a little bit about your exposure to the various areas of construction now with that kind of resetting in energy and magnitude of changes to think about in the various categories? And then specifically what we’re seeing as a result of the highway bill; is there a big response to that already?

David Meyer

We’re now in some fairly major metro markets now, there’s the Phoenix market; the Denver market; the Minneapolis; St. Paul market. We’re seeing some upticks in Omaha, De Moines, those metro markets, Larry. So, yes, I think that there’s going to be some positives from the highway bill. We’re starting to see some increased activity from the infrastructure, the increased housing starts in some of these markets. So, overall, we’re bullish on larger metro markets and the investment in the infrastructure.

Operator

We’ll take one more question from Mig Dobre of Baird.

Mig Dobre

Yeas, thanks for taking my follow-up, very quickly on the rental fleet. It’s really not been worked down a whole lot and my understanding from your comments is that you’re expecting it to remain flattish in fiscal ‘17. So, what I’m wondering here is have you in any way, shape or form redeployed this fleet from say the Bakken into other areas where demand is improving; where are you in the process of doing that? And if the answer is sort of no that you’re not redeploying the fleet, why shouldn’t you be actually reducing your rental fleet in fiscal ‘17?

David Meyer

Well, we’ve been redeploying, then we’ve also de-fleeted units that what we deemed as poor utilization, replaced those with what products were going to get industry higher utilization of. So, both deployment de-fleet and replace the de-fleet units with higher unit with higher utilization.

Mig Dobre

I see, but again I’m trying to understand really at what point is this business right sized and we can actually starts seeing a turn in a business because obviously construction activity ha0s been pretty good. And when you sort of looking even at the weather, you had nice weather tailwinds through the quarter and yet turns are still soft, so that’s kind of where I’m going at this one. At what point do you expect this business to bottom out, if you would?

David Meyer

Yes. We’re comfortable at this level for our market; we’re comfort at this size of fleet, Mig. And like you said, we do feel as bottom out as Mark said, and we’re looking for some gain in the utilization rate this year. So, I think we’ve done a lot of improvement in our rental business and we’re positioned for this fiscal year to do better.

Operator

And I’ll turn the conference back to Mr. Mills for the additional remarks.

John Mills

Okay. Well, that completes our call. Thank you everyone for your interest in Titan. And we look forward to updating you on our progress on our next call. Have a good day.

Operator

That concludes today’s conference call. Thank you for your participation. You may now disconnect.

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