Toromont Industries Ltd. (TMTNF) CEO Scott Medhurst on Q3 2018 Results - Earnings Call Transcript

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About: Toromont Industries Ltd. (TMTNF)
by: SA Transcripts

Start Time: 08:00 January 1, 0000 8:49 AM ET

Toromont Industries Ltd. (OTCPK:TMTNF)

Q3 2018 Earnings Conference Call

November 06, 2018, 08:00 AM ET

Executives

Scott Medhurst - President and CEO

Paul Jewer - EVP and CFO

Analysts

Cherilyn Radbourne - TD Securities

Jacob Bout - CIBC

Michael Doumet - Scotiabank

Derek Spronck - RBC

Devin Dodge - BMO Capital Markets

Ben Cherniavsky - Raymond James

Maxim Sytchev - National Bank Financial

Yuri Lynk - Canaccord Genuity

Operator

Good morning. Today is November 6, 2018. Welcome to the Toromont Industries announcement of the Third Quarter 2018 Results Conference Call.

Your host for today will be Mr. Paul R. Jewer. Please go ahead, Mr. Jewer.

Paul Jewer

Thank you, Tara, and good morning, everyone. Thank you for joining us today to discuss the results of Toromont Industries Limited for the third quarter of 2018. Also on the call with me is Scott Medhurst, President and Chief Executive Officer.

Before we continue, I’d like to advise listeners that this presentation may contain forward-looking statements or information that are subject to certain risks, uncertainties, and assumptions. For a complete discussion of the factors, risks and uncertainties that may lead to actual results or events differing materially from those expected, refer to Toromont’s press release from yesterday, which is available on our Web site.

We assume you've had an opportunity to review our press release from yesterday and, as such, we’ll focus on key highlights. Scott will begin with an update on the integration and a few general remarks and comments on our outlook, after which I’ll review the operating group results and financial position. Then we’ll be more than happy to answer your questions. Scott?

Scott Medhurst

Thank you, Paul, and good morning, everyone. On October 27 marked the one-year anniversary of the acquisition of our Maritimes and Quebec operations. Our Caterpillar geographic territory is now contiguous and covers Manitoba, Nunavut, Ontario, Quebec, Nova Scotia, New Brunswick, P.E.I., and Newfoundland and Labrador.

Our entire team has much to be proud of over the last 12 months as the effort and contributions have been significant. We thank our people for their contributions and incredible discipline ensuring the businesses continue to grow while staying focused on strong safety practices, serving our clients and aligning our strategies, all with the major business integration at the forefront. This integration process continues with alignment of common practices and goals which is a key to our collective teams’ success.

I would like to highlight a few of the key elements of the transformation over the past year. Branding was integral and we now have completed the rollout of our brands across Quebec and the Maritimes for all of Toromont CAT, Toromont Material Handling and Battlefield-The CAT Rental Store. Leadership appointments took root and the teams were engaged almost immediately. The new business structures, which emphasized the decentralized branch model has been unveiled and is in the early stages of the transition.

Integrating Toromont business philosophies that include enterprise alignment, empowerment and accountability remains ongoing and critical to our overall success. Operationally, we’ve advanced on significant integration of divisions and segments. In no particular order, we have aligned people and reporting structures for our power systems, mining, material handling, heavy rents and used equipment divisions, all have more robust go-to-market strategies.

Additionally, we have consolidated our marketing department with a heightened focus on actively promoting the Toromont brand along with our sales operations group. Over at Battlefield, we’ve made great progress rolling out the complete rental service model that includes a broader product line which will help meet the customer needs over a 12-month period. This integration also includes customer-centric interface solutions.

The rental services footprint expanded in Quebec and Ontario with new outlets in assumption [ph] of facilities from the heavy equipment side of the business in Quebec. Many of the expanded operations are at various stages of progress. The Battlefield QM team is embracing this strategy and changes with an understanding this is a journey focused on sustainability for the longer term.

Fortunately for us we’ve been down this road before and understand that patience is foundational throughout the process. As Paul has referenced a few times, we’re planting an orchid not a wheat field analogy to building our rental business. Building the rental services business means expense is frontend loaded through significant capital investment.

It also means growing and diversifying the fleets, adding to the sales force to sell our value proposition and investing heavily in this sort of infrastructure to support the broader lines such as trucks and adding technicians. This orderly transition disposition will be lower as the fleets need to age. It will take time to integrate a proper model which is as I noted will not provide the desired rate returns in the early stages of this strategy.

Our heavy and power rental teams are going through similar return challenges as we expand and diversify those fleets and invest for long-term sustainable returns. Nonetheless, we are on to the next phase of the integration and this one excites me. Understanding the importance of product support, we’ve begun working on our product support shared services structure across the Toromont enterprise.

Responsibilities have been delegated with the goal of improving productivity and efficiencies through common operational excellence practices and again the teams are locked in on the vision. The division of our corporate product support team into two pan-regional groups will allow one team to focus heavily on service and leveraging of our strengthened Reman [ph] portfolio while the other focuses on parts and logistics including a full evaluation of supply chain efficiency.

On the people side, we’ve been focused on the integration of consistent and combined safety training and practices. We’ve rolled out several management trainee courses focused on business fundamentals that represent core Toromont operating principles. And last by not least, I’m very pleased with the hiring and training of technicians so far. This continues to be of the utmost importance.

Most importantly, the team has driven significant growth through all the various businesses demonstrating early stage advancement in the market. That being said, we have considerable work to complete to unlock the significant value of the largest acquisition in our history. We remain pleased with the integration and the transition progress and with the earnings accretion over the relatively short timeline since the transaction closing.

The team has embraced the sharing of best practices including key operational and financial disciplines to further strengthen our position as a world-class dealership. Overall, the team delivered solid results in the third quarter and most important on a year-to-date basis demonstrating longer-term achievements through solid execution while facilitating a massive integration.

Revenues increased 54% in the quarter and 66% year-to-date with Toromont QM contributing 322 million in the quarter and 913 million year-to-date. Net earnings grew 39% in the quarter and 43% year-to-date. On a year-over-year comparable basis, the legacy businesses’ bottom line grew 7% in the quarter and 18% year-to-date.

In the Equipment Group, effective execution will be required to realize on the significant potential of the acquisition. Infrastructure projects and broader construction activity continued to present opportunities and the long-term outlook remains positive across most territories.

The parts and service business continues to provide a measure of stability and opportunity for further growth. Our shops remain busy and we continue to hire technicians in anticipation of an increase in demand.

In the mining space, we have experienced good growth in the product support side so far. Production continues at existing mine sites which is good for future product support business and incremental equipment sales to support the growth and expansion.

Over at CIMCO, the revenue base continued to grow reflecting our strong presence and solid reputation as the leader in key recreational industrial markets that we serve. While results have been challenged by problems encountered on one U.S.-based project, we believe that the processes have been addressed and the team is refocused on executing the growth strategy in the U.S.

Across our organization, tariffs implemented this year have not had material or direct impact on our business. Overall, the diversity of our markets in the new and significantly expanded territory, a strong management group and a solid financial underpinning provides substantial opportunities for continued success.

I’ll now turn the call over to Paul to take you through highlights of the financial results. Paul?

Paul Jewer

Thanks, Scott. Let's look at the operating results in more detail starting with the Equipment Group. The total revenue contributions from Toromont QM that Scott mentioned earlier represented a 20% increase for the quarter and 19% year-to-date from revenues generated under the former ownership.

For the legacy businesses, total revenues decreased 2% in the quarter but were up 5% year-to-date. New equipment sales in the legacy businesses were down 12% in the quarter but up 5% year-to-date. Construction sales in the quarter were up year-to-date with good activity levels in the GTA, Manitoba, offsetting some softness in Northern and Southwestern Ontario and Newfoundland.

Mining sales were lower in both periods against a tough prior year comparative which includes a large mining package. Our system sales decreased from record levels last year mainly on lower demand for electric and prime power generator sets. Agricultural sales were down in the quarter but up year-to-date.

Used equipment availability remained challenged due to the influx of U.S. buyers and were down 2% in the quarter and 12% year-to-date. In total, equipment sales were down 10% in the quarter but up 1% year-to-date at the legacy businesses.

Conversely, at Toromont QM, total equipment sales were up 32% in the quarter and 28% year-to-date from those recorded last year from predecessor organization driven by strong new equipment sales.

Rental revenues of the legacy businesses increased 14% in both the quarter and year-to-date. All areas of the rental businesses reported good growth with power rentals continuing along a record setting pace.

At Toromont QM, rental revenues increased 14% in the quarter and 16% year-to-date, approximately two-thirds of which were generated from the light equipment fleet and lift trucks.

At the end of September 2018, our net investment in the rental fleet was $527 million. During the quarter, we invested an additional 27 million in our rental fleets, net of dispositions, which on a year-to-date basis was $54 million higher than a year ago.

Product support revenues at the legacy businesses increased 2% in the quarter and 8% year-to-date with growth on both parts and service. At Toromont QM, product support revenues were up 12% in both the quarter and year-to-date.

Gross profit margins increased 170 basis points in the quarter and 120 basis points year-to-date buoyed by higher product support margins and a favorable sales mix of product support revenues in total. The margin gap at Toromont QM had a dilutive impact in the quarter and year-to-date.

Selling and administrative expenses increased mainly due to the expenses related to the acquired operations and certain integration-related costs. Excluding these, the expense ratio was 70 basis points higher in the quarter and 10 basis points higher year-to-date.

Operating income increased 34 million in the quarter and 89 million year-to-date. Toromont QM contributed 25 million in the quarter and 55 million year-to-date, net of integration-related costs.

At the legacy businesses, operating income increased 16% in the quarter and 23% year-to-date, which translates to an increase in operating margin of 230 basis points in the quarter and 190 basis points year-to-date.

Bookings at the legacy businesses were up 19% in the quarter with strong power and agricultural orders offsetting lower mining and construction orders. For the year, however, legacy bookings were relatively unchanged.

Over at Toromont QM, ordering activity was good across most market segments and accounted for $101 million of the orders in the quarter and 429 million year-to-date. Backlogs increased to 336 million including 142 million at Toromont QM. We expect about two-thirds of these orders to be delivered in the fourth quarter.

Let's turn now to CIMCO where revenues increased 4% in the quarter and were up 13% year-to-date. In Canada, packaged revenues were up 2% in the quarter with strong sales in Quebec and Western Canada, offsetting softer sales in Ontario, Atlantic and Quebec.

Year-to-date, all regions, except Atlantic Canada, reported growth and consequently led to a 25% increase over last year. In the U.S., packaged revenues were relatively unchanged from the quarter but up 10% year-to-date.

In both Canada and the U.S., sales to industrial markets were up in both periods while recreational markets were down. Product support revenues increased 10% in the quarter in Canada and 3% year-to-date. In the U.S., these were up 3% in the quarter and relatively unchanged year-to-date.

Margins decreased 380 basis points in the quarter and 450 basis points year-to-date, largely attributable to the problems encountered on the one U.S. project that Scott highlighted which resulted in a charge of 2 million in the quarter and 3 million year-to-date.

Selling and administrative expenses were relatively unchanged in both the quarter and year-to-date but down 50 basis points and 200 basis points, respectively, as a percentage of revenue. Operating income decreased 33% in the quarter and 20% year-to-date.

Bookings were down 64% in the quarter and 29% year-to-date versus the records set last year. In Canada, bookings were down 66% in the quarter and 23% year-to-date with lower industrial and recreational orders.

In the U.S., bookings were down 60% in the quarter and 47% year-to-date. While industrial activity decreased and returned to more historical levels in the U.S. recreational activity was significantly higher.

Backlogs of 126 million were down 50 million from the record set last year but still significantly higher than the previous five-year average. We expect about half of this backlog to be delivered in the fourth quarter.

On a consolidated basis, basic earnings per share increased $0.21 in the quarter to $0.84 and were up $0.57 for the year to $2.06. On a comparable basis year-over-year, this translates to a 5% increase in the quarter and 17% for the year.

At September 30, our overall financial position remains strong. In the quarter, we repaid the remaining 100 million drawn on the 250 million credit facility and ended with cash of $217 million. Our net debt to total capitalization ratio has decreased every quarter since closing the deal and now sits at 25% versus 40% at the end of 2017.

To reiterate what Scott said earlier, we are pleased with the traction seen over this past year and our even more encouraged by the level of enthusiasm that we’re seeing through our budget process that is currently underway. We truly believe in the opportunities which lie ahead and again caution you to not place undue reliance on any single quarter as a basis for modeling your expectations.

That concludes our prepared remarks and we’ll be pleased to take your questions. Tara?

Question-and-Answer Session

Operator

Thank you. We will now take questions from the telephone lines. [Operator Instructions]. We will now take our first question from Cherilyn Radbourne of TD Securities. Your line is open. Please go ahead.

Cherilyn Radbourne

Thanks very much and good morning.

Scott Medhurst

Good morning, Cherilyn.

Cherilyn Radbourne

Starting with the Equipment Group, just wondered how you would compare market conditions in the legacy territory versus the Hewitt territory? And has the strong growth that you’ve seen in the Hewitt territory created any challenges in terms of the integration process?

Scott Medhurst

First of all, the market activity has been very strong and solid throughout our territory. Quebec has been stronger if we compare to the balance. Actually Quebec’s up about 18% and we’re pleased with the growth and the advancement in the market. So that’s been a very positive story in our Quebec market and the Maritimes. I don’t think – in terms of the integration there’s a lot of moving parts and that’s why we’re really pleased with our performance so far because we have a massive integration going on and I think we should applaud the efforts and contributions of our folks and what they’ve accomplished so far on a year-to-date basis.

Cherilyn Radbourne

And in terms of the rental business, obviously that’s one of the key opportunities as you integrate the acquisition. Of your net rental additions year-to-date, can you comment on how much of that has gone into Toromont QM? And are you still tracking to about $140 million of net adds for the year?

Paul Jewer

Yes, so half of it went into Toromont QM, Cherilyn, and 140 million continues to be our expectation for the total.

Scott Medhurst

I’ll put a little more color on that, Cherilyn. We’re behind on our rental fleet uploads. We had to ship product with the retail demand. So we’re rebuilding – we’re not rebuilding, we’re building a new business of rental services in our QM. We’re excited about that and that has certainly some frontend loaded costs associated with this because we’re having to age those fleets as well. So we’re not being able to capitalize on disposition throughout our enterprise because of some of these availability challenges. So we’re a little bit behind. These products will come in, so that’s what’s going on in the rental services market.

Cherilyn Radbourne

And in terms of availability from CAT, what are you seeing as we look forward? I think CAT indicated on their call that their production levels are starting to catch up with retail demand.

Scott Medhurst

Yes, we’re going to see those products coming in. It’s just timing.

Cherilyn Radbourne

Great. I will pass it over. Thank you.

Scott Medhurst

Thanks, Cherilyn.

Operator

We will now take our next question from Jacob Bout from CIBC. Your line is open. Please go ahead.

Jacob Bout

Good morning.

Scott Medhurst

Good morning, Jacob.

Jacob Bout

I had a question on the legacy results. So specifically the construction side of things with equipment sales being down, how does that square with the strong results and the backlog build that you’ve seen with your construction clients? And is this really just a timing issue?

Paul Jewer

On a year-to-date basis, the legacy construction activity on sales has been very good. We’re pleased with that. We go through some ups and downs through these quarters, so I think we should focus on the year-to-date and it’s been a very active market and the revenues in the construction segment on new have been solid.

Scott Medhurst

The other factor that you have to take into account, Jacob, is if you were looking at – you’re referring to backlog build with construction clients, then obviously there’s a bit of a twirl between activities at the end customers for us and translation to an opportunity for us to serve.

Jacob Bout

So very optimistic.

Paul Jewer

I think it’s possible. We’re dealing with – Cherilyn had asked the question earlier about market conditions and one of the things I’d add to Scott’s comments is Ontario has been performing at a high level since quite some time, right? So we’re just seeing some maturity in the marketplace. I think with Quebec we’ve seen a bit of resurgence with infrastructure projects finally getting kicked off over the course of the past year or two. So our timing is ideal and we’re quite excited to have the opportunity to serve this large contiguous territory.

Jacob Bout

Maybe turning to CIMCO, how much should we read into the backlog and the bookings being down so sharply? Is there anything structural going on?

Scott Medhurst

Well, I think we’ve been coming off records for a few years and again if you look at it from a five-year historical, it’s right in line above a bit. So that basically tells the story there. We’re pleased with the growth again. Look at it from a year-to-date and you look at it our growth strategy from '14 to '17, there’s been significant growth over that period of time with improved margin. We hit a wall here with a large project in the U.S. that we’re obviously not pleased with as a team and it’s being addressed aggressively.

Jacob Bout

Last question just on the QM rental, the mix of light to heavy rentals you’re seeing I think was two-thirds, one-third. Is this the right target mix and maybe talk a bit about the profitability of those two segments or subsets?

Scott Medhurst

Yes, so we’re not where we want to be. As I said, this is going to be a – we’re on a journey. We are building a new business here for the rental services. And so when we look at our – when I quantify the light and the heavy in there, the utilization has been very strong on a year-to-date. Our timing utilization on the heavy was at 70% in the quarter. So we’ve got to upload those fleets. So we’re on a journey there to do that. And as I said, there’s costs associated with building this new rental services business. It will take some time. And then the other part of it, Jacob, is we’re not disposing of the assets like we would normally do. On the heavy side, we’re down $4 million in disposition because we’re having to hold on to those products until we can upload and we’re down over 3.5 million in rental services business. So that’s fairly impactful on our profitability. It also has an impact because then your rental repairs start to go up a bit as well. So we’re not in our sweet spot in terms of the model and but we’ll get there.

Jacob Bout

I’ll leave it there. Thank you.

Operator

We will now take our next question from Michael Doumet from Scotiabank. Your line is open. Please go ahead.

Michael Doumet

Good morning. Hi, Scott and Paul.

Scott Medhurst

Good morning, Michael.

Paul Jewer

Good morning, Michael.

Michael Doumet

So first, just a question on the Toromont QM. Obviously a lot of integration work being done there. First thing, I was expecting a little bit more strength this quarter given prior comments on historical strengths in the second half. Is the seasonality now somewhat diminished with the integration or were there one-time costs or weaknesses in the quarter that muted that margin performance?

Paul Jewer

What I’d say is seasonality is seasonality. And the nature of the seasons in Quebec and Maritimes aren’t radically different than they are across all of our businesses. So over the long haul I would expect seasonality to be reasonably consistent. Neutralized a little bit by the fact that we need to build up the rental fleet to service 12 months of the year as opposed to being more of a seasonal business that we had inherited. And we do that with allied products that are designed to run in the winter as well. So that’s certainly a factor taken into consideration. Having said that, anything can vary as it comes into a quarter of reported basis. I don’t think we’re dealing with substantial cost of integration at this point in time. As we look into the third quarter, I have the table that we have in the front of the press release that’s meant to provide visibility, transparency to the continuity providing comparable balances. Most of the line that’s there for integration and interest costs is interest costs on the third quarter. It would only be a relatively minor portion that we’re dealing with. But having said that, all that we’re tracking in terms of integration costs are those direct costs related to personnel changes or other minor matters that we’re dealing with. Obviously there’s a level of effort and mild disruption that goes along with the complete integration of businesses and we’re quite pleased with how that’s gone so far.

Michael Doumet

That’s great color. Thanks. Sorry, go ahead, Scott.

Scott Medhurst

Just to demonstrate our – we’re lumpy right now and then you see it when you look at the legacy on a year-over-year, there was a major mining deal that took place last year in the third quarter. So that creates some lumpiness in the cost. But we’re still pleased with the performance in the legacy.

Michael Doumet

Okay. Thanks. And just maybe looking at rental on QM and you commented the rental is expected to provide a large contribution to the margin improvement story there. But again as for your prior comments, I think you’ve made them again this quarter that the improvement should be gradual in nature. I think you also mentioned cost associated with building the rental business and that you’re not effectively at the sweet spot in terms of monetization. Like we think out one or two or three years, and I know you guys don’t want to provide guidance, but I just want to make sure that we at least have some reasonable expectations and set some right goalposts in terms of the improvement in that business and when you should be at your sweet spot?

Scott Medhurst

The analogy that I’ve used before is in building the rental business, we’re planting an orchid not a wheat field, right, and that’s a simplistic way but an apt analogy I believe of what we’re doing here. The rental services business is a full cycle business. So that means that you got to have the right equipment, maintaining it for quite periods of time, depreciating it properly and selling it at the right time. And when it comes into that full profitability in that cycle, it’s in the ultimate disposition of that rental fleet that you actually generate part of the profitability. So when I think about that and I think about our cycles of duration, we’re really on – if you’re starting from scratch, which we’re not quite starting from scratch. But if you were, then you’d be talking about three to four-year voyage basically before things are kind of in a steady-state environment. And that assumes that you’ve been able to build the business over that timeframe. So we’ve got quite a cycle of opportunity. When we look at our rental services business, the revenues that we’ve generated out of the legacy side of Battlefield, which is what we talk about in terms of rental services, would be between 2.5x and 3x those that have been generated on QM. So we think the market is much more comparable than that measure. And the rental book beyond just the rental services, we’re also – there’s a similar story going on there with the heavy rental and the power rental. We’re having to rebuild or upload those fleets and we’ve been slower because we’ve been moving units over the retail. So similar story in there, so it’s impacting our disposition in those areas as well.

Michael Doumet

Okay, helpful again. Thanks, guys.

Scott Medhurst

Excellent. Thanks, Michael.

Operator

We will now take our next question from Derek Spronck from RBC. Your line is open. Please go ahead.

Derek Spronck

Hi. Good morning. Thanks for taking my questions.

Scott Medhurst

Good morning.

Derek Spronck

Just on the SG&A costs as a percent of revenue, it’s trending a little bit higher on a year-over-year basis. Does that come down in 2019 or likely to remain more elevated as you continue to build out your rental business?

Paul Jewer

We’re currently going through our budgeting process now, Derek, so I’m not in a position to be able to forecast those properly. Obviously, we’re focused on bottom line growth. At this point in time we’ve seen – as we complete the integration, we’ve seen some transference in people from – we’re up people in total at the acquired businesses but some transference in salaries which will be SG&A into technicians. We’ve increased our technician base. So that could elevate us a little bit. But I don’t have any strong expectations one way or the other.

Derek Spronck

Okay. And have we come to any decision on the consolidated in the ERP systems?

Paul Jewer

No. Not at this point in time. As we said, it will be pretty clear that we’ll be taking a good year and a half to assess this and we’re on track with that. So we’ve looked at a number of different options. We’re certainly fine tuning it down. And as is our normal process, we’ll take it a slow and steady approach to this, a very methodical approach to it and implement it over a timeframe so as to derisk that exercise.

Derek Spronck

And there’s no issues running both at the same time concurrently?

Paul Jewer

No. Toromont has very much invested to bring philosophy versus a single ERP philosophy and our CIO would be able to articulate it much better than ours, extremely [ph] strong individual and highly respected in the CAT world. On our businesses that we had prior to the acquisition, we would have run multiple platforms for each one of those units. So CIMCO ran on SAP, for example, as does Toromont QM now and Toromont CAT legacy ran on a platform called DBS and Battlefield on Systematic and a number of other platforms that we have and we bring all those together with our backend tools.

Derek Spronck

Okay, great. And just one more quick one for my thoughts and I’ll turn it over. The deferred revenues and contract liabilities, there’s a little bit of a difference in magnitude between QM and your legacy business having around 67 million and the legacy business 8.5 million. Are you looking to normalize that or why is there a difference between the two, legacy and QM, on the deferred revenue side?

Paul Jewer

There’s nothing material that’s going on there. There’s no difference in terms of business approach that we’re dealing with. It’s just vagaries of business levels as it relates into sales with residual value guarantees and some other elements that will be impacted by deferred revenues.

Derek Spronck

Would QM historically then provided greater residual value guarantees as part of their sales process relative to what you’ve done on a legacy basis or --?

Paul Jewer

No. And the other thing that impacts us as well. So no, there would not have. So they would have been a little bit tighter on that front. And the other thing that impacts us is also CSAs, contract service agreements.

Derek Spronck

Okay, all right. Thank you.

Paul Jewer

Thanks.

Operator

We will now take our next question from Devin Dodge from BMO Nesbitt Burns. Your line is open. Please go ahead.

Devin Dodge

Thanks. Good morning, guys.

Scott Medhurst

Good morning.

Paul Jewer

Good morning.

Devin Dodge

So just to start with your rental business, it seems that timing utilization has been a key driver of results recently. Just wondering if you could provide some context for where timing utilization sits currently compared to maybe the range over the last 5 to 10 years and if there’s room for – or anymore headroom for this to shift higher?

Scott Medhurst

We’ve got some utilization on time here as high as 70% in the quarter, actually heavy went up 76 in the quarter and power is very high as well. So when you look at it over a year-over-year basis, we are up. And when you look at it – I look at it morph. So when you get into those high ranges, it means – you need to increase your fleet size which we do and wanted to do. So that’s where we focus on. And what you have to look at also is the market continues to trend with rental.

Devin Dodge

Yes, for sure. And I guess if utilization is still elevated or it has been elevated for a while here, when does this start to impact rental rates positively?

Scott Medhurst

It’s still competitive. That’s not going to change. It’s a very competitive market. So what you have to look at is what’s your value proposition, where are you positioned in the market to deliver the rentals on time, good product, focused on safety of the product. So that’s what we try and do with our – and how we interface. We put a lot of emphases on investment and how we interface with the customers. So that’s where our focal point is.

Devin Dodge

Okay, understood. Just maybe a question for Paul here just on your working capital. I believe Toromont’s benefitted from some favorable terms or transition terms from suppliers this year. How long do you expect these terms to be in place and is there a point when this becomes a headwind and terms go back to kind of normal levels?

Paul Jewer

The change isn’t imminent. So expect that to continue well into next year and then start to fade out.

Devin Dodge

Okay, makes sense. I’ll turn it over. Thank you.

Scott Medhurst

Thank you.

Operator

We will now take our next question from Ben Cherniavsky from Raymond James. Your line is open. Please go ahead.

Ben Cherniavsky

Good morning.

Scott Medhurst

Good morning, Ben.

Ben Cherniavsky

I would just like to ask you to elaborate on something that you’ve mentioned in the MD&A with respect to CIMCO where you say that the – obviously you highlight some of the margin pressures and project issues, but then gone to say that you’ve improved the processes and addressed them and that CIMCO is focused with its growth strategy in the U.S. Can you just elaborate a little bit more on what that revised growth strategy is and what processes have been changed to improve the performance there?

Scott Medhurst

So what we’ve zeroed in on as a team here is how we structure the deals when you get into certain types of work from estimating to our crosschecks to our interface with contractors, power monitoring the processes and then just the execution at site. So those are the variables that we’ve been very focused on. Again, Ben, it hasn’t been a good story on that one project and what we feel we’ve had some good lessons learned there to move forward. And in terms of our strategy --

Ben Cherniavsky

Yes, in terms of the growth strategy.

Scott Medhurst

Yes, it really is just a refocus to make sure that we’ve got our processes in place because we have been executing in a growth story in there since 2014. So we just went in and did an overview of our strategy making sure we looked at the different types of projects and made sure we’re comfortable on all fronts.

Ben Cherniavsky

But still to really capitalize on the size of that opportunity in the U.S. --

Scott Medhurst

Yes, absolutely.

Ben Cherniavsky

That kind of remains the code you need to crack there, right, how you get that market opportunity? Is there any change in how you address the market to capture that opportunity, or is it just continue to sort of go on it and hit singles and doubles as you bid on projects?

Scott Medhurst

Yes, that’s exactly it. What we had to do here is just make sure our [indiscernible] were in check because we have had significant growth since '14 and that’s what we zeroed in on the last couple of quarters.

Paul Jewer

Let me add to Scott’s comments a little bit. So when we break down and as we analyze our performance in the U.S., this year is weighed down by a project. We’re not particularly happy or proud of that in that circumstance. On the balance, execution’s been good. When we look over longer terms and when you look at the past 5 years or even 10 years, the growth rate in our product support business in the U.S. has been very steady and very healthy. So we’ve been doing well on that front. It’s challenging as we’ve said multiple times to get tax. But one of the areas where we are retooling our strategy is on that front. I’m not going to get into too many details right there. The other element is we’ve had some volatility in terms of margin performance and I think one of the things that we realize is I think we have assess where it is that we add the most value and focus and target our efforts into those areas where we add most value.

Ben Cherniavsky

Okay, that’s helpful. On the margins and gross margins in particular, you had a – they’ve been up in the last few quarters pretty much since you acquired Quebec this quarter I think in particular with a decent increase. I realize there’s obviously some mix issues on the equipment side that were in your favor this quarter. But on the other hand it sounds like CIMCO was probably a drag. So can you elaborate a little bit on what’s driving that margin increase? Is it simply mix or are there variables within the mix that are also a factor?

Scott Medhurst

When you look at the product support, we’re pleased with the product support growth and that’s obviously favorable. We have worked hard on our value proposition on some of the new sales as well, but we were favorable there on the mix.

Paul Jewer

Again, things can bounce around from a quarter-to-quarter basis.

Ben Cherniavsky

So it’s just a mix issue or like are the margins in any of those categories improving?

Scott Medhurst

There’s no issue. We’re pleased with the performance.

Ben Cherniavsky

There’s a mix out there but are the margins within any of the categories changing?

Scott Medhurst

Nothing dramatic.

Ben Cherniavsky

Service profitability isn’t particularly different or anything like that or margins on your sales aren’t changing?

Paul Jewer

No. Not systemically.

Ben Cherniavsky

Okay. And just finally and a quick one, could you comment, is availability – did it cost you anything in market share anywhere in the CAT dealership this quarter or recently?

Scott Medhurst

Well, where it’s really impacting us, Ben, is we’re shifting product into the retail that we had planned to dedicate to the fleets. So that’s where the real impact has been. And we’ve opened up which was powerful the visibility across our enterprise is our inventory, so there’s some push and pull in there across the territory. And we’re going to do better in our planning process this quarter. Obviously, we didn’t close that deal until October last year. So now we’re into our normal planning process on pipeline forecasting.

Ben Cherniavsky

Okay. Sorry, I wasn’t clear. So is that costing you – is availability costing you market share?

Scott Medhurst

I would say it has hurt us on a few deals, but again we’ve been able to – the teams’ worked well shifting iron from the fleets into the retail side.

Paul Jewer

And I would say the biggest area where it’s had adverse impact, as Scott said, we haven’t had the opportunity for the uploads as we indicated in the report. We’ve been retaining rental fleets for longer. Rental fleets are a good source of use for us. So it’s probably hurt us on the use side more than anything else.

Scott Medhurst

Yes, disposition is down.

Ben Cherniavsky

Right. Okay. Thank you.

Paul Jewer

You’re welcome.

Operator

We will now take our next question from Maxim Sytchev from National Bank Financial. Your line is open. Please go ahead.

Maxim Sytchev

Hi. Good morning.

Scott Medhurst

Good morning, Max.

Maxim Sytchev

I was wondering if you don’t mind just commenting on the product support in the legacy business. It looks like there was a bit of a deceleration relative to the prior quarters and maybe how we should think about this bucket on a going-forward basis?

Scott Medhurst

You’re going to get lumpiness in there with rebuild activity. Like Q2, we had some favorable business although product support is still strong. WIP levels are still strong in legacy. I think we’re up 22% on the WIP, so still good.

Maxim Sytchev

And visibility right now on rebuild, how should we think about this?

Scott Medhurst

Yes, from what we’ve seen so far it continues to improve.

Maxim Sytchev

And is that --

Paul Jewer

We’ve only strengthened our resources, Max. So Scott mentioned in his comments part of the restructuring that we did was to take a product support group basically and strengthen two pillars of product support; one of them focused on the service side and really focused on now the portfolio of Reman assets that we have available to us with four very solid locations. So that certainly provides us with opportunities to manage this more effectively than either one of the two predecessor organizations could have done.

Scott Medhurst

But that’s early stage. We’re just starting that process and establishment.

Maxim Sytchev

Okay. So right now you have the ability to shift like excess capacity between the four locations, right?

Scott Medhurst

Shift excess capacity and to focus areas of expertise in single locations, right, so obviously that provides efficiencies.

Maxim Sytchev

Right. Okay, that’s helpful. And then the comment, Paul, that you made around Ontario specifically about it’s been a good run for a long time. So are you seeing a moderation of growth because like I think if you look on the infra [ph] spending side, lots of horizontal infrastructure expected to be build out kind of between now for the next couple of years. So I’m just wondering if you don’t mind sort of re-qualifying that Ontario comment specifically, if it’s possible.

Paul Jewer

Yes, it was a relative comment, Max, related to growth rates that we’re seeing in Ontario versus growth rates that we’re seeing this year in Quebec. And Quebec has had that pent-up demand for quite a period of time. Obviously the impacts of – the Charbonneau Commission deferred things in the problems of Quebec when it came to releasing major projects. So you’re really seeing that sort of pent-up demand turn into a significant acceleration contributing to our growth already. In Ontario, we’ve seen good high level spend levels for a long period of time. I think it’s preliminary at this point in time to make any comments in terms of acceleration or deceleration or anything on Ontario. The spend levels appear to be decent and we’ll see how things unfold over the coming year.

Maxim Sytchev

Right. So again we should not be expecting a downward trajectory from the rate that we’re sort of seeing on a year-to-date basis, not in Q3 specifically?

Scott Medhurst

Well, from what we’ve seen so far there’s been solid activity. But we don’t speculate on what’s around the corner. We just call it like we’ve seen so far. And so far those markets have been active throughout the territory.

Maxim Sytchev

Okay, that’s helpful. And last question just in terms of the margin conversions between the legacy and the QM business, maybe if you have an update in terms of the timing on that dynamic?

Paul Jewer

Consistent with what we’ve said before, we don’t target an EBIT margin per se and I know there’s a lot of desire to model that in. But we are very focused on the myths [ph] of the business and the elements of operating discipline that will enable us to hopefully see better and improved profitability.

Scott Medhurst

The other key part of the strategy in QM is to make sure we’re advancing our market presence and we’re pleased with that progress in a very active market so far.

Maxim Sytchev

Okay, that’s very helpful. Thank you very much.

Operator

[Operator Instructions]. We will now take our next question from Yuri Lynk from Canaccord Genuity. Please go ahead.

Yuri Lynk

Good morning.

Scott Medhurst

Hi, Yuri.

Yuri Lynk

Scott, off the top you spoke about rental earning lower returns as you roll it out which obviously makes a ton of sense. I think what we’re all trying to figure is, are we still so early in the process of that rollout that we should expect returns to decline from here say in 2019 before we start to see them get better, or are we kind of in that – well into that process now?

Scott Medhurst

So we’re not going to speculate because what we’re doing is we’ve broadened the allied products. We’re entering – we’re building that business in QM in particular. So I don’t want to speculate on how quickly we’re going to get uptake in there. So far we’ve been pleased as you saw with the revenue on the rental side throughout the territory again. But we’re just sticking to the fundamentals here. We’ve got to increase those fleets size. We’ve got to look at our products to be able to serve customers for a 12-month period. We weren’t structured right to be able to do that. So we’re going to be in a better position to do so. And we need to upload these fleets. We need them to age. There’s considerable difference on the age of the fleets when you look at legacy versus QM. With some product lines we’ve got like 15, 16-month difference. That’s significant when you look at these rental models. And that demonstrates that we’re having to hold onto product here to age it. We can’t dispose. So we’re just not in the sweet spots here that we would normally enjoy and then the availability’s impact just a bit as well. So too hard to speculate here. We’re just going to stick to the fundamentals of building rental services business and also building heavy rent and power rental business as well.

Yuri Lynk

Okay. Paul, a question for you quickly. We haven’t talked about capital allocation priorities in a long time because you were deleveraging from the acquisition, but very strong balance sheet once again here all of a sudden. So maybe just remind us of where you sit on that.

Paul Jewer

Also we have significant investment opportunities in front of us. So consistent with even before the acquisition we’ll continue to invest in expanding our business opportunity and rolling out the rental footprint is certainly one of the primary focus areas. Beyond that, what’s clearly is our dividend policy. We certainly had a practice of paying a dividend, of increasing it for quite a number of years. It will be helpful that we will continue to have that opportunity every year. We’ve been opportunistic in terms of our NCIB although we do have some capital that we are prepared to allocate to it, so we’ll see how that unfolds. And then beyond it, it’s just – we’ll look at opportunities as we see them unfold.

Yuri Lynk

That’s fair. Okay. I’ll turn it over. Thanks.

Paul Jewer

Thank you.

Operator

It appears there are no further questions at this time. Mr. Jewer, I’d like to turn the conference back to you for any additional or closing remarks.

Paul Jewer

Thank you, Tara, and thanks to everyone for their participation today.

Operator

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