Titan Machinery Inc. (TITN) Q2 2024 Earnings Call Transcript

Greetings, and welcome to the Titan Machinery Inc. Second Quarter Fiscal 2024 Earnings Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Jeff Sonnek of ICR. Thank you. Please go ahead.

Thank you. Good morning, ladies and gentlemen, and welcome to Titan Machinery's second quarter fiscal 2024 earnings conference call. On the call today from the company are David Meyer, Chairman and Chief Executive Officer; Bo Larsen, Chief Financial Officer; and Bryan Knutson, President and Chief Operating Officer. By now, everyone should have access to the earnings release for the fiscal second quarter ended July 31, 2023, which went out this morning at approximately 6:45 a.m. Eastern Time. If you've not received the release, it's available on our Investor Relations page on Titan's website at ir.titanmachinery.com. This call is being webcast, and a replay will be available on the company's website as well. In addition, we're providing a presentation to accompany today's prepared remarks. You may access this presentation now by going to Titan's website again at ir.titanmachinery.com. The presentation is available directly below the webcast information in the middle of the page. We'd like to remind everyone that the prepared remarks contain forward-looking statements, and management may make additional forward-looking statements in response to your questions. These statements do not guarantee future performance, and therefore, undue reliance should not be placed upon them. These forward-looking statements are based on current expectations of management and involve inherent risks and uncertainties, including those identified in the Risk Factors section of Titan's most recently filed annual report on Form 10-K as updated in subsequently filed quarterly reports on Form 10-Q. These risk factors contain a more detailed discussion of the factors that could cause actual results to differ materially from those projected in any forward-looking statements. Except as may be required by applicable law, Titan assumes no obligation to update any forward-looking statements that may be made in today's release or call. At the conclusion of our prepared remarks, we will open the call to take your questions. And with that, I'd now like to introduce the company's Chairman and CEO, Mr. David Meyer. David, please go ahead.

Thank you, Jeff. Good morning, everyone. Welcome to our second quarter fiscal 2024 earnings conference call. On today's call, I'll provide a summary of our results, then Bryan Knutson, our President and Chief Operating Officer, will give an overview for each of our business segments. Bo Larsen, our CFO, will then review financial results for the second quarter of fiscal 2024 and conclude with some commentary around fiscal 2024 full year expectations. We will also follow-up on the O'Connors acquisition that was announced yesterday with a high-level overview. We carried a strong momentum into the second quarter with revenue increasing 29.4% to $642.6 million. This performance reflects double-digit same-store revenue growth across all three of our operating segments combined with an $86 million contribution from the Heartland and Pioneer acquisitions. Our organic revenue growth was also balanced across equipment, parts, and service, each of which performed well and also delivered healthy gross margins. Taken together, we generated a consolidated pretax margin of 6.5% and diluted earnings per share of $1.38, which is more than a 25% increase over last year's second quarter earnings performance. This once again demonstrates the strength of our organization and the efficiency with which we are operating in the business. Next, I'd like to provide an update on our equipment inventory. Consistent with our prior expectations, we are seeing some improvement in equipment availability in several equipment categories, but do not anticipate receiving shipments of high horsepower tractors, self-propelled sprayers, or wheel orders in excess of customer retail units. We continue to see demand for these products sustained at high levels and expect that to continue into next year. With our suppliers’ production capacities being limited, we do not anticipate replenishment towards targeted minimum stocking levels for these equipment categories until at least the second half of calendar year 2024. This is undoubtedly limiting our sales levels. I'm very proud of the team for achieving these record results given all of these constraints. Now, as you may have seen last night, we are also very excited about our definitive agreement to acquire O'Connors, the largest Case IH dealership group in Australia and a market leader in high horsepower equipment. O'Connors has a seasoned management team with a proven track record of driving solid financial performance through a combination of organic and acquisitive goals for nearly six decades. Additionally, the operating metrics, core values, and customer-centric focus highly aligns with our own, making them a great partner for our entry into the Australian agriculture market. In their fiscal year, which ended on June 30, 2023, O'Connors generated revenue of $258 million and an EBITDA of $21.4 million, demonstrating the scale of the network they've developed. Combined, the Titan Machinery enterprise, including the O'Connors acquisition, is expected to generate annualized revenue of approximately $2.9 billion and approximately $200 million in adjusted EBITDA, making us an even more formidable player as a global agriculture and construction equipment dealer. Australia is the largest wheat producer in the Southern Hemisphere and the third-largest wheat exporter only behind Europe and Russia. O'Connor stores are located in Australia's highly productive grain belt, which produces 60% of Australia's wheat. The Australian market is benefiting from strong fundamentals that are being driven by enhanced productivity, economies of scale, and farmer profitability. O'Connor's focus on high horsepower cash crop production equipment in Australia's grain belt region is being supported by combined farm expansions and increasing adoption of precision ag technology that enhances productivity and crop yields. These trends are very similar to that of Titan's domestic and European agriculture business, and coupled with Australia's native English language and comparable legal system, this transaction bodes well for a seamless integration that carries over into our shared values and customer-centric focus. We believe it also provides Titan with unique operational synergy opportunities to expand our global customer service capabilities and capacity across the network. The Australian market is at the early stages of dealer consolidation, and through a combined approach where we can leverage O'Connor's existing leadership team and bring Titan's broader capabilities and resources to bear, we believe we are well-positioned to capitalize on continued opportunities to unlock network synergies while driving market share gains. Together, we believe we will be able to build upon their presence in the heart of the Australian Grain Belt and capitalize on operational synergies across our three-continent footprint consisting of some of the best global agricultural markets generating significant value for our shareholders. We are excited to welcome the O'Connors management team and employees to the Titan Machinery family, and we look forward to a smooth transaction closing and integration process. We expect closing to be completed in Q4 of calendar year 2023. In closing, we remain highly encouraged by the ongoing demand we are seeing in our business, and we are working hard to get our customers their equipment as OEM production and delivery schedules allow. Our team is ready to support our customers through a very busy harvest and year-end construction seasons in the second half of our fiscal year. With that, I will turn the call over to Bryan Knutson for his segment review.

Thank you, David. And good morning, everyone. Today, I will provide a recap of our fiscal second quarter segment drivers and then review some of our high-level expectations for the balance of fiscal year 2024 across our respective segments. I will begin with our domestic agriculture segment, which produced strong organic growth with same-store sales that increased 10%. As you heard from David, we continue to be acquisitive, and the O'Connors transaction is particularly exciting. Our organic growth in the ag segment was further bolstered by revenue contributions from our recent acquisitions in our domestic market. We are also particularly pleased with our ability to maintain our strong pre-tax margin execution, which remained consistent with the prior year period at 7%. Although spring planting got off to a late start this year in some of our Northern markets, crop progress across our footprint is largely back on track following some timely precipitation. Although this precipitation was inconsistent across the Upper Midwest, yield potential has improved from earlier this summer, which is encouraging and is helping improve farmer sentiment. Additionally, with the planting delay, we realized some additional parts and service activity that moved from Q1 into Q2, which is also reflected in the strong growth that we reported today. As David touched on in his commentary, we are still experiencing tight supply in several of our highest selling equipment categories. Our dedicated inventory procurement team continues to work tirelessly to obtain as many of those units as we can from our OEM partners, other dealers, lease returns, and through the used market. Most other categories of equipment have returned to more normalized levels, and this same inventory procurement team has been monitoring inventory trends and made the appropriate adjustments to purchasing volumes to optimize inventory levels while continuing to do so on a forward-looking basis. While we remain focused on presell, especially for cash crop equipment, we feel good about where we have landed and are happy to have replenished stocking levels for many equipment categories that we can serve our customers well, despite not yet being able to procure enough equipment in our key cash crop product categories. We also have a team dedicated to our inventory valuation process regarding ongoing mark-to-market, as well as determining what price we should offer a customer for a trade-in unit. This team intensely monitors internal and external market trends and continually adjusts our trade-in pricing on a real-time basis to ensure healthy margins on future used equipment sales. Our used equipment inventories are in a very healthy position, thanks to our industry-leading inventory management processes, which reflect our scale, decades of experience, and continuous improvements. Looking to the balance of fiscal 2024 for our Agriculture segment, we remain on track with the modeling assumptions that we laid out at the beginning of the year. Net farm income remains well above historical averages and continues to support demand for equipment purchases. Further, with healthy farmer profitability remaining in place, coupled with continued tax incentives throughout Section 179 and bonus depreciation, the environment is setting up well for a strong second half of the year. Although equipment shortages in cash crop categories are expected to persist, we do foresee an increase in available slots as we move through calendar year 2024. Nonetheless, long lead times, coupled with strong fundamentals, have our order board consistent with our prevailing expectation that the industry is well-positioned heading into next year. Now shifting to our domestic construction segment. Construction activity was strong throughout our footprint during our fiscal second quarter, and we generated another great performance in all areas of the business with same-store sales growth of 18.5% and excellent pre-tax margin expansion of 60 basis points to 6.2%. We also achieved rental fleet dollar utilization of 30.2% and absorption of 91.2%. General construction activity remains strong, and infrastructure, energy, and agriculture projects continue to support demand for construction equipment, resulting in year-to-date segment revenue growth of 13%, which is above the initial modeling assumptions we provided at the beginning of the 2024 fiscal year. Although equipment availability is also a limiting factor in the near term for certain types of construction equipment, we continue to see a favorable backdrop, and as a result, we are increasing our full-year modeling assumptions for this segment today. Now moving to an overview of our International segment, which represents our business within the countries of Bulgaria, Germany, Romania, and Ukraine. Same-store sales increased 15.9% in the fiscal second quarter, and pretax margin remained very healthy at 6.1%. Conditions varied across our European footprint with excellent growing conditions in Germany and Ukraine, contrasting with those of Bulgaria, which is experiencing dry growing conditions, which are also present in Southeastern Romania, albeit to a lesser extent. As part of our footprint build-out strategy in our current German market, we acquired an adjacent two-store dealership complex in Germany during the second quarter. Looking ahead to the balance of the year, we are updating our modeling assumptions to reflect some conservatism given our year-to-date growth of 7.8%, which was at the low end of our prior range. We continue to expect European ag fundamentals to moderate with flat industry volumes given the ongoing conflict in Ukraine and the challenges with equipment availability that we see across the other segments of our business. Before I turn the call over to Bo, I'd like to echo David's comments with respect to the O'Connors team. A few months back, I had the privilege of touring all their stores and traveled their entire footprint. Doing so confirmed my expectations of their highly productive agriculture landscape, and I met a number of wonderfully talented people who make their organization so special. Throughout my visit, I was very encouraged by how similar our company cultures are, which is a testament to the focus that their leadership team has brought to their business over the years. We are extremely excited to welcome them to the Titan family and look forward to a smooth integration. With that, I just want to thank all the members of our Titan family for their hard work and dedication to our customers, which has produced fantastic year-to-date results. Now I will turn the call over to Bo to review our financial results in more detail.

Thanks, Bryan. And good morning, everyone. Starting with our consolidated results for the fiscal 2024 second quarter, total revenue was $642.6 million, an increase of 29.4% compared to the prior year period. Our equipment revenue increased 28% versus the prior year period, led by incremental revenue from our recent acquisitions, as well as double-digit same-store sales growth across all three of our reporting segments, which combined for a 12.1% increase on a same-store basis. This growth was also visible across our other revenue streams, with our parts revenue increasing 39.7%, service up 27.3%, and rental and other revenue, up 11.6% versus the prior year period. Gross profit for the second quarter increased 29.9% to $133 million. Gross profit margin increased by 10 basis points to 20.8%, driven primarily by a slight mix shift to higher-margin parts sales relative to equipment sales. Operating expenses were $88.8 million for the second quarter of fiscal 2024, compared to $68.8 million in the prior year. The year-over-year increase of 28.9% was primarily due to additional operating expenses from acquisitions that have taken place in the past year, as well as an increase in variable expenses associated with the increased sales. That said, we are pleased to achieve some modest operating leverage of 10 basis points versus the prior year as a percentage of sales. Floor plan and other interest expense was $3.7 million compared to $1.6 million for the second quarter of fiscal 2023, primarily due to higher interest-bearing floor plan borrowings driven by higher inventory levels. Net income for the second quarter of fiscal 2024 was $31.3 million or $1.38 per diluted share, and compares to last year's second quarter net income of $25 million or $1.10 per diluted share. Now turning to our segment results for the second quarter. In our Agriculture segment, sales increased 34.4% to $469.1 million. This growth was driven by our acquisitions of Heartland Ag Systems and Pioneer Equipment, as well as same-store sales growth of 10%, which was achieved on top of a strong performance in the prior year period. Despite the strong quarterly performance, second quarter revenues continue to be constrained by the equipment availability of high-demand cash product categories, as already touched on during this call. Agriculture segment pretax income was $33 million compared to $24.9 million in the second quarter of the prior year, which implies a pretax margin decrease of 10 basis points to 7%. Our Construction segment continued its momentum in the second quarter and grew sales to $82.9 million, up 18.3% compared to the prior year period. Benefiting from broad-based construction activity and improved equipment availability in some equipment categories. Pre-tax income was $5.2 million compared to $3.9 million in the second quarter of the prior year, and our year-over-year pretax margin increased by approximately 60 basis points to 6.2%. In our International segment, sales increased by 16.9% to $90.6 million, which reflects a 2.1% currency tailwind on the strengthening euro. Net of the effect of these foreign currency fluctuations, the segment achieved sales growth of 14.9%, which included a modest year-over-year decline in Ukraine as it remains impacted by the ongoing conflict. Pre-tax income was $5.6 million compared to $5.9 million in the second quarter of fiscal 2023, which implies a pretax margin decrease of 150 basis points to 6.1%. Now on to our balance sheet and inventory position. We had cash of $53 million and an adjusted debt to tangible net worth ratio of 1.0 as of July 31, 2023, which is well below our bank covenant of 3.5. Our total inventory balance at the end of the second quarter was $979.4 million, an increase of approximately $275.5 million during the first six months of this fiscal year. This increase came via growth in equipment and parts inventories of $259.1 million and $15 million, respectively. Of the total increase, $22 million is attributable to the Pioneer acquisition, which was made during the first quarter. The primary driver of this increase is the improvement in new equipment availability from our OEM partners as they have largely caught up on production outside of those key high horsepower equipment categories that David and Brian both mentioned, which are still on allocation. Overall, we are still a bit short of targeted stocking levels of available-for-sale inventory. Driving by some of our ag store locations, the lack of high horsepower display units is clearly notable. To put it in perspective, we have 74 ag dealerships domestically. And at today's industry volumes and the cost of equipment, we target a combined $7 million of new and used whole good inventory on average per location, which is the minimum we need to have one or two stocking units for sale demonstration or loaner for our highest demand categories. Add in a couple of weeks' backlog to account for pre-delivery inspection work, and you get to our target of about $600 million versus the $540 million we are at today for our domestic ag segment, which implies a shortage of about $60 million. However, if you then consider that backlog remains above targeted levels while we continue to normalize those turnaround times, our available-for-sale inventory is actually about $100 million short of targeted levels. As for other segments, while there are still key shortages impacting construction and international, their current inventory levels are more or less aligned with targeted levels. But again, there are a few key categories that are still short. Overall, we want to continue to normalize the amount of backlog in inventory and replenish stocking levels of those key equipment categories. Note that these targeted inventory levels take into consideration that we remain focused on those presale activities that Brian touched on earlier, and presale is an excellent opportunity to provide more visibility into future sales and maintain higher levels of inventory turns. With that, I'll share a few comments on our fiscal 2024 full-year guidance which we have updated to reflect the year-to-date performance of our businesses and to include an assumption for the partial year impact of the O'Connor's acquisition, which we expect to report as a fourth business segment. The year-to-date performance of our Agriculture segment has been consistent with our expectations, underpinned by strong organic growth and operating performance. We expect that to continue through the back half of this fiscal year. Our Construction segment has been exceeding expectations, and we expect construction activity to continue to support that trend for the rest of the year. As for our International segment, it is performing well but toward the lower end of our previous guidance range. As such, we are reaffirming our assumptions for our Agriculture segment of up 20% to 25%, increasing our assumption for construction to be up 5% to 10% as compared to the previous guidance of flat to up 5%. We are modifying our international segment assumption to be up 5% to 10%, as compared to the previous guidance of up 8% to 13%. This adjustment for Europe brings us more in line with industry volume forecasts for that region. Before adding the partial year impact of the O'Connor transaction, we are maintaining our expectation for diluted earnings per share with the midpoint of $4.80. Our first-half performance has added to our confidence in achieving the numbers that we presented at the beginning of the fiscal year, and we remain focused on execution for the remainder of the year. With respect to the anticipated partial year impact of the O'Connor transaction, we expect for it to close in the fourth quarter of this calendar year. For purposes of this estimate, we are assuming a closing date of October 1. Their results will be reported on a one-month lag, so these assumptions would result in three months of activity being reported in our fiscal 2024 results. With all of that said, we have provided an initial revenue estimate of $70 million to $90 million, which translates to a diluted earnings per share contribution in the range of $0.10 to $0.15 when factoring in financing and integration-related expenses. Adding the acquisition to our guidance, the range has risen to $4.60 to $5.25. Seasonality in the O'Connor business is similar to historical seasonality in that for O'Connors, about 45% of revenues have historically come in the first half of the year and 55% come in the second half of the year. O'Connor's business for the fiscal year ended June 30, 2023, produced revenue of $258 million, pre-tax income of $18.7 million, and EBITDA of $21.4 million. Adding estimated financing and integration expenses for the first 12 months of ownership to these results provides for a run-rate pro forma pre-tax income of $13 million or $0.40 of earnings per diluted share. We are excited to welcome the O'Connor's team members to Titan and look forward to providing further updates on this business segment on future earnings calls. This concludes our prepared comments, and we are now ready to take questions.

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

Hi, thanks for taking my questions and congratulations on a great quarter and it looks like a great acquisition as well. I'd like to start with the acquisition. I'm curious about the genesis of this acquisition. Was this a function of you guys actively looking to move into Australia and considering a lot of options? Or was O'Connors kind of a unique opportunity that you decided to act on?

Yes. This is Dave. So I actually go back a little bit. I think it's one of these classic situations where you had the two family owners, two brothers who both retired. They've been out of the business. I know Dennis O'Connor has been off for 10 years. They put a professional management team in and really didn't have that family succession. So I knew a couple of years ago that they were probably going to be looking for a partner. So some of it, they could sell their shares to. And I think as you recall, we just had some Heartland acquisitions last year, which were pretty important and strategic. And I didn't really want to come with those two together. But once we got that completed and integrated, I reached out to Dennis O'Connor earlier this year to understand the business a little better. But once you look into the Case IH business in Australia, O'Connor was hands down the market leader in high horsepower equipment. Every year, all the Australian and New Zealand dealers get together for an annual meeting, and they have a top dealer award. O'Connor has won that for the last five years in a row. So you couple that with operating in the Southeastern part of the country and the grain belt, one of the best farmlands in Australia. And I think most importantly, there is that proven and experienced professional management team that has been in place for over five years now. Add all this together, it really was a no-brainer. So we met with the team. Bryan went down there and toured the dealership. The metrics, financial metrics, culture, people, products, everything just aligns almost identically to ours. And with Australia's English language and comparable legal system, it was a great fit.

Yes, it sounds like that's very helpful color. Thank you. Follow-up unrelated to O'Connors, but just general sentiment on farmer sentiment. I appreciate your comment on the state of the business and understand the inventory dynamics that you guys are facing. But I'm wondering if farmer sentiment and buying patterns are being impacted by the interest rate environment. If you can elaborate on how interest rates over the last especially six months are impacting their buying patterns, that would be helpful.

Yes. This is Bryan. We're still actually having a historically high amount of cash transactions right now, especially on a lot of these larger ticket items. We do have manufacturer-supported programs as well, particularly for some of the lower horsepower or rural lifestyle products. This is definitely impacting and is something our farmers and producers are watching. It is cutting into their net farm income a little bit and is one of the contributing factors along with many others that are pushing prices up. However, urea and fertilizer being down is helping, and we're still on pace for a really good year. There are various estimates out there, suggesting it could be 15% to 20% below last year's record depending on where yields come in, but we are still on track for a solid year. Farmers did push a lot of income into this year from last year, and with many anticipating tax incentives still in place, we believe farmers will even consider pushing income into next year. There has been a lot of forward contracting happening. So there remains considerable cash out there, but yes, interest rates are on people's minds, and we do have a lot of different financing tools to help with that.

Yes, and I'd add that while interest expense is increasing, it's a fairly small portion of the overall cost equation for farm income. Other factors play a much larger role.

Yes, no doubt about that. Very good. Well, that's all very helpful. Congratulations again on a great quarter, and I'll get back in cue.

Thank you, Ben.

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

Thank you, and good morning gentlemen, and congratulations on the O'Connor transaction.

Good morning, Alex.

Questions here. You talked a lot about inventory, and that was all very, very helpful. But taking a quick step back, why do you think being at a target inventory level that's comparable to historical levels is appropriate in this higher rate environment that we're in right now?

I would start with saying that the levels we're talking about aren't comparable to historical levels. If you take it back to a prior peak, which some people do, you have to factor in the cost per unit, right? We're talking about significantly smaller numbers of units per location than we were a decade ago. If you simply ran the math on a 3% increase over a decade, you'd be looking at an equipment cost that is much higher than that. Even on a conservative basis, you're talking about one-third fewer units out at the locations. And as we discuss targeted levels, we're focused on our main categories, making sure that we have one or two available for demonstration purposes, loaner units, or display units. We need these in order to drive high volumes of sales. We're missing out on sales opportunities because we don't have those high horsepower items on our lots. If we did, our sales would be even higher than they are today. It's essential to keep all of that in perspective as we continue to improve our business model and focus on being as efficient as possible.

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

No, not yet, Alex. In fact, Bo spoke to his prepared comments that our backlog is actually up a little bit sequentially. So no, we anticipate likely at least another couple of quarters before we can get caught up on that. Our shops are really busy, which is good, and we're selling a lot of products, which is also good. It will just take a little time. Bo, anything to add on your end?

No, I think that's right. As we talked about our mix and available-for-sale inventory, we want to normalize that backlog, and we continue to see opportunities to focus on that in the second half of the year.

Thank you very much.

And one more comment I wanted to add regarding some of the supply-side issues. Some of the equipment is taking us substantially longer to process through our shops right now. We are seeing some improvement, and we do think that we will be back to normal towards the end of the year too, which will help a lot.

Thank you.

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

Thank you, and good morning. So I'm going to throw my two questions back as they relate to the O'Connor acquisition. The first one is just maybe a little more color on the Case IH Australia dealer network. Can you give us some sense in terms of how many locations there are across Australia, maybe the average locations per dealer, who the next largest dealer is now that you have the largest, and just some metrics to give us a sense of how it compares to the domestic dealer network for Case International Harvester?

In our discussions with the management team there, they had a pretty well-defined future growth strategy through acquisitions and had identified locations. But I'd say it's much different in the United States. You don't have a lot of big dealer groups, at least on the case side; there are more on some of the competition. A lot are family businesses or smaller businesses. The opportunity for consolidation is much greater than what we've experienced here in the United States. There are a lot of smaller family-owned groups, and I think that provides a ripe market for consolidation as we continue to expand. We have strong relationships among the existing owners, and we want to take a timely and managed approach in this regard, but that's one of the positives about the future opportunities for M&A.

Yes, and Ted, I would just add on to David’s remark. You asked about the next largest dealer. O’Connor’s footprint in the grain belt has a CNH dealership with six rooftops, and the average is around two to three locations per dealer.

Okay. And do you have any kind of sense in terms of just the number of locations in Australia? Just a bit of curiosity about the size of that market from a location standpoint?

Yes. We know the number in the grain belt specifically within O'Connor's footprint. Our interest lies there. The region holds great potential for consolidation over time. We are seeing that with Deere as well. RDO Equipment, headquartered out of Fargo, is a very large John Deere dealer with 25 locations in Australia and has been adding to their presence for years. Service Equipment, a large John Deere dealer located just north of us in Canada, has 15 locations. There is significant North American presence now between both us and RDO.

My second question is in terms of O'Connor's revenue mix. When you look at it from equipment, parts, services, rentals, etc., is it a mix similar to your domestic business in agriculture, or is it more like the international business? I mean, not that they're that much different, but you have a more pronounced skew towards equipment sales internationally than you do domestically.

Yes. It's pretty similar to our domestic ag business. The supplemental deck that we posted on our website breaks that down nicely. Looking at a three-year historical average, their equipment sales mix was 82%, whereas on the U.S. side, it's more like 77% to 78%. So a couple of percentage points different, but very similar. This is just one of the many similarities in the business profile and metrics that align with our domestic agricultural business.

Okay. Congrats on the quarter and the acquisition.

Our next question comes from the line of Daniel Imbro with Stephens Inc. Please proceed with your question.

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

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

Okay, thank you. And on the O'Connors acquisition, it looks like last fiscal year they finished with a gross margin slightly below yours. Do you all expect to see some synergies to uplift that gross margin, or can you touch on maybe some margin synergies? Just a little more color there would be great.

In the financials provided in the supplemental deck, O'Connors had a gross margin of 18.7%. I believe that was slightly below ours, along with a pre-tax margin of 7.2%. Their profitability is one of the many aspects that attracted us to their management team and operating model. In terms of synergies, we want to focus on a consolidated executive leadership team looking at the business from a global perspective. We want to continue to support the senior management team as they execute on their growth strategy. There are unique opportunities from a service model perspective, providing customers with 24/7 type support as we look at the different time zones we’re now operating in.

Right. Thank you all for the color.

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

Good morning. And thank you for the question here.

Hi, Mig.

I want to go back to the inventory discussion. I'm curious about how you think inventories will progress for you for the remainder of the year. It sounds like you'd like more inventory, if available. As the supply chain improves for the OEM, are you sort of inferring here that you're going to continue to build inventories through year-end? That's part number one. And then related to this, given that so much of your business is now presell, can you comment at all about your presale activity on model year '24 equipment in North America? Then I have some follow-ups. Thank you.

Yes, I’ll start with the inventory question, and then Brian might touch on the presales. From an inventory perspective, we expect inventories to probably increase sequentially in the third quarter and then come down a little bit from there in the fourth quarter, which is typical. We mentioned that from a high horsepower perspective, most everything we receive is retail to customers. We need to turn that around with pre-delivery inspection. So we’ll see how we can normalize that backlog. Those factors are at play for a bigger picture perspective on the increase we’ve seen year-to-date versus what we expect in the back half of the year. The back half should see a modest increase compared to what we saw in the first half, where we were replenishing levels in some other categories.

Yes, Mig, this is Bryan. I would just add that we're focused on key product categories where we are short and looking to get more in. There are several product categories where we feel pretty good. A couple of other categories we have a bit excess of smaller tractors. So you see that reflected in our guidance; we're proactive about cleaning up that mix a bit. In terms of presale activity for model year '24, the OEMs are keeping the order books tight. These key product categories are on allocation. We’re finally out into '24 now and have names on all those key product category units.

But again, do you get a sense that demand for model year '24 is up relative to '23? I ask because it matters within the context of inventories building on your balance sheet and in the industry more broadly.

No, I would say demand is still very similar to prior levels in those key product categories. However, demand has been consistently outpacing supply for a long time now, while normalizing in other product categories. So I don’t see demand increasing, particularly given lower net farm incomes on the construction side too, but demand remains strong. Our order boards in key product categories show we’re still selling everything we can get for the allocation we have so far.

I’ll reiterate that I don’t see us receiving any shipments of sprayers, high horsepower tractors, or wheel orders in significant quantities until at least the second half of 2024. That's how tight it is.

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

Yes, thanks. Good morning. First question, let's pick up where we left off. Regarding the early order programs in presales, what insights do you have for calendar 2024? Are there any cancellations? Are we anticipating a flat calendar for 2024 at this moment? What specific updates can you share from the order programs about next year?

Yes, I think so, Larry. To answer your first question, no cancellations to report, and yes, '24 is a long way out, but at this point, we're anticipating flat demand. We need to factor in production availability as key product categories have not caught up with demand, and the fleet continues to age in certain product categories.

Farmer sentiment may be tempered a bit. There's a lot of noise out there with interest rates and other factors. Farmers are always negative by nature; they have been for 40 years. However, I believe the demand is still good, as the production levels are significantly below previous peaks.

Yes, good point, Dave.

Okay. Thank you. And can you give us color on the second half? You had a good quarter. Construction looks stronger and since you're actually lower, it seems like the core guide excluding O'Connor should be going up rather than staying flat for the year. Could you talk about the expectations in the second half? Is there a deceleration expected, or is it just about the confidence in production and your fiscal 3Q versus 4Q sales split?

A couple of pieces of commentary on that. From a top-line perspective, looking back, same-store sales growth on our domestic ag business has been about 7% in the first half of the year. We anticipate similar levels for the second half. Additionally, layering on any growth expected from Heartland, their growth might be above those levels given the sprayer production commentary. Thus, mathematically, the margin perspective must be considered, as we discussed. So, again, our guidance has been reiterated while we expect some moderation in gross margin. Year-over-year in Q3 and Q4, we expect margins to be low compared to the prior year due to several factors, including the prior expectations about financing and operating expenses. To help you on your math, you may note that other interest expenses are higher this quarter, and we expect that in the third and fourth quarters. Overall, we’re excited about execution into next year.

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

Good morning, Brian, Bo. Ryan on for Steve. Just want to follow up on that last time. When you say Q3 highest, is that the core business, excluding the acquisition you just made of O'Connors? Or will all Q3 be the highest revenue?

That's a great point, and thanks for allowing me to clarify that. That was our expectation, excluding the O'Connors acquisition. So then we layer the O'Connors acquisition on top of that.

Great. And just a quick follow-up. Could you realize any manufacturing incentives in Q2? What are your assumptions within guidance for the back half of the year regarding incentives?

Sure. Last year, we accrued for manufacturer incentives in the second quarter at the tune of $2.6 million. This year, we haven't done that yet, aligning with the cadence of production. We're expecting to continue this in the back half of the year, so we will recognize similar levels overall for the year but predominantly in the back half.

Great. Thanks, Bo. Good luck, guys.

Thank you.

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

Thank you, everybody, for your participation and your interest in Titan Machinery. We look forward to updating you on our progress on our next call. Have a great day.

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