AVL Manufacturing Inc. (TIH) Earnings Call Transcript & Summary

Good afternoon. Today is Monday, February 3, 2025. Welcome to the Toromont Industries Limited Investor Call. Please be advised that this call is being recorded. [Operator Instructions] Your host for today will be Mr. John Doolittle, Executive Vice President and Chief Financial Officer. Please go ahead, Mr. Doolittle.

Thank you, Constantine. It's John here. Hi, everybody. Thanks a lot for joining us this afternoon. With me today, as usual, is Mike McMillan, our President and CEO. Although we are about a week away from holding our Q4 results conference call, we thought it will be a good idea to have a brief call today to discuss the announcement we made this morning. Before we get to that, however, a couple of important comments are worth noting. First, we are a week away from announcing our Q4 and 2024 results, and as such, we will not be commenting on those results during this call. Stay tuned for next week's usual call. Also, the tariff situation is quite fluid, and it would be inappropriate for us to speculate or speak to this dynamic situation. Suffice to say, our team is highly engaged, monitoring and developing an appropriate action plan to navigate the potential impacts over the short and longer term. I'll pass it over to Mike to talk specifically about our AVL acquisition.

Great. Thanks very much, John. And thanks, everyone, for joining. So back to the topic at hand. The AVL acquisition announced this morning may not look like a natural fit with our existing business on the surface. However, on the contrary, as all of you know, the data center business is advancing very quickly. And you'll be familiar with the fact that we are already a supplier to the industry in our territory with power equipment, which includes both prime and standby power generation. Also, we have strong relationships in the Cat dealership network and well aware of many Cat customers across North America in the data center business. It has been clear to us within the dealer network and the customer base that there are a number of gating supply issues that are constraining growth. One of those key constraints, of course, is the enclosure business that house the backup power and other important components. It so happens that one of the preeminent suppliers of enclosures to the key players in this industry is AVL led by Vince DiCristofaro, someone that we have had a deep relationship with for many years. As well, the production happens to be right in our backyard in Hamilton. So by doing this deal, we have secured an important part of our own supply chain and potential to support other Cat dealers and customers. In addition, we will be partnering with Vince to grow the business significantly over the next few years, and we expect to see return prospects that meet or exceed our usual hurdle rates. We've also considered the current economic and political landscape, and we are thoughtfully developing plans, as John mentioned, to mitigate these potential risks. John, why don't you provide some additional color on AVL?

Yes. Thanks a lot, Mike. So just a few more details, and you'll get more details when we publish our financial information later. But AVL has grown to approximately 300 employees in Hamilton and serves customers in both Canada and the U.S. It's a very strong operational foundation in a robust fabrication process for the enclosure. It holds a number of industry certifications, including ISO, among others. We've been very impressed with AVL's manufacturing processes, and they are second to none. In addition, AVL has a robust order backlog with most of its enclosures used for data center backup power applications. AVL also has a strong engineering design team working closely with customers to innovate and design new solutions for customers. Their innovative approach is one of the reasons we've chosen to invest in AVL. Overall, we have seen strong growth in AVL's enclosure business up until now, and we believe there is more room to grow. This is a great area to complement the products -- the offering we have on our existing products. So with that, that's the -- those are the prepared remarks. I'll pass it back to Constantine for questions.

[Operator Instructions] Your first question comes from the line of Cherilyn Radbourne from TD Cowen.

Could you give us a bit of background on how this deal came together? My assumption in reading the press release is that AVL is likely a supplier that Toromont has worked with for some time.

Yes thanks, Cherilyn. Yes, it's an important point because as I mentioned in some of the comments, we've had a long-standing relationship with Vince DiCristofaro, the principal there, in this company, and largely through our power systems group, where he provided enclosures for our business and very similar applications that you see for data centers today. But we've worked pretty closely with him over a number of years. And I think over time, as the data center business and other applications, frankly, continue to evolve, we're working closely with Vince and his team. And the opportunity came about where they were looking to expand and grow, and we looked at it as a partnership opportunity for us, both in the Canadian market, but also I think he does do some work with other Cat dealers and others. And we thought it might be a great opportunity to help support growth in this space and plan for the future in that way. So we do think that there are a few other potential opportunities to -- enclosures are pretty common in a number of areas, including our CIMCO business and other things, and we think that there may be the opportunity there also down the road as we see that part of the business growing as well.

Interesting. How important, just given how rapidly this market is growing, was securing supply as an aspect of the deal?

Maybe just to start on that, Cherilyn, John can provide some color. I had a couple of things actually come to mind on this. Like absolutely, we recognize that because of the demand now, the engines typically used in the data center application are similar engines that we use for mining trucks. And they also use it for oil and gas fracking equipment and so forth. And so because we knew -- certainly know that the engine supply is constrained and there's a lot of investment going there. One of the bottlenecks is the enclosures that you put around such equipment. And what we found was the AVL team has developed one of the strongest designs, I think, and has had great industry acceptance. And so I would say that, that was a leading indicator for us, I mean, a very high-quality design and the opportunity for us to participate in that market and support growth. John, anything you want to add?

No, I think you covered it, Mike.

Okay. My last question before I turn it over is Toromont has always worked on a very decentralized basis. And I think in terms of your total data center offering, AVL will bring something, but it's going to work separately. CIMCO brings something but continues to work separately. Can you just talk to us about how you're going to integrate those 3 businesses to really drive the maximum value out of this?

Yes, great question. I would say maybe off the top there, Cherilyn, we absolutely like our decentralized model. We're not looking to differentiate or take a different direction in that regard. Now having said that, the AVL business does support complement. I think it's probably the right approach, complement both our power and, say, our CIMCO businesses to some degree. And so there are some natural synergies and so forth. But we would want to make sure that we continue to manage this business very similar to the way we do CIMCO today, as you point out, or Battlefield and some of the other divisions where we have a very strong ownership accountability and empowerment model. But also, the business receives the support and requirements to make sure that it's operating effectively. And so the support side of that business would be -- it would be handled similarly to what we do with our other divisions today. And so Vince has agreed to stay on and work with us over the next -- through 2031. And I think that's a really important aspect of this business, where he is the absolute leader of that business and will continue to work very closely with our teams.

Your next question comes from the line of Jonathan Goldman from Scotiabank.

So Mike, you've given a lot of color around the strategic rationale behind the deal. I was wondering if you can help us think about the revenue or potential revenue synergy opportunity, how AVL can benefit from their platform or vice versa and if you're able to quantify or even talk directionally about the organic growth profile of AVL and how that's trended over the last few years.

Yes, I'd say -- again, I would say very carefully here, Jonathan, in the sense that we haven't disclosed the full details on the transaction as yet. And so what I would direct you to is as we progress, I guess you'll see some disclosure here. There'll be a subsequent event. Then there'll be some more details around our Q1 when we actually start to consolidate and report on the transaction itself to give you a sense. And so I think, again, this is an emerging market. And I would say it's -- we haven't provided many details in terms of the backlog or the sales level, except to say that it's accretive to our business, but it's -- I would say that it's not overly material at this stage of its development, but we do see some great growth prospects over time.

Yes. The only thing I would say, Jonathan, is what I kind of finished off with. And as Mike said, we'll give more details when we release our numbers. But they're seeing very strong growth. They have seen very strong growth up until this point. We think we are a great partner of theirs with our relationships with other dealers and customers of Caterpillar, and we think there is much more room to grow. And so that's kind of what we're buying into.

Okay. Makes sense. And I guess my second question is it's the second deal you guys have done in a little over 4 months. Can you discuss what the current pipeline looks like and how the recent transactions fit within the broader M&A strategy and how you might approach M&A going forward?

Yes. Maybe just to start there, Jonathan. Thanks for the question. I would say like all the deals that you consider, I mean, they are, I would say, mutually exclusive to a great degree. And so when we looked at Tri-City, for example, that was a deal that we worked on for quite a few months. Likewise, in this case, we were working closely with the AVL team for several months. And I -- we don't comment a lot on our pipeline, except to say that we continue to look for businesses such as these 2 where we think, number one, it's a great run business. We can add value by bringing it into the Toromont family. And I think we can get a good value and work together collaboratively to grow the business. And so I would say these 2 business opportunities meet our criteria and so forth. But I wouldn't speculate that we have a number of deals in the pipeline that we expect to close in a similar fashion or over a similar time frame. John?

Yes. So don't expect one a quarter, Jonathan. These things happen to come in fits and starts, as you know. And it just so happened that these 2 deals that we closed are right in our sweet spot. We really like both deals. We meet all of our criteria. And we'll continue to look at each one carefully, make sure we can add value to make sure the returns are there for shareholders. It's still the same capital allocation process we've always had, which is organic growth, dividends, buybacks and M&A, the kind of 4 pillars. So nothing really has changed there.

Yes, [indiscernible].

Yes.

So we won't model one per quarter as a run rate going forward?

Please don't. Yes.

Your next question comes from the line of Steve Hansen from Raymond James.

Just 2 related questions. The first is just, how fragmented is this landscape? You described a pretty strong growth profile here. Just curious if you think you can satisfy the demand you're seeing all from this footprint? Or is there additional consolidation steps to be had in the same markets?

Yes. I would say it's pretty fragmented, Steve. We're obviously really comfortable with the footprint that AVL has today. It's highly likely that in order to grow the business like we want to grow the business, we'll have to extend the footprint. But that doesn't mean more acquisitions. That just means more space to build enclosures. So that will likely come down the road, but that doesn't mean additional acquisitions in this space.

Got it. And then just the second part of the question then is, what kind of capacity does this group have? It sounds like they've been growing quickly here. Do you need to invest into the existing plant and equipment that stands today to satisfy that growth? Or do you feel like you got some, I guess -- or some idle capacity still to grow into?

They're pretty well set in terms of the technology and capability that you have with the existing footprint. And as I said, down the road in order to grow the business, we may need to look at additional footprint. But for now, things are fine.

Okay. Helpful. And then just one last one. I know you're going to give us some better details later, but if you're describing this as sort of a high-quality, highly engineered design, how should we think about this margin profile relative to other parts of your business? Is it fair to say this is sort of a mid-teens type business? Is it high? I'm just trying to get a sense for...

Yes. Let us come back to that question, Steve, when we talk to you on the next call. We said it's accretive. So that's probably -- yes.

And our hurdle rates are...

And our hurdle rates are there. So...

Yes.

Your last question comes from the line of Maxim Sytchev from National Bank Financial.

I just had one quick question, if I may. In terms of CIMCO, and I mean, obviously, as that entity is trying to kind of attack a data center cooling market, do you think the transaction today is potentially putting you in a slightly better position just because you have like more touch points with potential customers? I'm just wondering if that could be helpful as well.

Yes, it's a great question, Max. I think it does broaden our customer base to a certain degree. I mean as I mentioned in the comments, a number of AVL's customers are Cat dealers, which we are very familiar with. Having said that, I think when you look at CIMCO, they're in thermal heating and cooling business. There certainly is an opportunity down the road as they potentially get certified or designed into certain applications that they could also play a part, right? And so I would say that we would carefully be pursuing some of those opportunities, but know that it does take time for acceptance and certification and design in to occur, right?

Yes. Just to add, it probably gives us a better avenue to end customers than we had before. It kind of affirms our commitment to the data center space. So just to add on to what Mike said. Any other -- thanks, Max. Any other questions on the line? Okay. Constantine, nothing?

There are no further questions at this time. I'm going to go ahead and turn the call over to you for closing remarks. Mr. Doolittle, please go ahead.

Okay. Well, listen, thanks, everybody, for joining. I know it was a brief call, but hopefully, we gave you some more information on AVL and why it makes sense for us. And appreciate everybody joining, and we'll talk to you on the 12th at February. Thanks a lot.

Have a safe week. Take care.

This concludes today's conference call. Thank you very much for your participation. You may now disconnect.