Environmental Solutions Group (DOV) Earnings Call Transcript & Summary

Greetings, and thank you for joining Terex's call about its planned acquisition of the Environmental Solutions Group from Dover Corporation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jon Paterson, Vice President and Treasurer.

Good morning, and thank you for joining us on short notice to discuss Terex' planned acquisition of the Environmental Solutions Group from Dover Corporation. A copy of the press release and presentation slides are posted on our Investor Relations website at investors.terex.com. In addition, the replay and slide presentation will be available on our website. We are joined by Simon Meester, President and Chief Executive Officer; and Julie Beck, Senior Vice President and Chief Financial Officer. Their prepared remarks will be followed by Q&A. Please turn to Slide 2 of the presentation, which reflects our safe harbor statement. Today's conference call contains forward-looking statements, which are subject to risks that could cause actual results to be materially different from those expressed or implied. These risks are described for detail in the presentation and in our reports filed with the SEC. In addition, we will be discussing non-GAAP financial information we believe is useful in evaluating the company's operating performance. Reconciliations for these non-GAAP measures can be found in the conference call materials. Please turn to Slide 3, and I'll turn it over to Simon Meester.

Thank you, Jon. Good morning, everyone, and thank you for joining our call on what is an exciting day for Terex and our stakeholders. This morning, we announced that Terex has entered into a definitive agreement to acquire Environmental Solutions Group or ESG from Dover Corporation. Represents a significant milestone in our company's multiyear transformation and will amplify our ability to capitalize on the growth opportunities that lie ahead. ESG is the leader in the waste collection and recycling industry, designing best-in-class refuse collection vehicles and waste compaction equipment as well as related aftermarket equipment and digital solutions. ESG has a 100-plus year history and has a stellar portfolio of industry-leading product brands, widely respected for their quality, durability, reliability and unmatched service. I couldn't be more excited to welcome ESG to the Terex family. ESG also boasts a robust financial profile, an efficient operating model and a decade-long track record of strong, consistent organic growth. Their equipment, aftermarket and digital solutions provides predictable and recurring revenue streams, supported by an attractive margin profile with low capital intensity. Importantly, Terex and ESG also have highly aligned values and a shared commitment to best-in-class service, innovation and safety for every community we serve. I want to congratulate the entire ESG team on the excellent businesses it has built. ESG brings a deeply experienced bench of senior executives with broad industrial engineering and supply chain expertise led by its President, Pat Carroll. Please turn to Slide 4. This transaction is compelling for several reasons. First, with ESG joining our portfolio, we're adding meaningful scale and significantly reducing Terex cyclicality. ESG has demonstrated a sustained track record of resilient high single-digit organic growth through the cycle. Second, the transaction adds a financially accretive business ESG's EBITDA margin, including run rate synergies is expected to add 130 basis points of margin accretion. Terex will have approximately $1 billion in pro forma EBITDA. Third, we're delivering value creation by capturing tangible cost and revenue synergies. Terex expects approximately $25 million of identified synergies to be achieved by the end of 2026, largely driven by operational efficiencies and commercial opportunities. Fourth, we're adding the market leader in the growing waste collection and recycle industry. Waste is an attractive market and is projected to grow for years to come. Fifth, we're expanding our addressable market in North America. Our North America revenue exposure will increase to 65% and our total Terex addressable market opportunity expense to $40 billion. And lastly, we are reducing Terex capital intensity. ESG's efficient operating model with low net working capital will drive a meaningful improvement in free cash flow accretion for Terex. Altogether, we believe ESG is a very strong fit. Please turn to Slide 5. ESG demonstrated a track record of consistent resilient growth, delivering a plus 7% organic revenue CAGR over the last 10 years. ESG has made some very successful acquisitions in the past 10 years, including 3rd Eye and Soft Pak, key elements of its digital platform and Boivin enhancing its electrically powered refuse collection vehicle bodies. I would now like to turn the call over to Julie to discuss details of the transaction.

Thank you, Simon. Please turn to Slide 6. We are acquiring ESG from Dover Corporation in a $2 billion all-cash transaction. When adjusted for the present value of expected tax benefits of approximately $275 million, the purchase price is $1.725 billion. This represents approximately 8.4x 2024 estimated EBITDA, including expected run-rate synergies. We expect annual run-rate synergies of approximately $25 million to be achieved by the end of 2026. These synergies are largely driven by operational efficiencies as well as commercial synergies. Given Terex and ESG's complementary product offerings and solutions, we expect to realize additional upside through digital offerings and cross-selling opportunities to existing and new customers. We have fully committed financing and expect to fund the transaction with cash on hand, and the combination of Term Loan B and Senior Unsecured Notes. We expect to maintain our strong balance sheet with a 2024 net leverage ratio of 2.2x net debt to EBITDA under Terex's 2.5x through-the-cycle net debt-to-EBITDA target. We expect net leverage to be below 2x by the end of 2025 with consistent deleveraging thereafter from an enhanced free cash flow profile. Ultimately, this deal will offer significant financial advantages to Terex's and its shareholders. By integrating a resilient and recurring revenue stream, we are reinforcing our market presence in a sector with a robust growth outlook. This acquisition not only enhances our scale, but also diversifies our revenue streams and end market mix, positioning us for sustained long-term success. We also expect this transaction to expand our EBITDA margins, reduce our capital intensity and be free cash flow accretive. We expect adjusted EPS to be double-digit percentage accretive in 2025 and to increase meaningfully thereafter. The transaction is expected to close in the second half of 2024, subject to regulatory approvals and customary closing conditions. Given ESG's proven track record of sustained growth and resilience through the cycle, we are confident that this transaction will enhance Terex's financial profile and create long-term value for our shareholders. One quick note before I pass it back to Simon. The purpose of this call this morning is to discuss our agreement to acquire ESG. We look forward to discussing our second quarter performance on our earnings call on July 31. I'll now turn it back to Simon.

All right. Thanks, Julie. Please turn to Slide 7. Post transaction, we will be creating 3 market-leading business segments with a $40 billion total addressable market. This includes a $4 billion parts and services addressable market. Our Materials Processing segment will stay as is. Aerials will be its own reporting segment in our newly created third segment called Environmental Solutions will encompass ESG and our utilities business. This new segment, which serves a $6 billion addressable equipment market will be a clear customer-focused segment, supporting our goal to increase synergies across all of Terex. As of March 31, 2024, the new segment would have generated pro forma last 12 months' revenues of $1.4 billion and had a 15.8% EBITDA margin. Our Environmental Solutions segment will be #1 in waste collection vehicles, stationary compaction equipment in the U.S. and #2 in insulated utility vehicles in the U.S. Please turn to Slide 8. The combined business will be approximately $6.2 billion in pro forma sales and $960 million in pro forma EBITDA, inclusive of approximately $25 million of expected synergies. Terex and ESG's complementary portfolios will enhance diversification and reduce cyclicality. In addition, we will increase our exposure to the North American market and have approximately 24% of revenue tied to our newly created high-growth Environmental Solutions segment. We will also be increasing our exposure to the resilient and growing waste and recycling end market, which will now be 25% of our end market mix. Please turn to Slide 9. I'd like to focus on waste and recycling and what really excites us about our increased focus on this growing end market. As we all know, waste is an essential service and the demand for waste collection equipment and associated services has been consistently trending upward with projected market growth at a 5-plus CAGR over the next 10 years. We have strong conviction in the future of this market, especially as waste collection is the gateway to recycling which in itself, we consider to be a fast-growing market where we can leverage legacy businesses like Terex recycling systems, our sorting robust business and mobile waste shredders and material handlers. It will also give us an opportunity to further leverage emerging technologies in our portfolio like digital, electrification and robotics. Please turn to Slide 10. We are excited about the future of Terex plus ESG, and we believe the 2 are a perfect fit. It literally checks all the boxes. With that, we'll open the call for your questions. Operator?

[Operator Instructions] Your first question comes from the line of Stanley Elliott from Stifel.

Congratulations on the news. It sounds like a great fit. Simon, can you talk about kind of the electrification within the Heil portfolio and kind of the rest of the ESG business and how you see that progressing? When does that become a real meaningful part of the overall on that truck side and the collection side?

Yes. Certainly, chassis are electrifying. I think that's well known. At what pace is to be determined. The markets seem to be moving more first to hybrid solutions than full electrical solutions at the moment. But then that's the chassis side, but you also have the body side. And with Boivin and ESG has a very competitive differentiated solution in terms of just an electrified body, which basically eliminates pretty much all of the hydraulics and really manage this contamination. So we believe that ESG is very, very nicely positioned for whatever pace the electrification might happen and whether it will be chassis first or whether it will be bodies first or both.

And they've got a nice kind of software portfolio with 3rd Eye and some other things in there. How quickly can you all kind of take the technologies from them and incorporate into Genie and other products or vice versa? Just curious kind of what the ramp might end up looking like for some of the software synergies within that.

Yes, great question. Obviously, we're very excited about what ESG has built from a digital solution standpoint and not just on how it works, but it also actually delivers tangible benefit to their customers. And we believe maybe not so much in Genie right away, but we definitely believe that there are cross-selling opportunities in utilities. Obviously, you need to be careful when you work on live wires with whatever you have in the platform. But we do believe there is a technical road map there where we can start leveraging some of that work that ESG has done in our utilities business. And that might not be too far out. So very excited about that piece of the business as well.

Perfect. Congrats again and chat with you next week.

Your next question comes from the line of Jamie Cook from Truist Securities.

Congratulations. I guess just 2 questions. Can you just unpack for me what the growth profile has been on the digital solutions business and where you think that business can be over longer term and the profitability relative to the overall mix? And then I guess just my second question, Yes. Julie, just comfort level with leverage just given the macro environment?

Yes. Thanks, Jamie. Yes, definitely, digital has grown quite nicely. We're not attaching a specific number to it. Obviously, we need to be all aware that it's very much still a Dover business until we close, but definitely a fast-growing segment. And I forgot your second part -- your second question, Jamie, on the digital revenue growth.

No, I was just trying to understand -- sorry, try to understand the margin profile of the business relative to the overall mix?

Yes. On the margins, definitely industry standards and definitely accretive to ESG overall.

And Jamie, on your leverage question, I feel confident that we're financing the transaction in a prudent manner. Our balance sheet is strong and pro forma for the transaction, we expect a net leverage ratio of 2.2x at the end of 2024, below our stated target of 2.5x through the cycle. And we expect our leverage to be below 2x by the end of 2025, and we'll have consistent deleveraging going forward from an enhanced free cash flow profile.

Your next question comes from the line of Steve Volkmann from Jefferies.

Julie just a couple of modeling questions. How should we think about this tax benefit to $275 million and how that sort of plays out over the next few years as we model tax rate?

Yes. So when you think about the tax rate, this is -- we're evaluating the benefit at $275 million. And so what happens is that, that will be a reduction in cash taxes going forward over time, over the next 10 years or so.

Okay. So no change in book tax?

Correct.

Okay. Great. And then maybe just back to the electrical question. I can imagine that there might be a real ramp-up in R&D spending as we sort of transition to electric or other drivetrains. Is that something we should consider?

I would say not a significant change. It's basically more a change in our R&D than a ramp-up in R&D, I would say.

Our next question comes from the line of David Raso from Evercore ISI.

Julie, did you say EPS accretion double digit, just so I understand what that means. I mean you're run rating around $7 of earnings, you expect the accretion of EPS next year to be above $0.70. Can you just define that? I have a follow-up on that.

That's correct, David. You got -- that's correct. Those numbers are correct. On an adjusted EPS basis, we would expect the double-digit accretion.

And the funding rate for this, I know it's a blend of debt and cash on hand. What kind of funding rate? And do you feel you'll get the tax synergies quickly enough that we should be doing that rate on $1.725 billion or better to do it on the $2 billion? What's the blended rate? And what's...

So we will be doing a combination of cash on hand, Term Loan B, and secure -- unsecured notes that will be the combination. We'll be looking to finance this over the coming months and interest rates will be determined at the time that we go to market.

Okay. But I mean, to get that kind of run rate just feels like it has to be around a blended 6% or something like that, not just on the debt, but the utilization of the cash as well. I'm just trying to get the numbers. And then real quick on the TAM. What caught my eye was that the change in the TAM, you went up $6 billion from $34 billion to $40 billion. Nothing changed on the existing businesses. But of that $6 billion increase, you increase your Parts and Service opportunity by $1.5 billion. So essentially 25% of the TAM increase was aftermarket and the business you acquired was only doing 18% aftermarket -- so I'm just curious, when you look at the business, what has you excited about the Parts and Service opportunity above and beyond what they were capturing? I'm just curious [indiscernible] and service, what has obviously [indiscernible] the margin profile. So I'm just trying to capture it.

Yes. So there's a little bit of apples and oranges here because in the case of ESG, there's also The Curotto-Can acquisition that runs through some of those numbers. So maybe what we do is just we circle back with you, David, on this one because there's a little bit of detailed modeling behind it.

The aftermarket, parts is remanufacturing. There's digital. There's all of these different things that make that up to you as well, David.

All right. Perfect. And the closing time, you just said roughly, I think, second half. Any help if you [indiscernible] trying to think should this be by the end of the third quarter? Or how...

Q4.

Q4.

Your next question comes from the line of Nicole DeBlase from Deutsche Bank.

Congratulations. Maybe just on the synergies. Any more color on the timing of that $25 million, like what would come through in year 1? And then it sounds like there are some revenue synergies embedded in that $25 million number. Can you just give a split between cost and revenue synergies?

Yes. So thanks for the question, Nicole. We expect annual synergies of approximately $25 million and we're expected to achieve that by the end of 2026. And those synergies are largely driven by procurement, supply chain efficiencies and some commercial initiatives as well.

Okay. Okay. Got it. And then I guess you guys said I think you're expecting kind of a 5% growth rate over the next 10 years. But I think you also cited 7% CAGR over the last 10 years. So what's causing that step down? Is it something with where we are in the cycle of investment for refuse vehicles? Or maybe is there just some conservatism embedded in that multiyear outlook?

Yes. So collection vehicles 5%, but collection vehicles and solute -- total solutions, 7%, then when you get into recycling, then it's actually in the double digits. So it depends on which subset of the market of waste and recycling you look at.

Our next question comes from the line of Jerry Revich from Goldman Sachs.

Congratulations. Simon, I'm wondering if you wouldn't mind just talking about the digital growth outlook from here in terms of where your offering fits into the digital plans that the major haulers have? Is there a revenue concentration towards regional versus waste haulers and how does the tie into your digital approach map to what the majors are doing in terms of their own [indiscernible] management systems, et cetera?

Yes. I would just say we're just still very much at the beginning of kind of the digital value at here. Obviously, ESG has some very tangible solutions that bring very tangible returns for their customers but there are more use cases out there that we're working on -- that ESG is working on with their large customers. So there's still definitely upside in applying more digital solutions, think about additional safety features, think about additional reducing liabilities, service confirmations, contaminations in the waste stream. There's just a lot what you can do with digital. And then if you combine it with one of our businesses that, for example, as in robotics business, our sorting robots business, where we are using AI to sort waste streams, you can start picturing all sorts of synergies that we have in terms of digital use cases.

Very interesting. And then can you talk about the sales process to the extent you can comment pretty interesting free cash flow multiple for a well-regarded business. I'm wondering if you could just step us through the process to the extent you're able and willing on this call.

We will comment on the specifics of the deal process, but we can share that we're pleased with the outcome. The purchase price represents approximately 8.4x the 2024 EBITDA including expected tax benefits and run-rate synergies. And so we're just really excited about the financial benefits that ESG brings to Terex. And we've identified the synergies that we talked about, financially accretive. ESG needs a margin profile, including the synergies, we're expected to add 130 basis points of margin accretion. So we're just really excited with the business. They have a sustained track record of resilient, high single-digit organic growth through the cycle, and as well as best-in-class margins and free cash flow conversion. And it also reduces our capital intensity going forward which is the strong capital -- net working capital and free cash flow generation. So we're just very pleased.