Custom Truck One Source Q1 2024 Earnings Call Transcript

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May 2, 2024

There are 7 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Custom Truck 1 Source's First Quarter 2024 Earnings Conference Call. Please note this conference call is being recorded. I'd like to hand the conference call over to your host for today, Brian Permant, Vice President of Investor Relations for Custom Truck OneSource. Please go ahead.

Speaker 1

Thank you. Before we begin, we would like to remind you that management's commentary and responses to questions on today's call may include forward looking statements, which by their nature are uncertain and outside of the company's control. Although these forward looking statements are based on management's current expectations and beliefs, actual results may differ materially. For a discussion of some of the factors that could cause actual results to differ, please refer to the Risk Factors section of the company's filings with the SEC. Additionally, please note that you can find reconciliations of the historical non GAAP financial measures discussed during the call in the press release we issued today.

Speaker 1

That press release and our quarterly investor presentation are posted on the Investor Relations section of our website. We filed our first quarter 2024 10 Q with the SEC this afternoon. Today's discussion of our results of operations for Custom Truck OneSource, Inc, or Custom Truck, is presented on an historical basis as of or for the 3 months ended March 31, 2024 and prior periods. Joining me today are Ryan McMonagle, CEO and Chris Eperjesy, CFO. I will now turn the call over to Ryan.

Speaker 2

Thanks, Brian, and welcome everyone to today's call. Custom Truck continues to see robust demand in our rail and telecom end markets, which all contributed to strong performance in our TES segment in Q1 and helped the segment deliver double digit revenue growth for the 6th consecutive quarter. As we discussed on last quarter's call, our core T and D markets continue to have favorable macro demand drivers, namely data center investment, electrification and required grid upgrades. However, these markets have been meaningfully impacted in the short term and specifically in Q1 as supply chain issues, regulatory approval and ownership and funding details contributed to project delays, resulting in lower rental revenue and rental asset sales in the quarter. Overall, we delivered revenue of $411,000,000 in Q1.

Speaker 2

We continue to believe that the slowdown in the utility end market is temporary and anticipate a return to growth later this year and heading into 2025. Despite the current headwinds affecting transmission and distribution, our team continues to execute well and to demonstrate the value of our business model with our ability to pivot between product categories and between selling and renting equipment as the markets dictate. Our TES segment delivered 15% revenue growth in the quarter versus Q1 of last year, keeping us on track to meet our 2024 revenue guidance for the segment. We've seen growth across the board in the TES segment, which we have been able to meet as product availability has improved and certainly led by increased spend in our infrastructure, telecom and rail end markets. Segment gross margin saw a 170 basis point improvement versus Q1 of 2023, which highlights the continued strong demand environment as well as the progress the team has made in continuous improvement in our production capabilities.

Speaker 2

The entire TES team performed extremely well and continues to deliver production near record levels, something the entire organization is very proud of. As we've discussed previously, our significant inventory investment last year has positioned us to meet the continued resilient customer demand for new equipment sales as well as allow us to quickly serve our customers' rental and rental asset sales needs when demand returns to our core utility end market. We are closely following the upcoming chassis emission regulations and are well positioned for the anticipated demand increase resulting from the change in emission standards that is coming between now and 2027. In our infrastructure end market, we continue to experience high levels of demand for certain products like our specialty dump trucks, roll off trucks, hydro excavators and water trucks, which supports our belief that demand is beginning to be positively impacted by the early stages of the deployment of federal infrastructure investment and Jobs Act dollars for infrastructure projects. As we've discussed before, approximately 60% of our revenue comes from the utility end market, which includes both distribution and transmission work.

Speaker 2

We continue to see favorable increases in electricity load growth, driven by manufacturing on shoring, AI data center development and the current electrification trends. The amount of incremental power and grid enhancements required to meet this broadcasted load growth as well as the deferred maintenance that is required on our aging grid creates significant demand momentum in the sector. Transmission line development and regional interconnection continue to be the bottlenecks in meeting this future energy demand and there is a significant backlog of transmission projects that are ready to go. As I said earlier, work on these projects is advancing slowly as supply chain, regulatory approval and ownership and funding details get resolved, but provides strong tailwinds for future growth across the entire business. Chris will walk through the details of the performance of our ERS segment, which continued to see strong utilization rates in the mid-seventy percent to high-eighty percent range for all end markets other than the transmission portion of utility.

Speaker 2

Our rental CapEx plan for the rest of the year reflects investment in our fleet to meet demand across our end markets with a focus on those sectors where we are seeing particular strength. We are confident that the tailwinds that support the ERS segment are robust and will continue to provide significant growth in the years ahead. The breadth of our vehicle product offering and our ability to meet customers' rental and sales needs uniquely positions Custom Truck to capitalize on the future tailwinds created by the sustained demand, particularly as these transmission projects advance. We continue to invest in geographic markets where Custom Truck is underrepresented and which we believe offer compelling long term growth opportunities for our business. In addition to the new branch openings in Casa Grande, Arizona, Sacramento, California and Salt Lake City, Utah that we discussed on last quarter's call, we subsequently announced 2 small acquisitions.

Speaker 2

First, we acquired SOS Fleet Services in Alexandria, Louisiana, which strengthens our presence in the Gulf Coast region. We also acquired the business of AMD Maintenance and Repair on Long Island, New York, which significantly expands our presence and service capacity in the Greater New York City Metro area. We'd like to welcome the employees of both businesses to the Custom Truck family. These recent branch openings and acquisitions brings our location count to 40, up from 35 at the end of Q3 last year. We expect all these locations to be fully operational later this year.

Speaker 2

With respect to our 2024 guidance, while we continue to have confidence in the long term strength of our end markets and the continued execution by our teams to profitably grow our business, Our updated outlook reflects the risks associated with the near term challenges for our rental customers in the T and D sector, resulting primarily from the delay in transmission projects and lower rental used sales demand, which we now expect could persist through the balance of the fiscal year. As such, we are lowering our revenue guidance for ERS by $50,000,000 to $680,000,000 to $710,000,000 Regarding TES, supply chain improvements, healthy inventory levels and continued strong backlog levels continue to improve our ability to produce and deliver even more units in 2024. As a result, we are reaffirming our revenue guidance for TES of $1,115,000,000 to $1,255,000,000 which reflects another year of double digit revenue growth, as well as our revenue guidance for APS of $155,000,000 to $165,000,000 Consolidated revenue guidance is now $1,950,000,000 to $2,130,000,000 Given these changes, we are also lowering our adjusted EBITDA guidance range to $400,000,000 to $440,000,000 While we are reducing our consolidated revenue and adjusted EBITDA guidance for the year, we continue to focus on generating meaningful free cash flow in 2024 and are reaffirming our target to generate more than $100,000,000 of levered free cash flow.

Speaker 2

In closing, I continue to have the highest degree of confidence in the entire Custom Truck team in our ability to navigate the current softness in the utility end market and to deliver profitable growth and long term value to our shareholders. With that, I am going to turn it over to Chris to talk through the details of our Q1 results.

Speaker 3

Thanks, Ryan. For the Q1, we generated $411,000,000 of revenue, $134,000,000 of adjusted gross profit and $77,000,000 of adjusted EBITDA. Our first quarter results were significantly impacted by a decline in average utilization of the rental fleet to just over 73% from almost 84% in Q1 of last year, which was historically higher than our average levels. In addition, average OEC on rent in the quarter was $1,070,000,000 down from $1,210,000,000 in Q1 of 2023. These declines reflect the impact of the slowdown in transmission utilization that continued in the quarter, which Ryan mentioned.

Speaker 3

On rent yield was 40.5% for the quarter compared to 39.6% for Q1 of 2023. Given the trends in utilization and average OEC on rent, the ERS segment had $136,000,000 of revenue in Q1, down from the all time quarterly record of $206,000,000 in Q1 of last year. Adjusted gross profit for ERS was $82,000,000 for Q1, down from $106,000,000 in Q1 of 2023. Adjusted gross profit margin was 60% in the quarter, up from 51% in Q1 of last year, largely because rental revenue, which has a higher margin associated with it and rental equipment sales, comprised a larger percentage of total ERS revenue in this quarter than in Q1 of 2023. We continue to invest strategically in our rental fleet and sell certain age assets in the Q1 and our fleet age remained steady at 3.5 years.

Speaker 3

Net rental CapEx in Q1 was $15,000,000 Our OEC and the rental fleet ended the quarter at $1,450,000,000 down marginally versus the end of Q1 of last year. We expect to continue to invest in the fleet in 2024, but have the flexibility to pivot our CapEx spending plans in 2024 depending on the trends we're seeing in our end markets. In the TES segment, we sold $240,000,000 of equipment in the quarter, a 15% increase compared to Q1 of last year and a record for the 1st fiscal quarter. Gross margin in the segment was 18% for the quarter and approximately 170 basis points improvement versus Q1 of 2023, which we attribute to the ongoing production efficiencies resulting from our high level of production as well as an improved mix related to higher specialty and vocational truck sales. In line with our expectations, TES backlog continued to moderate, ending the quarter at just under $538,000,000 Record levels of production and continued strong new equipment sales in the quarter allowed us to make headway toward reducing our backlog to a more normalized level, which currently stands at more than 6 months of PES sales.

Speaker 3

This is down from a peak of more than 12 months in early 2023, but still above our historical average of 4 to 6 months. Our strong and long standing relationships with our chassis, body and attachment vendors continue to be an important driver of our record TES production. Our intentional inventory build throughout 2023 and into 2024 position us well to meet our production, fleet growth and sales goals for 2024 and beyond. Our APS business posted revenue of over $35,000,000 in the quarter, down slightly from $37,000,000 in Q1 of last year. Adjusted gross profit margin in the segment was 26% for Q1, down from a little over 27% in Q1 of last year.

Speaker 3

Overall, in Q1, the APS business was impacted by a decrease in rentals of pools and accessories, which were affected by the utility end market softness. Borrowings under our ABL at the end of Q1 were 5 $52,000,000 flat versus the end of last quarter. As of March 31, we had $195,000,000 available and approximately $332,000,000 of suppressed availability under the ABL with the ability to upsize the facility. With LTM adjusted EBITDA of $399,000,000 we finished Q1 with net leverage of 3.79x. Achieving net leverage below 3x remains a primary and important goal.

Speaker 3

However, given year to date performance and our current expectation for the rest of the year, we expect to achieve net leverage of less than 3.5x by the end of the fiscal year. With respect to our guidance, while we expect 2024 to be another year of growth given the current conditions in the utility markets, we continue to expect TES to be the primary growth driver for 2024. We believe our ERS segment will continue to experience near term pressure and demand in the utility market as a result of supply chain, regulatory and financing factors affecting the timing of job starts. These headwinds in our utility end markets are driving lower OEC on rent in our core ERS segment. We now expect to grow our rental fleet based on net OEC by low single digits versus the mid to high single digits we discussed on our last call.

Speaker 3

Regarding TES, supply chain improvements, healthy inventory levels and historically high backlog levels continue to improve our ability to produce and deliver even more units in 2024. As a result, we are reaffirming our 2024 revenue guidance for TES, which reflects another year of double digit revenue growth. Our outlook for our APS segment remains unchanged. While this all combines to reduce our consolidated revenue and adjusted EBITDA guidance for the year, we continue to focus on generating meaningful free cash flow this year and are reaffirming our target to generate more than $100,000,000 of levered free cash flow in 2024. Updated guidance for our segments is as follows.

Speaker 3

We expect ERS revenue of between $680,000,000 $710,000,000 TES revenue still in the range of $1,115,000,000 to $1,255,000,000 and EPS revenue of between $155,000,000 $165,000,000 This results in total revenue in the range of $1,950,000,000 to $2,130,000,000 or growth of 5% to 14% versus 2023. We are projecting adjusted EBITDA in the range of $400,000,000 to $440,000,000 In closing, I want to echo Ryan's comments regarding our continued strong business outlook. Despite some temporary demand weakness in certain utility markets, we continue to be optimistic about the long term demand drivers in our industry and our ability to deliver strong revenue and adjusted EBITDA growth to hold or expand margins to produce significant levered free cash flow and to reduce leverage, all while providing the highest levels of service to our customers. With that, I will turn it over to the operator to open the lines for questions.

Operator

Ladies and gentlemen, we will now begin the question and answer Your first question comes from the line of Justin Hauke with Baird. Please go ahead.

Speaker 4

Yes. Hi. Good afternoon, everyone.

Speaker 2

So

Speaker 4

I guess I wanted to start, just what has changed, I guess, in terms of the utility or your customers' communication, in a sense, the kind of the beginning of March? I mean, isn't it is it a whole bunch of project delays? Or I guess I'm just curious how that conversation kind of developed over the last several weeks? And then I guess the second part of the question is, even with the ERS guidance taken down here, I mean assuming that 2Q is still going to be pretty negative revenue decline, it's implying the back half of the year has pretty strong growth, like high single digits, if not closer to 10%. And I guess just the visibility you have this far out to kind of have that embedded assumption?

Speaker 2

Yes, good. Justin, thanks for the questions and happy to talk through it. But I'll start with the first question of really how's the message with our customers. I think that it is continuing to see good macro trends. So they know the work is there.

Speaker 2

We're just not they're just not starting to work yet. And so that message is continuing, still talking about opportunity later in the second half of twenty twenty four, which is kind of a lead to your second question there as well, Justin. But still know that the work is there. There's just this temporary delay in the work starting, which is most prevalent on the transmission side and shows up most in the transmission equipment that we sell, but is also showing up in the Q1 from some of the rental asset dispositions that we had some of the rental asset sales that we had in the Q1. So still good macro environment of demand, but just a short term headwind that's certainly carried in Q1 and is likely to be in place through Q2 as well.

Speaker 2

So and then the second half is, yes, we do we still expect that the second half of the year will have growth. There is some normal seasonality in there, Justin. Q4 has always been our best quarter historically. And so we are expecting that. And then that also does imply some growth in OEC on rent or rental revenue for us, which is based on our conversations with customers.

Speaker 2

I will say that our conversations are getting more specific to when equipment is going to be going out versus kind of general comments of it, it should pick up later this year. So I think that gives us some positive indication of why things are going to improve in the second half of the year.

Speaker 4

I guess, I mean, how much lead time do your customers typically have? Like if they're going to start a job in 3 months, do they need to rent it now or are they kind of just in time deliveries?

Speaker 2

Yes, I mean our typical customers, the utility contractor, utility contractors and certainly when you get into some of the smaller utility contractors are just in time delivery. So that's where it's important to have availability. That's where we think the one stop shop model really allows us to keep inventory. Obviously, we have underutilized rental equipment right now and it's ready to go. We've got a position where we think it makes sense to be positioned and where our customers are asking for it to be positioned.

Speaker 2

But it is on the rental side of the business, it is much more just in time. On the sales side of the business, we do have backlog that is still sitting north of 6 months that gives us some good visibility on that side

Speaker 3

of the business.

Speaker 4

Okay. And then I guess my final question here before I jump back in. I mean it looks like the purchase price in the cash flow at least was pretty modest for these two acquisitions. Was some of that, I guess, kind of an asset purchase where it showed up in the CapEx? Or I'm just trying to understand kind of the size of how big these two locations are.

Speaker 3

Yes. No, you said this is Chris, Justin. You said it right. And so it shows up in the acquisition of business there. Although I would point out that is only the first acquisition, the second acquisition occurred post the end of Q1.

Speaker 3

So that would just be the first acquisition you're seeing there, the $1,400,000

Speaker 4

Okay. Okay. All right. Well, let me I'll jump back to you then, I guess. Thank you.

Speaker 2

Thanks, Justin.

Operator

Your next question comes from the line of Tami Zakaria with JPMorgan. Please go ahead.

Speaker 5

Hi, good afternoon. Thank you so much.

Speaker 6

Hi, good

Speaker 5

afternoon. So my first question is on the ERS segment guide, you lowered it by about $50,000,000 it seems. So that would suggest there's been a you expect a ramp to the rest of the year versus the Q1 performance. So am I thinking it right in terms of modeling that 2Q should see a notable step up and then 3Q sort of stays similar and then again another step up in the Q4? Or is it more like 2Q doesn't see that much of an acceleration, but then the back half sees a notable step up.

Speaker 5

So if you could just give some color on how to think about the next three quarters for ERS?

Speaker 3

Yes. This is Chris, Tammy. In our guidance, you should assume a more modest step up in Q2 and then a more meaningful step up in Q3 and then into Q4 again is kind of what is how you should model that.

Speaker 5

Got it. Okay. That's helpful. And then going back to the previous question that was asked, I want to ask it in a different way. So you expect utility end market to improve as we head into 2025.

Speaker 5

But is the expectation for an improvement in the utilities end market predicated on a Fed rate cut or is there something else that makes you or maybe supply chain getting better or something? What is going to drive the pickup in the utilities end market?

Speaker 2

Yes, it's a great question, Tammy, and happy to talk about it. But I think there is so much pent up demand kind of in the space overall for the work to be done. So it's really more of what caused the short term dip from a CapEx spend perspective. When you think about when we think about data centers, when we think about AI as kind of a new short term demand driver, when we think about electrification, when you think about grid upgrades, to me those are all clear long term macro demand drivers that are all really compelling for why T and D makes sense. We're managing through the short term blip.

Speaker 2

We really do think it is a combination of customer supply chain challenges. What I mean by that is making sure they have all of the supplies needed to build the power lines in the case of transmission work that might be generators, it might be superstructure, it might be all sorts of things, right, that are needed, but they want to make sure those are all in place before they send crews to work. A lot of those are supplied by the power producer or the IOU in many cases. And so we've got that dynamic and then we've got regulatory that seems to be holding up. And obviously there's a lot of press out there right now with what the Department of Energy is doing and what FERC is trying to do to try to accelerate approvals

Speaker 6

of some of these lines.

Speaker 2

I think that will be an unlock as those improve. Those obviously take time. That regulatory process takes time. But I think those are the biggest 2. And then the third would be as IOUs finalize CapEx plans and as they make their decisions on rate base increases and then as they make their decisions on how that CapEx will be spent between transmission and distribution, that's also kind of the final unlock for As those plans are finalized and as that CapEx dollar is spent, that's the work that our customers, utility contractors are primarily doing.

Speaker 2

And so I think it's an unlock of all three of those.

Speaker 5

Got it. Okay. Thank you.

Speaker 2

Thanks, Tammy.

Operator

Your next question comes from the line of Michael Slifske with D. A. Davidson and Company. Please go ahead.

Speaker 6

Yes. Hi, good afternoon and thanks for taking my questions. Want to ask on ERS first. Did the sales of used units in ERS surprise you at all? And can you maybe share if pricing was a driver in this quarter's result at all?

Speaker 2

Yes, it did come in lower than we expected. And some of that is just a function of as our customers are deploying their CapEx and when they expect to buy. So it did come in lower than it expected. For the assets that we sold, we still saw very good residual values. But in the used equipment market right now, yes, we are seeing some pricing pressure on there, but we are still able to sell and generate kind of compelling gross profit.

Speaker 2

But Mike, yes, it absolutely came in lower than we expected in the year. And as we've talked about in the past, that's always the hardest part of our business to forecast. And so we're going to continue to refine how we do that and get better at it. But yes, it did come in lower than expected to answer your question.

Speaker 3

And Mike, this is Chris. Maybe just a little more color there. The comp year over year was going to be a tough one. If you look back at Q1 of last year, which tends to be more of a softer quarter, it actually is our highest quarter by, I think, 40% in terms of magnitude. And so it was a very unusual Q1 of last year, some demand moved from Q4 of 'twenty 2 into Q1 of 'twenty three.

Speaker 3

And so we were going to have a tough comp and we knew that that was clearly wasn't in the cards to be at that level. So it was a really tough comp. We don't have the same kind of comp situation in Q2.

Speaker 6

Okay. Got it. Also wanted to touch on our projects that you're tracking, are they being pushed out on the calendar or do you have the sense that they're being canceled? And I guess I'm just trying to kind of figure out whether we need to be increasing our end of 'twenty four or probably our 'twenty five numbers, what may not have hit the P and L this quarter or last couple of quarters or if we just have to adjust even for the end of this year for things that are being pushed out? Or does 24 get pushed to 25 and then 25 get pushed to 26 and so on?

Speaker 6

Just sort of a sense as to what's not being put in the ground today, kind of what period should that revenue eventually hit?

Speaker 2

Yes, no, it's a great question. And we are not hearing of cancellations, we're hearing of delays. And so I think it's an important question, right. So that will push the work still has to be done. The macro factors are still what they are.

Speaker 2

In fact, I would argue the macro forecast have even gotten more compelling. But the work in the short term is just getting pushed. And when I listen to what our customers are saying and even listen to some of the other public companies in the space, it seems consistent that the expectation is later this year, those will begin and they should carry well into 2025 and even in 2026.

Speaker 6

Okay. Maybe one last one for me. Can you give me updates on the cadence fit utilization as we go through the rest of the year? And maybe can you update us on, at this point, where do you think is the kind of sweet spot utilization? Has it changed at all given the recent developments or you still feel pretty confident maybe it's in the 70s or high 70s where you can get your best results?

Speaker 2

Yes, I'll start and Chris can give some more color on cadence, Mike. But yes, look, I think it's an important question because we talked about last year, we were running kind of at very high utilization numbers when we were running in the mid-80s or even in the upper-80s. So even in a quarter like this quarter, we're running in the low-70s from a utilization standpoint, which is very good in the grand scheme of rental businesses. If you look across a broader portfolio of rental, it is meaningfully down from where we ran in Q1 of 2023. But Mike, I think you're right, it's still running in the mid-70s is certainly where we should shoot for and can achieve as you think about steady state.

Speaker 2

And so there's a little bit of this as we're just comping off very hard utilization numbers that we talked about a year ago, we talked about 18 months ago as well. And so there is a bit of that that we're dealing with. So even when we're seeing this delay and the rental fleet is we're seeing this delay and we're seeing the slowdown on the transmission side of things. And yet the entire rental fleet is still running in the low 70s. In the grand scheme of historic performance, that's still not a bad number, it's still a good number.

Speaker 2

And in the grand scheme of rental businesses more holistically, it's still a very compelling kind of lower end that we're running towards right now.

Speaker 6

Great. And again, the cadence, Chris, if you wouldn't mind giving us a little bit of update, how you think Yeah, I guess so.

Speaker 3

I guess, obviously, it's hard to predict on some of the variables that Ryan just went through. But clearly, on the high end of our EBITDA range, we would expect to see more meaningful increase in OEC on rent as we progress through the end of the year. The lower end would see a more modest increase. And so I think I'd leave it at that in terms of any guidance we want to give.

Speaker 6

Okay. Thanks. I'll pass it along. Appreciate it.

Operator

There are no further questions at this time. I will now turn the call back over to Ryan McGonigal for closing remarks. Please go ahead.

Speaker 2

Thanks everyone for your time today and your interest in Custom Truck. We look forward to speaking with you on the next quarterly earnings call. And in the meantime, please don't hesitate to reach out with any questions. Thank you again and have a good evening.

Operator

Ladies and gentlemen, that concludes today's call. Thank you all for joining and you may now disconnect.

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