Herc Holdings Inc Q4 FY2020 Earnings Call

Good day, and welcome to the Herc Holdings Inc. Fourth Quarter 2020 Earnings Conference Call. I would now like to turn the conference over to Elizabeth Higashi. Please go ahead.

Thank you, Grant, and thank you all for joining us this morning. Welcome to our fourth quarter and full year 2020 earnings conference call. Earlier today, our press release, presentation slides and 10-K were filed with the SEC and are all posted on our IR website at ir.hercrentals.com. This morning, I'm joined by Larry Silber, President and Chief Executive Officer; Aaron Birnbaum, Senior Vice President and Chief Operating Officer; and Mark Irion, Senior Vice President and Chief Financial Officer. We'll review the fourth quarter and full year, our view of the industry, and our strategic outlook. The prepared remarks will be followed by an open Q&A. Before I turn the call over to Larry, there are a few items I'd like to cover. First, today's conference call will include forward-looking statements. These statements are based on the environment as we see it today and therefore involve risks and uncertainties. I would caution you that our actual results could differ materially from the forward-looking statements made on this call. Please refer to Slide 3 of the presentation for our complete safe harbor statement as well as the Risk Factors section of our annual report on Form 10-K for the year ended December 31, 2020. In addition to the financial results presented on a GAAP basis, we will be discussing non-GAAP information that we believe is useful in evaluating the company's operating performance. Reconciliations for those non-GAAP measures to the closest GAAP equivalent can be found in the conference call material. Finally, a replay of this call can be accessed via dial-in or through a webcast on our website. Playback instructions were included in our earnings release this morning. We have not given permission for any other recording of this call and do not approve or sanction any transcribing of the call. I'll now turn the call over to Larry.

Thank you, Elizabeth, and good morning, everyone. First of all, I'd like to thank everyone on the Herc Rentals team for their tremendous efforts in 2020, a most challenging year on both the personal and work-related levels. Hopefully, getting the pandemic under control is in sight, with COVID-19 vaccines becoming more readily available around the country and which we hope will make 2021 a bit brighter for our communities, our customers, and our Herc Rentals team. Herc Rentals continues as one of the leading rental companies in North America with ample scale and capital resources to provide a broad range of equipment that supports a wide variety of customers and industries. With a history of over 56 years in the equipment rental industry, our 4,800 employees are focused on serving our customers safely, efficiently, and effectively. Our specialty equipment rental business continued to expand in 2020 as we proactively assisted customers in response to the pandemic and weather-related events this year. ProSolutions revenue increased by 22% in Q4 when industry rental revenue declines were the norm. Our strategic customer and fleet diversification helped to offset the COVID slowdown we experienced in certain parts of the business with the stability of our national accounts business helping to offset the declines in local customer revenue. Our customer-centric culture and high priority for safety also provide a strong foundation as we serve our customers and keep our team and communities safe. As we adjust to this new and challenging operating environment, the strengths of our organization and our business are more evident than ever. We currently operate 277 locations across the United States and Canada in 39 states and 5 Canadian provinces. We were excited to recently announce our first multi-location acquisition since we became a public company in 2016, 4 locations in Houston. We are excited to add the Champion Rentals team to the Herc family. Our full year 2020 results ended up exceeding our COVID-revised expectations as we maintained positive pricing despite a decline in volume related to the COVID-19 business slowdown. We overcame the challenge of the prospect for lower demand by responding quickly, while continuing to deliver outstanding cost savings and efficiencies despite the extra diligence and cost of implementing new safety precautions relating to disinfecting equipment, social distancing and wearing protective personal equipment. Since spin, we have been focused on organic growth and self-help initiatives, and we've demonstrated a solid track record in achieving these positive results. As our industry and the economy continue to climb the steps out of COVID-19 economic impacts, we look forward to moving into a growing economy, where we will be well positioned to accelerate our growth. We've made significant improvements in our operating efficiency over the last 2 years, and now intend to focus on accelerating top line growth through both the addition of new locations in major metropolitan markets and by driving utilization of more fleet through our network of branches. And we prudently managed our balance sheet by reducing net capital expenditures early last year. We generated approximately $425 million in free cash flow and increased our liquidity to $1.4 billion by the end of the fourth quarter. Our carefully disciplined capital approach, ample liquidity and modest leverage position us to accelerate our growth in 2021 as the business environment returns to a normal cadence. While we continued to experience a normal seasonal cadence in the fourth quarter, we also continued to show positive momentum from a double-digit percentage rental revenue declines we experienced in the second and third quarter. Equipment rental revenue was $1.54 billion for the full year, a decline of 9.3% or $158.1 million compared to the prior year. Volume trends continued to show positive momentum in the fourth quarter over the third quarter. Adjusted EBITDA ended the year higher than our expectations and outside the higher band for our previously stated guidance at $689.4 million. We very successfully managed costs. And despite the decline in revenue, we delivered an adjusted EBITDA margin of 38.7% for the full year, our best annual adjusted EBITDA margin since the spin-off, and we continue to close the gap with our industry peers. Our focus on many of the cost savings initiatives that were introduced in 2019 also continued to contribute to our bottom line throughout 2020 as we continued to successfully reduce direct operating costs, selling, general and administrative costs, and interest expense. As a result, we reported net income of $73.7 million or $2.51 per diluted share for the full year 2020. Now I'm going to ask Aaron Birnbaum, our Chief Operating Officer, to pick up from here to discuss in more detail our fourth quarter operating performance and current environment. Aaron?

Thank you, Larry. Before I start my discussion of our results, I would like to take this opportunity to thank all of our team members. The company's results speak to the team's outstanding focus and execution in a challenging year. We effectively served our customers and controlled expenses while operating with safety as our foremost priority. We greatly appreciate the contributions of each and every one of our team members, and I want to say great job, team Herc. Our diverse customer base, both by industry and geography, helped mitigate the full impact of COVID-19 business slowdowns. We continued to see positive momentum in our rental volume in Q4 with steady improvements from the pandemic trough we saw in Q2. Unlike previous economic downturns, we continued to successfully hold rates to only a slight decline in the fourth quarter, down just 80 basis points compared to the prior year. And for the full year of 2020, our rates were actually up 10 basis points. Solid performance by our team accelerated ProSolutions' rental revenue in the fourth quarter with an increase of 22% over the prior year, aided by both weather-related and emergency response activity. Now please turn to Slide 9 for our safety results. As a provider of essential services, our core operations remained open throughout this pandemic to serve and support customers. While balancing customer service with the impact of practicing new health and safety standards, our team continued to deliver outstanding safety results during the quarter and for the full year. Our total recordable incident rate, which we report annually, declined to 0.86, a ratio that has been declining over the last several years, as you can see from the chart on the left. One of our major internal safety programs focuses on perfect days, that is days with no OSHA recordable incidents, no at-fault motor vehicle accidents, and no DOT violations. In 2020, on a branch-by-branch measurement, our branch operations reported 98% of days as perfect. A commitment to safety means continuous focus through communications and training. And in 2020, we conducted over 58,000 hours of safety training. New employees go through a rigorous safety program when they are hired, and we require annual safety training of all of our employees, including those in office settings, such as our field support center and call centers. We have a strong footprint across North America and continue to invest in our future growth through the openings of new greenfield locations and fleet investment in high-growth regions. During 2020, we opened new greenfield locations in Fort Lauderdale, Toronto, Denver, and 2 in Dallas. At the end of December, we completed the acquisition of Champion Rentals in Houston. Champion Rentals' 4 locations serve contractors and industrial customers in the Houston metropolitan area. The integration of the new locations is going well, and we're pleased to welcome the Champion team into the Herc family. Houston was a market we wanted to grow faster, and the Champion acquisition allowed us to do that in filling the geographic footprint we desired in that market. We intend to continue to implement our growth strategy with new locations planned in other high-growth urban markets and are currently targeting between 10 and 20 new locations in 2021. Our fleet composition at OEC is on the left-hand side of this slide, especially includes ProSolutions and ProContractor and now accounts for $833 million of OEC fleet, about 23% of our total fleet as of the end of Q4 2020. The investments we have made since 2016 in developing our specialty businesses have continued to pay off in this environment, where the core rental business was under pressure from the pandemic shutdowns. By year-end 2020, the total fleet was reduced by approximately 6% to $3.59 billion, as we focused on optimizing the utilization of our assets in an environment where demand was impacted by COVID-19 shutdowns. OEC fleet disposals were $234 million in the fourth quarter, higher than the $188 million of OEC sold in last year's comparable period. The average age of our disposals was 85 months in the fourth quarter. With our used equipment channels operating closer to normal in Q4, we targeted a reduction in older, less desirable fleet given the COVID-19 impacts on demand during the year. With the average fleet down by 6% in Q4 compared to prior year Q4, we believe we have rightsized the fleet to the current environment and have more than enough capital to invest in key markets and fleet categories in 2021, wherever we see an opportunity for growth. Approximately 51% of the fleet was sold through auction, with retail and wholesale channels representing the other half of our channel sales in the fourth quarter. Proceeds were approximately 36% of OEC. Our fleet age for the period ending December 31, 2020, was 46 months. Now please turn to Slide 12. We continued to climb the steps back out of COVID-19 impact. And during Q4, our rental volume of OEC fleet on rent continued to close the gap with last year's levels. Rental volume was down by 6% in Q4, which represents positive momentum and a steady improvement from the bottom in Q2. We have a diverse customer mix with many of our large national account customers operating in the essential business sectors. They include major industrial customers in utilities and energy, health care, warehousing and manufacturing, and general construction. These national account customers have been more resilient in the COVID-19 slowdown and a key strategic advantage of Herc. National account revenue represented about 44% of the total in the fourth quarter, with local rental revenue now representing 56% of total rental revenue. We are focused on high-growth segments of the economy and see further growth opportunities in our end markets as we return to more normal times. Current expectations for the equipment and rental industry, as outlined by the ARA, suggest flattish overall equipment rental revenue in 2021 for all of North America. We intend to outperform the industry forecast by sticking to our strategy. Mark will discuss our financial guidance for the year, but those expectations are based on the following initiatives. We will continue to focus on the well-being of our team by investing in training and operating a safe environment for our employees, customers, and communities. We will continue to focus on investing in fleet growth in fast-growing urban markets to drive top line growth. We plan to drive more fleet through our existing network of branches and improve utilization. We plan to expand our network by 10 to 20 greenfield locations. We plan to invest aggressively in our specialty businesses. We shall continue to deliver a lean cost structure and improved margins, and we remain committed to providing excellent customer service and premium equipment to our customers. And now I'll pass the call on to Mark.

Thanks, Aaron, and good morning, everyone. Our fourth quarter results continued to demonstrate that we have a business of scale and a resilient business model that is less volatile than many other industries in this challenging operating environment. We are really pleased with our performance in Q4 and for the whole of 2020, considering the challenges we faced. Our results exceeded our own expectations and the top end of the guidance we provided in Q3. Our focus on margin improvement over the last couple of years is paying off. We are pleased with how quickly we were able to adjust to the COVID-19 shutdowns by accelerating initiatives that were already in place, managing variable expenses, and other costs to contribute to our margin improvement for the year. Slide 15 shows the financial summary of our fourth quarter and full year 2020 results. Equipment rental revenue declined 6.5% from $457 million to $427.3 million in the fourth quarter of 2020. With less bad being good in this environment, we came in at the lower end of our guided range for a decline in rental revenue of 6% to 8% in the quarter. Total revenues declined just 3.6% to $520.4 million, primarily due to lower rental revenue and was partially offset by a $10.8 million increase in sales of rental equipment in the fourth quarter as we took advantage of some stabilization in the used equipment market and focused on tightening up the fleet. Despite the challenges of COVID-19 on our top line, we remain profitable with our adjusted net income in the fourth quarter of 2020 of $40.2 million or $1.35 per diluted share compared with adjusted net income of $38.9 million or $1.33 per diluted share last year. Adjusted EBITDA in the fourth quarter of 2020 declined 8.8% or $18.8 million to $195.6 million for the same period in 2019. Adjusted EBITDA margin of 37.6% in the fourth quarter was 200 basis points lower than the 39.7% in 2019, primarily due to a decrease in rental revenues and the impact of increased low-margin sales of rental equipment compared with last year. REBITDA was $197 million and REBITDA margin declined by 80 basis points to 45.8% during the fourth quarter. Despite the decline, REBITDA margin for the fourth quarter of 2020 was still the third best quarter since the spin. Our REBITDA margin for the full year of 2020 expanded by 150 basis points to 44.2%, which we consider to be an excellent result, given the challenges COVID-19 placed on our operations and results during the year. On Slide 16, we highlight pricing and utilization trends for the quarter. The graph on the upper left illustrates our year-over-year pricing, with the latest quarter reflecting average rates down by only 80 basis points. As we have already discussed, we are quite pleased with the nominal decline in rates that we managed for the last 3 quarters despite the dramatic impact of COVID-19 on our rental volumes. In fact, thanks to the positive momentum coming into 2020, we managed to record positive rental rates for the full year of 10 basis points. All in all, excellent rate results that far exceed any previous downturn and reflect on the professionalism of our sales team, the improved tools we now have at our fingertips, and the continued maturity of the rental industry. The industry, in general, has been more disciplined on price in the current cycle than previous downturns, and the Herc team is determined to maintain rate discipline in 2021. Dollar utilization was 40.6% in the fourth quarter compared to 40.5% last year. While a slight increase year-over-year in this environment is a bit of a win, the sequential improvement from Q3 to Q4 was also a meaningful increase of 300 basis points despite the normal seasonality we experienced in Q4. The chart on the top right shows that the average fleet in the fourth quarter declined about 6% over the comparable period last year. Our rental fleet closed the year at $3.6 billion and is now close to the 2016 year-end OEC level. With a vigorous sales campaign in Q4 of 2020, we believe we have rightsized our fleet to address expected demand in early 2021 and have plenty of capital available to deploy growth fleet to any markets or segments that get hot and justify investment. In the lower right-hand chart, you can see that during the fourth quarter, average fleet volume on rent was down by 6% compared with the prior year. The chart also highlights the steady improvement we have made in terms of closing the gap to prior year comps created in Q2 with the COVID-19 shutdowns. The waterfall on Slide 17 shows adjusted EBITDA for the fourth quarter was $195.6 million, a decrease of 8.8% or $18.8 million compared to $214.4 million in the fourth quarter of 2019. Adjusted EBITDA was primarily impacted by the reduction in rental revenue, which declined by $29.3 million over the prior year. DOE decreased $8.6 million compared to the fourth quarter of 2019. Savings and rerent, personnel-related expenses, and lower freight costs were significant and only partially offset by higher insurance expenses. We reduced SG&A expenses by $3.1 million, primarily through lower selling expenses, personnel costs, and travel expenses. Adjusted EBITDA margin in the fourth quarter was 37.6%, a decline of 210 basis points year-over-year, primarily due to lower rental revenues and losses incurred in the sales of used rental equipment. Please turn to Slide 18. We reacted quickly to cut capital expenditures as soon as it became clear that COVID-19 shutdowns would impact rental demand in Q2, and then stepped up sales of used equipment in the last two quarters of the year. As a result, we preserved our capital extremely well and have generated exceptional free cash flow this year of $425 million. This is our second consecutive year of positive free cash flow since going public, and we more than doubled the $176 million we reported in 2019. Our net rental equipment CapEx came in at $152 million, well below our guided range. Our collections team also remained active and productive, and our receivables balance remains healthy with a quality day sales outstanding of only 52 days. We continue to reduce net leverage, which decreased to 2.4 times as of December 31, 2020, compared with 2.8 times a year ago. We are now below our previous target net leverage range of 2.5 to 3.5 times, and we'll adjust our target down to a range of 2 to 3 times. And our credit ratings were maintained at a solid B1 and B+. Total debt was $1.7 billion as of December 31, 2020, a reduction of about $415 million from December 31, 2019. The actions we took in 2019 to refinance our balance sheet positioned us well to navigate through this challenging time. We had total liquidity of $1.4 billion as of December 31, 2020, comprised primarily of availability on our ABL credit facility and cash equivalents of $33 million. With no near-term maturities, we have ample liquidity for 2021 and into the future. We remain cautious with our capital allocation, and we'll continue to apply free cash flow to pay down debt and invest in new locations and fleet growth. On Slide 19, we share the latest industry forecasts. Coming off a couple of the worst quarters in modern economic history, the industry forecast is stabilizing and becoming more consistent. The ARA forecast for North American rental revenues is probably the best estimation of rental revenue trends, taking into account the current macroeconomic environment and forecasting forward the North American rental revenues. The most recent industry forecast for 2021 is $51 billion, a modest increase from 2020. The overall market is forecast to improve over the next couple of years to $62 billion by 2024. As you can see from the chart, the current ARA estimate resets rental industry revenues back to 2017 levels in 2021, before returning to previous peak levels in 2023. On reflection, 2017 was a decent year for the rental industry. And as I mentioned earlier, we have reset our fleet to 2016 levels. So we believe we are well set up to be able to respond to demand in our end markets. Our industry is resilient and tends to benefit in some ways during recessionary times such as these, when the secular trends of ownership to rental accelerates as our customers conserve capital. While industry estimates of current rental versus ownership is about 55%, many categories of equipment we offer are still well under that penetration level, which provides us with an ability to grow faster than our macro end markets. We are cautiously optimistic that we will be able to return to our previous peak levels of profitability in 2021, which will be included in our guidance. We are not dependent on any one end market, and the fleet can move freely to where the demand is, both geographically and by end market. Scale is also a strength in a challenging environment. Herc Rentals is the third largest rental operator and has a long history of established relationships. We have the capital and the strategy to take advantage of growth opportunities in select markets and for select equipment. Our goal for 2021 is to outperform projected industry rental revenue growth as we believe there will be plenty of rental activity for Herc to target. We are committed to growing our market share and closing the gap with our largest peers. On Slide 20, we have our guidance update. We are cautiously optimistic with our outlook for 2021. We have positive momentum from our Q4 results. And despite a little headwind from the pre-COVID comps early in 2021, we look to continue growing our rental volume as we return to a normal operating environment. The current COVID-19 impacts continue to lighten up and are not directly impacting a lot of our customers and end markets in a dramatic fashion. We anticipate we have a good chance of exceeding our pre-COVID 2019 profitability in 2021, and that is reflected in our guidance range for adjusted EBITDA of $730 million to $760 million. With a return to a more normalized operating environment, we expect to increase our net CapEx, with a focus on growing our fleet in strong markets and customer segments with net rental equipment CapEx in the range of $400 million to $450 million for the year. With 2020 behind us, we believe with the lessons learned on our cost structure and a focus on growth targeted to key markets and fleet categories, we are well positioned to accelerate our growth in revenues and margin expansion into 2021 and beyond.

Thanks, Mark. Now please turn to Slide 21. This slide shows how far we've come over the last 5 years in closing the gap with our industry peers. Our adjusted EBITDA margin has increased from a low of 33.4% in 2017 to 38.7% in 2020. REBITDA margins are even better and a cleaner comparison with 2020 REBITDA margin of 44.2%, an improvement of 150 basis points over the prior year. As you can see, we've improved our net leverage substantially since we went public in 2016, reducing net leverage from 4.1 times to 2.4 times. With 2020 behind us, we intend to focus on top line growth and to continue to control incremental costs to improve margins. Our strong free cash flow provides flexibility for new growth initiatives, and we'll continue to add new greenfield locations while seeking accretive M&A in select geographies, industry verticals, and products. Thank you for your time this morning. And now operator, please open the line.

Our first question will come from Mig Dobre with Baird.

Congrats to all your team for how they handled 2020, a very challenging year. I guess where I would like to start is maybe with a shorter-term question here, trying to understand kind of what's baked into your 2021 outlook. I appreciate the color on EBITDA. Can you maybe give us a little bit of context of how you're thinking about equipment revenue growth? Kind of what's underpinning this guidance? And I would also appreciate a little color on how you're thinking about gross CapEx in 2021?

Yes. Thanks, Mig. I mean, the guidance for 2021, we're really looking at continued momentum in terms of closing the year-over-year gap in rental volume and then we're running into sort of year-over-year growth in volume in Q2 and Q3 with soft comps from COVID and looking towards stronger growth running into Q4. So we're sort of pushing back towards 2019 levels. I don't really think we'll get there in terms of rental revenue, but we should get close. We've got room to improve EBITDA margins with the cost structure staying relatively light as we sort of were just pushing the lessons learned during 2020. So we don't see the cost structure getting back towards 2019. There's room to improve EBITDA margins on slightly less rental revenue.

So if I understand this, you're saying that rental revenue is going to be up, but not quite to 2019 levels? But I'm presuming it's going to be up higher than what the ARA is forecasting for '21.

Yes, we mentioned in our commentary that we see an opportunity to grow faster than the overall market, given the strength in our business.

I see. And on the CapEx component?

In between sort of 2019 and 2020 levels. So we've got a healthier environment. We're going to invest in growth in the fleet. We took a lot of fleet out in Q4, and just dry powder available with the free cash flow that we generated last year to be able to invest in any areas of strength or equipment categories where we're seeing positive demand.

Or in greenfield rent locations.

Right. Well, so that's kind of the thing that got me scratching my head a little bit as I was looking through your slides, right? You're talking about 10 to 20 new locations. This is, give or take, 3% to 6% growth in footprint. But obviously, you're exiting 2020 with your fleet down 6%. If you're going to be opening these new locations, you're going to have to have some fleet in there. So I'm sort of trying to think as to what exactly would be implied in terms of gross CapEx because, by math, right, if your disposals are anywhere near what you've done in 2020, then we should be looking at something close to, give or take, $800 million in gross CapEx? Am I off? Or is this kind of how you guys are thinking about it as well?

Yes, we're looking at something between 2020 and 2019. We haven't reached $800 million in gross CapEx for some time. Your calculations regarding fleet consumption at greenfield sites might be slightly off. At the start of the year, we can adjust our fleet to support these sites without relying solely on growth fleet. Additionally, your figure for disposals may not be accurate. We made most of the necessary changes to our fleet size in Q4 of 2020, and I don't foresee a significant need for disposals as we move into 2021.

That's very helpful. And then my final question is sort of a longer-term question. As you talked about penetration of the rental industry as a long-term driver. But I'm sort of curious, as you're looking at the next cycle here, and you look through the mix of your business, contractors, industrial, infrastructure, government, other, which one of these verticals do you think has the most opportunity to see increased penetration? And what does that mean for capital deployment or your business strategy as you look 3 to 5 years out?

Yes. Good question, Mig. We kind of believe we are well diversified across our industries and across the customers that we serve. And quite frankly, we're pretty optimistic about all of the industries that we're in or we wouldn't be there. If we felt it wasn't a space that had ample room for our growth, regardless of whether the industry was going to grow, which means we would be taking share, we probably wouldn't be there. So we're pretty optimistic about the markets and the verticals that we play in. And for the growth opportunity, both in and of itself, the industry or our ability to take share and grow within those industries.

Our next question will come from Ken Newman with KeyBanc.

Congrats on the solid quarter. So first question for me. I'm curious if you could just talk a little bit more about the Champion deal that you announced. I'm curious if you could just talk a little bit about the market opportunities for M&A as the year progresses, given the fact that you did lower your net leverage target. So just trying to balance out the priorities for capital deployment as the year progresses.

Yes, good question. Champion was a business that we looked at that expanded our capability in Houston focusing on local contractors, whereas our more traditional business was focused on our national account and government business in that marketplace. Also, it added significant geographic coverage footprint in portions of the Houston market that we didn't believe we had ample coverage. So that was the rationale and the reason for that. I'll remind everybody that we're primarily an organic growth company. However, we'll look for opportunities in M&A where we have gaps in our coverage and it's not easy or readily available to find real estate to open up a greenfield. That would be our preferred approach, would be a greenfield approach. We'll also look for opportunities in verticals or new products that give us new capability and get us some additional customer coverage opportunities as a result of a new product offering for a new vertical or a vertical that we'd like to go into. So there are opportunities for M&A. We are very selective in what we look at. And we'll identify those. But again, our primary focus is going to be organic growth through greenfields.

Right. So given the fact that they are in Houston, obviously, we've seen some headlines about severe weather in the area. Maybe just any color on the impact that you've seen over the last week from severe weather? And what's kind of embedded in your longer-term view from a potential opportunity after everything falls out?

Yes, Ken, this is Aaron. I can provide some insight on that. It was indeed a hectic week regarding the weather. We have about 35 branches in Texas and some in Oklahoma, which experienced significant issues. Certain branches were unable to open for one or two days. I spoke with our Regional Vice President last night about reopening those affected branches, primarily due to power outages. We are getting back on track and anticipate recovering quickly. Our specialty business, particularly ProSolutions, is designed to address such challenges with power generation and equipment. They have been quite busy during this time, and I expect they will continue to be in high demand in the coming days to deal with the weather-related challenges we've seen reported in the news.

Right. Makes sense. One last one, if I could just squeeze one in. Just going back to Mig's earlier question, I think you made the comment about improving margins on the better cost structure. Can you just remind us, are there any returning cost actions that we should be aware of in terms of the new EBITDA guidance? And just help us kind of understand how you're thinking about the embedded flow-through for EBITDA margins as the year progresses?

Sure. So, Ken, that's a good question. There are costs that are reemerging following the significant cost reductions we implemented in the second quarter and the suspension of various activities. Those expenses, like travel and entertainment, will start to normalize toward the end of the year. Payroll costs and the expenses related to furloughs from the second quarter will also begin to resume. So, we’re seeing some opposing effects. There’s potential for EBITDA margins to improve. We don’t expect to face the same level of losses from equipment sales in 2021 that we did in the fourth quarter and throughout 2020. REBITDA margins should remain relatively stable. Some operational costs will return, leading to flat REBITDA margins, with flow-through anticipated to be on the lower side. Typically, we would expect a flow-through of 60% to 70% in a standard scenario, but due to the effects of 2020 comparisons, we might fall below that range in 2021.

Our next question will come from Jerry Revich with Goldman Sachs.

This is Ashok Sivamohan on for Jerry Revich. Regarding the 2021 EBITDA guidance at the midpoint, what level of price increases does the guidance embed? And how is that tracking in the first quarter?

We generally do not discuss pricing in detail. However, you can refer to the chart on Page 16. We've managed pricing effectively, maintaining an 80 basis point margin for the last two quarters, with continuous improvement since Q2. We are entering a typical seasonal pattern in Q1, which tends to be a challenging pricing environment. Nevertheless, we aim to return to positive pricing throughout 2021. We have consistently outperformed the industry in this regard and have all the necessary tools to continue excelling in pricing. We expect to transition from a slight decline in the past couple of quarters to some improvement in pricing during 2021.

Great. And you mentioned the plan is to invest aggressively in the ProSolutions business in 2021. How should we think of the business and its potential to sustain meaningful growth in 2021?

We'll continue to invest in our ProSolutions and specialty businesses. And on just a normal quarterly cadence, we expect very strong double-digit type year-over-year growth there as well. And then when there's events like we're seeing this week or natural disasters, right, they'll respond to that and we could get some higher growth rates in those environments.

Our next question will come from Steven Ramsey with Thompson Research Group.

Maybe to start with some additional color on the flow-through. But can you talk to the expenses with SG&A and DOE from branch openings and bringing on Champion, how that factors into the expense base in 2021?

Neither of them have a significant impact in terms of percentage of revenues or actual gross dollars. We're expecting mid- to single-digit growth in DOE and SG&A in 2021 as we move back toward a more normalized cost environment, while keeping both of those below 2019 levels. This gives us the opportunity to maintain a better margin profile going forward.

Excellent. And then also to understand net leverage target being lowered. Maybe kind of go into more details on why lowering it, especially in the midst of increasing greenfield openings and more openness to doing acquisitions?

I think it's really just a continued improvement in our sort of free cash flow profile. We've got a big pay down this year in 2020 with the reduction in net CapEx. And we really just don't see any big need in the sort of mid- to medium-term for any usage of cash. So we're going to continue to be free cash flow positive. We see ourselves staying below sort of in this new guided range, with the ability to grow fast in terms of fleet expansion when markets turn around and show some strength, and also in terms of greenfields and any opportunistic acquisitions that come along. I mean, the guidance range doesn't anticipate a big acquisition. And if something of scale came up, then we would communicate that at that stage. So it's really just anticipating bolt-on acquisitions and continued acceleration in greenfields.

And that, Steve, would keep us well within that new leverage guidance that we talked about, anything that we either forecast or plan to do.

Great. Additionally, I wanted to follow up on the topic regarding excess cash flow. In the absence of acquisitions and aside from regular capital expenditures, it's going towards debt reduction and is already near the lower end of the range. I'm curious about the EBITDA and operating cash flow's ability to cover interest expenses. Is there any interest or inclination to repurchase shares at the current levels?

Yes. Look, at this point, we believe the best investment for the free cash flow in this business is to invest in the growth of the company, whether that be fleet, whether that be new branch openings or some bolt-on M&A. And I think our liquidity position and our cash position sort of reflects that, and that's what we'll continue to do.

Yes. At this point, we believe the best investment for the free cash flow in this business is to invest in the growth of the company, whether that be fleet, new branch openings, or some bolt-on M&A. Our liquidity position and cash position reflect that, and that's what we'll continue to do.

Grant, I think we have one more.

Would you like me to take the last one?

Yes.

Sure. Absolutely.

We have a question from Ken Newman.

I just had one more qualitative question here. I'm just curious, obviously, the guidance looks pretty optimistic here for 2021 in terms of the EBITDA. Can you maybe just talk a little bit about what's giving you confidence on that outlook? Or just provide any color on some of the conversations you're having with your customers in terms of their outlook for securing projects in the near term?

Sure, Ken. This is Aaron again. As we concluded last year, we saw improvement each quarter. We believe we will become even stronger in 2021. Looking at our end markets, we expect some projects that were postponed last year will be coming online. We have a diverse range of markets, including industrial sectors that typically conduct planned shutdowns, preventive maintenance, and turnaround projects, which were delayed last year. We know these are necessary and will move forward once their teams return to work following the pandemic. Large construction projects are ongoing, and new ones are appearing in our forecasting tools like Dodge and IRR. Our entertainment business, which faced significant challenges last year, is now recovering, reaching about 80% of its normal levels as we enter this quarter. We also see significant opportunities in the alternative energy sector, which is experiencing high demand. We are actively collaborating with our customers and have a robust pipeline of upcoming projects. Additionally, there are prospects in data centers, healthcare, and government sectors. Our business is diversified, and we are optimistic. Our customers indicate that work is on the horizon, and we believe we just need to navigate through a couple more quarters before we see the results.

Right. You mentioned the alt energy renewables, obviously, I think potential for infrastructure, whether it happens or not, is on a lot of people's minds. Do you have any commentary or color in terms of how you're thinking about capital deployment actions? Or any actions you might have to take if something is passed?

Yes. Ken, look, I've been a bit reluctant even to sort of include any infrastructure bill or spending into anything that we're doing. And I really don't think we have any of that forecasted into our 2021 plans. And if a bill was fortunate enough to get through this new Congress and administration, there's really no shovel-ready projects that are even going to hit the ground in 2021. It will be well into 2022 before that funding, if passed in 2021, will make its way to the market. So we're not holding our breath on a cooperative Congress to get that done. So we don't really have any of that forecasted into our business. If we do, it's gravy, and we'll deal with it when and if it happens.

Thanks, Ken. And seeing that there are no other further questions, I'd just like to thank you all for joining us on the call today. And obviously, if you've got any other questions, please feel free to just give me a buzz. My contact information is at the back of the deck and also on the website. So we look forward to talking with you soon, and thank you all for joining us today. Bye-bye.

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