Earnings Call Transcript - HRI Q3 2021

Operator, Operator

Good morning and welcome to the Herc Holdings Third Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note today's event is being recorded. I would now like to turn the conference over to Elizabeth Higashi. Please go ahead.

Elizabeth Higashi, Investor Relations Manager

Thank you, Rocco, and thank you all for joining us this morning. Welcome everyone to our third quarter 2021 earnings conference call. Earlier today, our press release presentation slides and 10-Q were filed with the SEC and all of them are posted on the Events page of 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 our third quarter and year-to-date results, with comments in operations and our financials, including our view of the industry and our strategic outlook. The prepared remarks will be followed by an open Q&A. Before we begin our formal remarks, I'd like to remind you to review our Safe Harbor statements on Slide 3. Today's 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. You should also refer to 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 these non-GAAP measures to the closest GAAP equivalent can be found in the conference call materials. Finally, a replay of this call can be accessed via dial-in or through a webcast on our website. Replay instructions are 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.

Larry Silber, President & CEO

Thank you, Elizabeth, and good morning everyone. Please turn to Slide number 4. Our third quarter results continue to demonstrate outstanding operational execution and reflect new records in many of our financial metrics. Slide 4 shows the third quarter results over the last three years. Given the unusual performance in 2020 due to the impact of COVID-19, we share a comparison with not only 2020 but 2019. As you can see, our performance in 2021 clearly accelerated our growth trajectory. Equipment rental revenue was $519.6 million in the third quarter, an increase of 29.2% or $117.3 million compared to the prior year and 13.1% over 2019. This increase was driven by solid performance in our core business and growing market share from our specialty businesses, both of which continue to outpace our pre-pandemic performance in 2019. Adjusted EBITDA grew by 25% over the prior year and 17.4% over 2019. Our focus on operating leverage improved year-over-year adjusted EBITDA margin by 160 basis points to 44.7% in the third quarter of 2021. We reported net income of $72.3 million, or $2.37 per diluted share in the third quarter, compared with $39.9 million or $1.35 per diluted share last year. We're on our way to a record 2021. This is an exciting time for Team Herc. As you know from our growth goals we presented at our recent Investor Day, we have the appetite and desire to achieve even greater success. Our industry-leading rate management delivered strong results in a favorable operating environment which benefited from tight equipment supply and steady rental demand. Given the indications for the rest of the year, we're affirming the full-year adjusted EBITDA guidance range we provided at our Investor Day of $870 million to $890 million, which was the third time we raised guidance. Now please turn to Slide number 5. 2021 has turned out to be a pivotal year for the equipment rental industry. Tight supplies of equipment and steady demand have created an optimal environment for us. We increased dollar utilization year-over-year by 840 basis points to 46% in the third quarter, reflecting improved volume, mix, and rates. Our focus on the top MSAs in North America and filling out our urban density in select locations is driving both our Greenfield and acquisition targets. Since December 2020, we have completed five acquisitions for a cumulative total purchase price of $280 million and announced our sixth acquisition Rapid Equipment Rental of Toronto earlier this month. We also recently announced the declaration of our first quarterly dividend of $0.50 per share to shareholders of record as of October 20th, and payable on November 4th. Our strong year-to-date performance is clearly providing the momentum and growth that we expect going forward. Now please turn to Slide number 6. With a history of over 56 years in the equipment rental industry, our 5,100 plus team members work hard to ensure our customers achieved optimal performance safely, efficiently, and effectively every day. Everything we do is built on our promise and commitment to help our customers and communities build a brighter future. As of today, we are now operating approximately 295 locations across the United States and Canada in 39 states and five provinces. We're excited about the momentum we are generating and in developing our M&A pipeline. Please turn to Slide number 7. We introduced our strategy Shifting Into High Gear at our Investor Day last month. The business model is simple yet it takes experience and commitment to truly capitalize on the opportunities we have in an expanding addressable equipment market and truly fragmented industry. Our team is hungry to take advantage of the exceptional opportunity before us. Now for more details about our operations in the quarter and our outlook here's Aaron Birnbaum, our Chief Operating Officer.

Aaron Birnbaum, COO

Thank you, Larry. The third quarter and year-to-date results reflect the contributions of our outstanding Herc Rentals field management and team. Every day our team demonstrates their dedication to serve our customers with their level of professionalism and commitment unparalleled in the industry. Coming off a really tough 2020, we challenged the organization to exceed our 2019 performance. They've stepped up to the challenge and not only are they exceeding our pre-pandemic results, they're delivering exceptional performance throughout North America. We greatly appreciate the contributions of each and every one of our team members. Congratulations, Team Herc for a job well done. Now please turn to Slide 9. Our Q3 results showed exceptional performance compared to 2020 and compared to a strong third quarter in 2019. Equipment rental revenue in the quarter was $520 million and rose nearly 30% compared with 2020 and 13% higher than the comparable periods in 2019. Business activity was solid and all of our end markets are showing positive momentum. Our ProSolutions business continued to increase year-over-year by approximately 30% in the third quarter of 2021, as we continue to expand our market share. Our focus on the power generation climate control and remediation needs of our customers has contributed to the double-digit revenue growth in ProSolutions over the last four years. The strategic investments we made to diversify our customer base and industry verticals provided a solid foundation for growth, as we successfully built upon our urban market strategy and deepened and widened our market segments throughout North America. Our core business showed the normal upturn in demand in the third quarter, we benefited from solid operating performance in our regional operations. The integration of the acquisitions we've made to date is on track, and we are actively pursuing other acquisitions in targeted markets. Our Herc operating model continues to drive operational performance and fleet efficiencies and margin improvement offsetting increases in year-over-year personnel related costs in the quarter. Our scale and leverage will support further margin improvement over the next few years as our revenue remains robust. Please turn to Slide 10. Our fleet composition at OEC is on the left-hand side of this slide. The total fleet was $4.1 billion as of the end of the third quarter, about 9.4% higher than OEC at the end of Q3 2020. We continue to invest in our specialty fleet, which includes ProSolutions and ProContractor and accounted for about 23% of our total fleet as of the end of Q3 2021. We also continued to improve dollar utilization each quarter in 2021 and achieved a record 46% in the third quarter. On the right-hand chart, you can see OEC fleet expenditures in Q3 2021 were $210 million, an increase from our third quarter in 2020. Fleet disposals were $44 million in the third quarter of 2021, compared to $124 million of OEC sold in last year's comparable period. Our fleet department has done a great job getting in front of a tight market for new equipment purchases from the OEMs. We ordered early for 2021, and while we have experienced delays of certain equipment, we have largely received fleet from our initial orders. You may recall that in the second quarter, we announced that we were ordering an additional $100 million in fleet in 2021 and we expect delivery this year. Our equipment cost increases have not been material this year, but as shortages, inflation and labor costs impact the industry, we anticipate that industry fleet costs will continue to rise in 2022. Fortunately, we had most of our 2022 orders in by September, some at 2021 pricing, so the inflationary impact for our 2022 orders will remain muted. Given the current operating demand for our rental fleet, we reduced third-quarter disposals in 2021 year-over-year by $80 million. Even as equipment sales proceeds as a percentage of OEC rose from 37% last year to 42% this year. The average age of our disposals was 86 months in the third quarter, and fleet age is now about 48 months. Please turn to Slide 11. Our diverse customer mix with our base of large national customers operating in the essential business sectors, and our expanded specialty business continues to drive our sales strategy. Specialty is expected to continue to be a growth driver, as we focus on the expanded addressable markets of climate control, remediation, and entertainment. Our other verticals on major industrial customers in utilities and energy, healthcare, warehousing, manufacturing, and general construction are gearing up and look to support growth in 2022 and beyond. We're also focused on high-growth segments of the economy and our end markets are showing momentum to continue a strong recovery in 2022. We expect to drive additional fleet efficiencies and operate a lean cost structure to drive margin improvement. Turning now to Slide 12. We shared the cumulative values of our acquisitions we have made to date on the right-hand side of this slide at our Investor Day on September 20th. Since then, we also announced the signing of a purchase agreement with Rapid Equipment Rental with 110 employees in seven locations in the Greater Toronto area. The transaction, subject to the customary closing conditions, is expected to be completed in the fourth quarter. So we'll start 2022 with 13 locations in the GTA, more than double our current capital. The EBITDA contribution from the acquisitions we've made so far in 2021 isn't material to our reported results, but our M&A pipeline is quite robust, and we are aggressively seeking additional targeted markets in the top MSAs to help us enhance our urban density and improve our operating leverage and scale.

Mark Irion, CFO

Thanks, Aaron. We continue to be really pleased with our performance and have delivered another excellent quarter in Q3. It's a great environment for the rental industry with strong demand although supply is constrained like it is in many other industries at the moment. Our fleet team has done a great job with getting our orders in early this year, so that our new fleet arrived steadily throughout the quarter. Our operations team have also done a great job with managing record utilization, getting the fleet to the right customers in the right jobs, managing peak demands with strong response, and integrating new team members, customers, and fleet into the Herc model. This consistent execution has led to a record quarter and is maintaining strong momentum into Q4 and 2022. Slide 15 shows the summary of our third quarter results compared with 2020 and 2019. Q3 was a record quarter for many key metrics including rental revenues, net income, adjusted EBITDA, adjusted EBITDA margin, and dollar utilization. Equipment rental revenue increased 29.2% from $402.3 million in 2020 to $519.6 million in the third quarter of 2021, primarily due to improved volume and continued momentum in pricing. Compared with 2019, equipment rental revenue increased 13.1%. We continue to deliver solid profitability with adjusted net income in the third quarter of 2021 of $72.7 million or $2.38 per diluted share, compared with adjusted net income of $43.2 million or $1.48 per diluted share in 2019. Adjusted EBITDA increased 25% in comparison to Q3 2020 and was up by 17.4% in comparison to our previous peak cycle in the third quarter of 2019. Adjusted EBITDA margins were also a record for the third quarter at 44.7% in 2021, improving from 43.1% in 2020 and by 350 basis points from 41.2% in 2019. As expected, rolling over the low base effect of the cost side of the business in the COVID impacted quarters of 2020 was likely to impact our ability to maintain our historic flow through and will temporarily slow our margin expansion. EBITDA margins of Q3 2021 remained strong at 45.9%, down by 240 basis points from 2020 and an increase of 100 basis points from 44.9% in 2019. There are all sorts of quick temporary cost anomalies in the Q3 2020 results, and we did not expect to be able to replicate those margins this year. Adjusted EBITDA flow through of 37.5% was in line with our expectations and should return to our targeted range of 60% to 70% in 2022. On the cost side, we have some operating expenses coming back into the business, along with record rental revenues where we incurred delivery, re-rent, payroll, and commissions in order to provide superior customer service and supply to our customers. In order to be the employer of choice in the industry, we also have to provide competitive compensation and benefits. We have been adjusting our operating team's compensation to strategically stay ahead of wage inflation and build our platform for growth. All of this is manageable within the context of double-digit growth in rental revenues. We can invest in our business and in our people and continue to improve our margins and investor returns. The 2020 COVID impacted base effects will run out over the next couple of quarters and we will focus on returning to our targeted flow through range of 60% to 70% in 2022 and beyond.

Operator, Operator

Our next question today comes from Ross Gilardi at BoA. Please go ahead.

Ross Gilardi, Analyst

Just had a question on your capital spending. I mean you guys are getting your deliveries this year from the sounds of it have managed that well but and you're obviously out there with big capital spending growth projections for next year. We've all seen what at least JLG has said about the short-term for now and they're obviously got to be a big supplier. So I understand you've got the orders in for next year but explain again what gives you the confidence that your suppliers can actually produce at the level necessary to deliver that fleet and do you have to take bigger cost increases to ensure that your prioritized buyer suppliers next year? Thanks.

Larry Silber, President & CEO

Yes, Ross, great question and certainly there has been obvious news that we’ve all heard JLG announced and certainly with your strike that has potential to impact as well, not as great for us but certainly impact supply chain for others in the industry. But generally we have received confirmation from all of our major suppliers where we have placed orders for 2022 that our order and production slots are intact and for the most part we will receive everything according to the schedules that we have agreed to with them, and we work very closely with them to do things to make sure that our gear is delivered on time. As far as your question about rate, we have been able to do very well in negotiating our rates for next year and we're in the low-single-digits relative to inflationary pressures on that gear. And for now, I don't foresee any issues relative to us receiving that gear in an orderly manner or fashion as we've negotiated with those suppliers. Aaron, maybe you want to comment more?

Aaron Birnbaum, COO

Larry, I think you've covered it very well. When you look back to this year, we did receive all of our fleet supplies that we planned when we initially started 2021 and I think that because we started early planning forward and then so as you look into 2022 we started early planning for that well. So we fully expect to receive the fleet we planned for, I expect disruptions to an extent, maybe some delays, but I do expect to receive the fleet we planned for.

Ross Gilardi, Analyst

Okay, great. So you would say that, so you're baking in low-single-digit type cost inflation into your CapEx outlook for 2022, is that right? And just, can you remind everybody how the accounting works on equipment in inflation? Do your rental gross margins get squeezed next year a bit due to the inflation or does the impact get smoothed out just because of the depreciation accounting over the life of the fleet?

Mark Irion, CFO

Yes, I think Ross, so yes, we are looking at low-single-digit cost increases next year for the broad spend and accounting. I mean, it gets smoothed out. So I mean, that fleet comes in and is depreciated over seven, eight years. So the increase has smoothed out with no real immediate depreciation impact.

Ross Gilardi, Analyst

Right, okay. That's what I thought. All right. I'll hand it over and get back in the queue. Thank you guys.

Operator, Operator

Our next question today comes from Steven Ramsey at Thompson Research Group. Please go ahead.

Steven Ramsey, Analyst

Hi, good morning. Maybe wanted to get into the rate environment, clearly the things that won't change your discipline on getting strong rates, but do you feel like this rate environment is pretty favorable into the first half of next year, or if this tight supply environment gets incrementally less tight, do you think this pressures rates for the industry and what you could get in FY 2022?

Mark Irion, CFO

Yes, there is rate momentum in this environment, and we expect that to continue. It creates a flywheel effect for rates, which tends to build positively. We anticipate rate momentum will carry into 2022, making it a favorable rate environment for us as well.

Steven Ramsey, Analyst

Okay, great. And then in the other customers group seeing growth of 70% plus again in Q3 after Q2, is the strength in that purely the entertainment sector coming back off the bottom last year or what other areas are driving that strength?

Larry Silber, President & CEO

In the other categories would be some of the government activity as well.

Mark Irion, CFO

Yes, that's the local portion there, Steven, and that's not really entertainment at all. So that's a swing back from COVID that market was more volatile last year and is coming back stronger this year. So starting to reflect the normal mix we see in local customers versus national accounts.

Steven Ramsey, Analyst

Excellent. And then last one to clarify on operating expenses being normalized. Are both SG&A and DOE kind of running back at normalized levels? And if not, what elements are coming in place in the next few months to normalize into next year? Thanks.

Mark Irion, CFO

Yes, we are back at normalized levels. We're currently achieving record levels of revenue. The operating expenses and SG&A are back to normal, without any of the COVID-related cost reductions from last year. We will continue to operate at these levels through Q4 and into 2022.

Operator, Operator

Our next question today comes from Jerry Revich with Goldman Sachs. Please go ahead.

Jerry Revich, Analyst

Can you talk about the acquisitions that you closed on over $200 million in fleet? How much room do you have to grow that fleet with your specialty business and other areas, and now that you have the additional branch locations, can you step us through the plan? So we can think about what it might look like as you make additional acquisitions?

Aaron Birnbaum, COO

Well, the ones that we have done so far, Jerry what's exciting about them is that it gives us a lot of the urban density that we want in some of the big MSA markets. Only one of them was what we would call a specialty business, which was a trench business in California. The rest of them are just core general rental businesses. So we have lots of opportunity to drive our specialty synergies through those businesses and we began that right away working on that with the sales teams.

Jerry Revich, Analyst

And can you comment on order of magnitude, is it an extra $50 million in fleet, $100 million in fleet, just to give us a rough context?

Aaron Birnbaum, COO

Well, I think if you just took the revenues that we acquired from those acquisitions and then assume that there's no specialty business running through them, extrapolate our 25% specialty number on that that's the fleet that we could push through there to grow that specialty segment type of business through there.

Jerry Revich, Analyst

Very interesting. And from a utilization standpoint, you folks have worked hard to get fleet availability up. Was the third quarter essentially full out for you folks or as we think about third quarter 2022 might look like and the comps, is there room to take utilization higher? And what's your seasonally strongest quarter? How would you frame that opportunity?

Aaron Birnbaum, COO

I would say, this is Aaron, I would say that there's still some room for us to run at a higher time than what we did through Q3 this year.

Mark Irion, CFO

So yes, I mean, you've got it right. There's a lot more momentum in the spot market as those rates sort of cycle in every 45 days, if you like. So the rate growth that we're seeing in the spot is probably two to three times what we've got going in national accounts at the moment. We do have positive momentum in the national accounts, it just takes longer to sort of get going, as they sort of cycle every 12 months. And they're relatively evenly spread throughout the year. So we've got a monthly cadence of renewals within those national accounts and we continue to focus on getting right to left as they come up for renewal.

Operator, Operator

And our next question today comes from Rob Wertheimer with Melius Research. Please go ahead.

Rob Wertheimer, Analyst

Hey, good morning, everyone. I wonder if you could just remind us or talk through the dynamics of the drop that you expect in the next couple of years. Is it largely just SG&A leverage that will become more evident as you've now done a reset? Is it how much is price versus rental rate versus cost inflation, etc.? Maybe just some background around that? Thank you.

Mark Irion, CFO

It's probably mostly operating cost leverage, it's the bigger portion of the cost spend in the P&L, but it's a combination of the two, obviously SG&A, there's a lot more fixed than operating expenses. So most of it really comes from just putting more fleet on existing locations. So as you add fleet, there is a step function in the cost that comes along with that, so you don't need to add drivers and mechanics straightaway. You do as those sort of fleet increase gets more substantial, but there's a step function to the cost and the OpEx and as that you just sort of work your way through that there's a pretty steady flow through and that sort of 60% to 70% time. Most of our branches can handle existing fleet and a big part of the strategy over the next couple of years is just really accelerating the fleet growth on those existing locations.

Rob Wertheimer, Analyst

Okay. That was very helpful. And then just can I ask you a question about IT. Larry, we chatted about this at the Investor Day, but just what's your feeling on whether IT spend goes up materially or not where you're positioned on your sort of technology base and maybe the opportunity from IT as well? And I'll stop there. Thank you.

Larry Silber, President & CEO

Look, I think when we were at Investor Day, and presented our plans. Our IT spend is baked into everything that we're doing, and that planning and spending is sort of baked into what we're looking out over the next three years. So I don't think there's any kind of a step function, or any kind of incremental spend that you'll see that's not already baked in.

Rob Wertheimer, Analyst

And then just the opportunity and separation versus smaller competitors as you use your scale?

Larry Silber, President & CEO

The market is highly fragmented, with the top three or four players controlling about a third or more of it. This presents significant opportunities because of the fragmentation in the industry. Our advantage lies in our ability to invest heavily in fleet, IT, and overall business structure, which sets us apart from smaller independent rental companies. This trend will continue, leading to further consolidation within the fragmented market, and we will be involved in that process.

Operator, Operator

Our next question is a follow-up from Ross Gilardi of BOA. Please go ahead.

Ross Gilardi, Analyst

Good morning. Thanks, guys. Can you just touch on your energy exposure and what you're seeing there, what kind of pickup you're seeing there, if any? You had referenced just pent-up demand for industrial maintenance. Is that we're tapping and just remind us of your exposure and roughly how it's divided by upstream, midstream and downstream?

Aaron Birnbaum, COO

On the upstream part, I know the price of oil has accelerated pretty rapidly; the demand for rental gear into that segment hasn't really accelerated as fast as the price of the barrel of oil. We have our basket of customers in the Permian area that we like to serve, and we stick with that play. On the downstream part, we did mention that we continue to expect more turnaround activity or pent-up turnaround activity that was delayed. That's happening, and we've used some of our capital, some of our new fleet to move into that segment to satisfy our customers in that segment as well. And we continue that downstream improvement and activity to continue all the way through starting in the fourth quarter and continue all through next year.

Ross Gilardi, Analyst

Aaron, can you share your approximate percentage of fleet or sales related to energy these days, as well as the breakdown between upstream and downstream?

Aaron Birnbaum, COO

For us, the upstream is about 3% or 4% and the downstream is like 5% or 6%.

Operator, Operator

Thank you. And our next question today comes from Steven Fisher at UBS. Please go ahead.

Steven Fisher, Analyst

Great. Thanks. Good morning. You guys mentioned that mechanics are hard to find. Curious how the availability of parts is, are you seeing any challenges there and how might that be affecting your ability to kind of turn equipment around and get it back out on rent?

Aaron Birnbaum, COO

This is Aaron. Yes, we have similar parts delays as the fleet delays. Although, we have a team here that specifically focuses on fulfilling the parts demands that our branches need and connecting with the OEMs and other secondary suppliers daily. The good news is that we really haven't had any degradation of our operating model during the last 15 months. So we are keeping our fleet running and although it's not as easy and efficient getting the parts, we are putting the resources in human capital towards it to move it along faster and the way we're running our business is very similar to how we were before the pandemic.

Operator, Operator

And ladies and gentlemen, this concludes the question-and-answer session. I would like to turn the conference back over to Elizabeth Higashi for any closing remarks.

Elizabeth Higashi, Investor Relations Manager

Thank you all. We appreciate you participating today. And as always, if anybody has any further questions, please feel free to give me a call and we look forward to seeing you all soon. Thank you.

Operator, Operator

Thank you, ma'am. This concludes today’s conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.