Earnings Call Transcript - HRI Q4 2022

Operator, Operator

Good morning. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the Herc Holdings' Fourth Quarter and Full Year 2022 Earnings Conference. All lines have been placed on mute to prevent any background noise. After today's speakers' remarks, there will be a question-and-answer session. Thank you.

Leslie Hunziker, Senior Vice President of IR Communications

Thank you, operator, and good morning everyone. Welcome to Herc Rentals' fourth quarter 2022 earnings conference call and webcast. Earlier today, our press release, presentation slides, and 10-K were filed with the SEC and are all posted to the Events page of our IR website at ir.hercrentals.com. Today we’re reviewing our fourth quarter and full year results with comments on 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. Now, let’s move on to your Safe Harbor and GAAP reconciliation on slide three. 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 the Form 10-K for the year ended December 31st, 2022. 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. And a replay of this call can be accessed via dial-in or through webcast on our website. Replay 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. Finally, please mark your calendars to join our meetings and presentations at three conferences this quarter. We'll be participating in the Barclays' Industrial Conference in Miami on February 23rd, J.P. Morgan's High Yield Conference on March 6th also in Miami, and Bank of America's Industrial Conference in London on March 22nd. With that, let me introduce you to our speakers. 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. I'll now turn the call over to Larry.

Larry Silber, President and CEO

Thank you, Leslie, and good morning, everyone. Let's start on slide number four. There's no question that 2022 was another exceptional year for Herc. We delivered record level financial performance across the board. Equipment rental revenue growth was 34% on top of 24% growth in 2021. In support of the rising demand, we invested $1 billion in net fleet purchases, while improving fleet productivity as evidenced by an annual increase in dollar utilization year-over-year. We also invested in expanding our branch network by completing 18 strategic acquisitions and opening 21 greenfield locations in key markets in 2022. And focusing on rate growth and operating efficiencies, we've more than offset inflationary pressures as we delivered 160 basis points of adjusted EBITDA margin improvement and 120 basis points of higher ROIC. We're operating from a much stronger position today than at any time in our history with better systems and processes, more diverse end markets, a broader portfolio of products, a growing branch network, economies of scale and a solid balance sheet. As one of the largest equipment rental providers with a national reach, our size, resources, and operational excellence are giving us a significant advantage in the marketplace. Moving on to slide five. From a macro standpoint, the North American equipment rental market generated 11% growth in 2022 on robust infrastructure, industrial, and other non-residential construction spending. Tailwinds came from a ramp-up in domestic manufacturing after years of inadequate investment, the beginnings of allocation of federal funding for construction projects, and the ongoing shift that is now taking place in specialty categories from equipment ownership to equipment rental. Contractors understand better than ever the economic, environmental, and logistical benefits of running equipment across categories. In 2022, Herc grew three times faster than the industry and gained a full point of share by leveraging our increased scale, network, and capabilities to ensure that we continue to meet the needs of existing and new customers and deliver on our commitments. While demand has been strong, supply constraints are ongoing. We managed to secure the fleet necessary by leveraging our purchasing power, placing orders early in the buying cycle, utilizing our solid balance sheet, and capitalizing on our preferential position as a Tier 1 national equipment rental company. On slide six, you can see the successful execution of our growth strategies also contributed to our outsized performance relative to the overall industry. We increased revenue in our core categories of aerial, material handling, and earthmoving equipment last year by investing in fleet and optimizing our branch network. Revenue from our high-margin ProSolutions business also grew in 2022 compared to 2021, incrementally benefiting from new products, new locations, and cross-selling synergies. And our innovative customer-facing digital capabilities were the catalyst to several new project wins late last year, especially at the national account level. You'll hear more about that from Aaron in a minute. At the same time, we're committed to responsible ESG operating practices built on a strong cultural foundation, a safety-first protocol, and a pledge to continue to work hard to do more to protect the environment, often in partnership with our customers and suppliers. Finally, between fleet investments, strategic M&A, dividend growth, and opportunistic share repurchases, I'm confident that Herc is allocating capital in the right areas and at the right time. We entered 2023 from a position of strength with a commitment to our growth plan. The strategy is driving it and the incredible people who executed at such a high level. On slide number seven, in addition to continued strength in data centers, healthcare facilities, petrochem, and other key end markets, onshoring and fiscal stimulus trends have only accelerated despite concerns about a potential slowdown in the market. These mega projects represent the beginning of a multiyear flow of dollars into the industrial space. Every time you hear sustainability, climate change, and resiliency, you're hearing about growth opportunities for our company. In 2021, we outlined our three-year strategic plan to grow and strengthen our core business, diversify our products and services, and operate more efficiently as we drive higher, more durable returns. Today, we're tracking ahead of that plan as industry demand surpasses forecasts and we continue to follow the Herc playbook for superior performance. With that, I'll turn it over to Aaron Birnbaum to take you through the fourth quarter details and provide some high-level operational drivers for the year. And then Mark Irion is going to walk you through the fourth quarter financial metrics and share our targets for 2023.

Aaron Birnbaum, Senior Vice President and Chief Operating Officer

Thanks Larry and good morning everyone. Our record fourth quarter results for revenue and profitability served as a great conclusion to a year marked by strong execution, geographic expansion, and new account wins. I'm really proud of the way our team continues to focus on delivering superior products and services for our customers, while executing well against our strategic growth initiatives. Execution starts with safety. And of course, safety is always at the core of everything we do. As you know, from slide nine, our major internal safety program focuses on perfect days that are days with no OSHA reportable incidents, no at-fault motor vehicle accidents, and no DOT violations. And we strive for 100% perfect days throughout the organization. In the fourth quarter on our branch-by-branch measurement, all of our branch operations achieved at least 98% of days as perfect. Equally notable, our TRIR improved to 0.52, a best-in-class result. On slide 10, our fourth quarter results reflect the market opportunity we seized by accelerating our investment in equipment with average OEC fleet up 31% over last year's comparable period. Equipment rental revenue also increased 31% compared with the prior year fourth quarter. Our regional leaders and their teams are doing an excellent job placing our expanded fleet offering into new locations and with larger projects to incrementally drive the topline. Our core business benefited from the continued strong demand for equipment across all of our regions and our ProSolutions business delivered double-digit growth year-over-year again in the fourth quarter. As you know, ProSolutions includes our specialty categories of mobile power and distribution, climate control, remediation, and pump equipment to see a fast-growing high-margin segment of the market. We are capturing shares here by capitalizing on cross-selling opportunities with new and existing core business customers and leveraging the increasing density of our branch network for faster responses. On slide 11, you can see our fleet composition at OEC on the left side of the page. Total fleet is now a record $5.6 billion as of December 31st, 2022, 29% higher than OEC fleet at the end of 2021. You'll note that higher-margin specialty fleet represents about 24% of the total, and there's room to grow. Our fleet expenditures at OEC totaled $327 million in the recent fourth quarter. At the end of 2022, we continued to accept new fleet deliveries despite seasonal demand slowdown as we prepare for additional growth in 2023. We disposed of $140 million of fleet at OEC in the recent quarter, $80 million more than last year's similar period. We effectively balance the need to refresh some older fleet while continuing to be prudent in managing our equipment level to meet strong customer demand and address the ongoing supply chain constraints. Proceeds from fourth quarter disposals were 44% of OEC and benefited from continued strong pricing of used equipment as evidenced by our 510 basis point margin improvement on these sales. The average age of our disposals was 94 months in the fourth quarter with average fleet age at about 48 months. In addition to a best-in-class fleet, you can see on slide 12 that we have a diverse, well-balanced customer mix made up of large national accounts and local contractors across all business sectors in North America with a wide variety of equipment needs. National Account business is benefiting from traditional end-market demand and the increasing number of new multiyear reshoring and infrastructure projects being rolled out. In the fourth quarter, local accounts represented 57% of rental revenue. Our goal is to have our annual split of local and national customer revenue to be about 60/40, respectively. Our acquisition and greenfield strategy supports greater local account penetration. Slide 13 is a quick snapshot of the acquisitions we made in 2022. In the fourth quarter, we completed the purchase of two additional businesses with five locations, which brings last year's total of 18 companies in 29 locations as Larry mentioned. As you know, we are focused on opportunities in high-growth markets that complement our current branch network and fit our strategic, financial, and cultural filters. Moreover, many of the mega industrial projects being announced in the geographies where we have focused our acquisitions and greenfield additions, such as Texas, California, Ohio, and Arizona in the cities of Phoenix, Houston, Toronto, Detroit, and Chicago. We spent $515 million in net cash last year with an average multiple of approximately 5.5 times. We see compelling revenue synergies in most every company we acquire. And over time, we can earn the fleet and operations more efficiently, generating synergized multiples of approximately 3.5 times to 4.5 times. Our acquisition process is now a core competency having successfully integrated nearly 30 businesses with 62 locations into the Herc network over the last two years. We have efficiently assimilated these companies, teams, equipment, operations, and customer accounts to rapidly add value to our operations in line with our urban market strategy. And we had a very knowledgeable, experienced, and skilled team internally made up of region operators and M&A specialists who know our markets well and can leverage relationships. This gives us confidence as we explore and evaluate new opportunities. As we look forward on slide 14, M&A is only one of our building blocks for future growth. Starting with our foundational core business, fleet CapEx, and continued investments in greenfield locations provide a launching pad for incremental growth initiatives. Our ProSolutions business also has a lot of runway. It saw growth through seven acquisitions last year in addition to a larger fleet, cross-selling benefits, and product line expansions. When it comes to winning new projects by raising the bar on customer experience, our investments in digital technology are making a difference. Our ProControl next-gen digital platform provides customers with more control and risk data to improve efficiency and lower costs on their job sites. As Larry mentioned, we launched our advanced fleet management system last summer and will continue rolling it out to our broad customer base this year. Another area of growth stems from our capabilities of providing customers with logistical expertise and full service on-site support. As an experienced manager of on-site solutions, we are well-positioned to take the primary fleet management role on large projects as well as to secure recurring revenue from long-term contracts for day-to-day rental fleet oversight, cost control, and maintenance at industrial customers' existing facilities. National accounts, as I mentioned, are also important to Herc's growth as they are a legacy strength for us. As large manufacturing and infrastructure projects continue to ramp up, we are leveraging our reputation and relationships to win more than our fair share of these projects from battery and EV plants to renewable and ship facilities. Among our 2022 national account customers, the average tenure with Herc was more than 28 years. We have earned their loyalty. National accounts, as you know, are characterized by high volume and longer duration with less seasonality and cycle risk. Together, these initiatives represent the foundation of building blocks for substantial long-term growth opportunities for Herc and our regional operations are primed and ready to advance our progress. I'd like to thank Team Herc for their commitment to growth, operational excellence, and safety. Their professionalism shows up in the execution of our services to our customers every single day. Now, I'll pass the call on to Mark.

Mark Irion, Senior Vice President and Chief Financial Officer

Thanks, Aaron, and good morning, everyone. The consistent application of our growth strategies, as discussed by Larry and Aaron, has provided strong momentum in our results throughout 2022 and into 2023. In 2022, we achieved excellent results, with fourth-quarter equipment rental revenue reaching a record $713 million, up from $542 million in the fourth quarter of 2021, reflecting a 31% increase due to ongoing volume and pricing momentum. We are actively pursuing both organic growth and acquisition strategies with great success. Regarding the 31% rental revenue growth for the fourth quarter, approximately two-thirds of this growth was organic, while one-third was attributed to acquisitions. This demonstrates our capability to continue expanding our core business organically, with our organic growth nearly twice that of the overall rental market. Our strategic acquisition approach effectively supplements growth by allowing us to quickly acquire essential rental talent, fleet, and customers, strengthening our position in the market. Our focus on operational efficiency has led to improved profitability and expanding margins. In the fourth quarter of 2022, adjusted net income rose by 37% to $103 million, or $3.44 per diluted share, compared to $75 million, or $2.46 per diluted share, in the same quarter of 2021. Adjusted EBITDA increased by 41% year-over-year to a record $361 million, and our adjusted EBITDA margin expanded by 160 basis points to 46%. Overall, this quarter and year have been excellent. We made progress across every metric and are particularly pleased with our margin expansion and an EBITDA flow-through of 54%. Our business model supports rapid growth and expanding margins, enabling us to invest in our equipment, locations, and personnel, while also creating shareholder value, evident from a 120 basis point increase in ROIC in 2022 to 10.8%. Our focus on driving rate growth remains essential, especially given the inflationary pressures we face. In the fourth quarter, rates rose by 6.6% year-over-year, and we have seen increasing momentum with rate growth in every quarter over the past two years. We will maintain our emphasis on rate in 2023, targeting mid-single-digit rate growth using our effective pricing tools, the professionalism of our sales team, and benefits from national account contract rate increases secured last year. Market conditions favor rate growth as demand continues to outstrip supply, and industry discipline remains amidst inflationary pressures on fleets. Our fleet size at the end of the quarter was approximately $5.6 billion, with our purchasing team contributing to consistent fleet delivery in 2022, complemented by fleet integrated through acquisitions. Our average fleet on rent in the fourth quarter increased by 29%, while dollar utilization slightly declined to 43.5% due to a return to normal seasonality, exacerbated by our decision to retain more fleet for the winter off-season. In a conventional supply environment, we would typically place orders in the fourth quarter, scheduling deliveries for the spring construction season. However, we are currently placing orders nearly a year in advance to receive equipment as soon as it becomes available, which will influence utilization in the first quarter of 2023. By receiving new fleet now, we prepare to meet customer demand this spring. Overall, we improved our utilization to 43.3%, continuing to approach our mid-40% target range. For 2023, we aim for further improvement in annual dollar utilization as we maintain our focus on rate and return to normal seasonal demand. We have no near-term debt maturities and have ample liquidity to execute our growth strategies. In 2022, net capital expenditures surpassed cash flow from operations, with cash outflows totaling $250 million before acquisitions. We will persist in deploying capital to enhance our business and fleet growth during this ongoing strong demand environment. Our current leverage ratio is 2.4 times, well within our target range of two to three times. Additionally, we repurchased over 0.5 million shares of our common stock in the fourth quarter at an average price of about $110 per share, and we have announced a 10% increase in our quarterly dividend for 2023 to $0.6325, or $2.53 per share for the year. We are confident in our business model and committed to delivering shareholder value. The rental market remains strong, with ARA estimating North American rental industry revenue at $60 billion in 2022, representing an 11% growth over 2021, with an additional 5% growth projected for 2023. Herc’s rental revenue growth significantly outpaces the broader industry growth rate, illustrating our continual outperformance. The benefits of scale are enhanced in this environment, where large rental companies can capitalize on diversified end markets and seize opportunities from significant industrial projects. Our key markets, industrial and non-residential construction, experienced strong growth in 2022 with positive outlooks for 2023 and represent about two-thirds of our customer base. Industrial spending forecasts indicate a 13% growth in 2023 following an 11% increase in 2022, while non-residential construction starts in 2022 are estimated to be $427 billion, reflecting a remarkable 42% year-over-year growth. These developments signify robust activity that will continue into 2023 and 2024, driving demand for our equipment. As a result, we are prepared to invest significantly in fleet growth to maintain double-digit volume expansion moving forward. For 2023, our guidance indicates plans for net fleet CapEx between $1 billion and $1.2 billion, allowing us to sustain double-digit growth in fleet on rent. We also anticipate an increase in used equipment sales as we transition to a more normal pace of fleet replacement. With expectations for improved operating leverage, we project adjusted EBITDA in the range of $1.45 billion to $1.55 billion for the year, representing growth between 18% and 26%. This guidance is organic, but we also have the potential for M&A activity, with a pipeline that may facilitate an additional $500 million in acquisitions, further boosting our growth outlook. Interest expenses are expected to rise in 2023, reflecting the cumulative effect of Fed rate hikes and continued funding for our M&A activities. We are experiencing trends consistent with an industry in an upcycle and are committed to achieving excellent performance as our growth strategies remain on track. I will now turn the call back to Larry.

Larry Silber, President and CEO

Thanks Mark. And everyone, please turn to slide 21. Everything we do starts with our vision, mission, and values and a purpose statement that focuses on equipping our customers and communities to build a brighter future. We do what's right and we're in this together. We take responsibility, we achieve results, and we prove ourselves every day. So, now operator, please open the lines for questions.

Operator, Operator

Your first question comes from the line of Jerry Revich from Goldman Sachs. Your line is open.

Jerry Revich, Analyst

Yes hi. Good morning everyone.

Larry Silber, President and CEO

Hey Jerry.

Mark Irion, Senior Vice President and Chief Financial Officer

Good morning Jerry.

Jerry Revich, Analyst

Hi. I'm wondering if you folks can expand on the M&A pipeline this year, Mark, is there an opportunity for that to be over $500 million as we look at the impact of higher rates on a lot of the smaller players that are ABL funded? To what extent could this be an outsized year of M&A relative to the $500 million target?

Mark Irion, Senior Vice President and Chief Financial Officer

I mean I'm not sure. I mean, I think we're comfortable with the pipeline and yes, sort of guided. Our goal is that sort of $500 million range. If something opportunistic was to come up bigger than the kind of deals that we've been doing, we certainly look at that. But that's the sort of level that we're comfortable with and that's the level that we're sort of looking to achieve this year.

Jerry Revich, Analyst

Okay. And then I'm wondering if you could just expand on the time utilization discussion. So, you mentioned just the timing of year deliveries means lower time utilization in the first quarter. Are you expecting an outsized pickup in time utilization versus normal seasonality in 2Q to where we can return to time utilization we saw during the construction season in 2022? Or is that just running time new hot, that's not optimal for the business?

Mark Irion, Senior Vice President and Chief Financial Officer

I believe the construction season usually brings us into a period of peak time utilization. Therefore, we anticipate returning to the levels we saw in 2022 during Q2 and Q3. It is Q4 and Q1 that we are pointing out due to the return to a more typical seasonal slowdown and the larger fleet size we have, which will affect us more during the winter.

Jerry Revich, Analyst

Got it. And lastly, on the rate outlook, just considering the carryover effect at the start of the year, it sounds like you're going to be exiting with rate up in the, call it, maybe 3% range, but considering costs are slowing as well? Are you expecting year-over-year margin expansion in the back half of the year at that lower comp-driven rate number market?

Mark Irion, Senior Vice President and Chief Financial Officer

I think you can see we've got a bit of traction in the flow-through in the back half of 2022. So, we're continuing that momentum through into 2023, and we look to sort of see that range moved from low 50s into that sort of mid-50 to 60 range, typically picks up in the back half of the year, similar to what you saw this year just as you roll over the previous year's costs and headcount increases.

Jerry Revich, Analyst

Super. Thank you.

Mark Irion, Senior Vice President and Chief Financial Officer

Thanks Jerry.

Larry Silber, President and CEO

Thanks Jerry.

Operator, Operator

Your next question comes from the line of Rob Wertheimer from Melius Research. Your line is open.

Larry Silber, President and CEO

Good morning Rob.

Rob Wertheimer, Analyst

Good morning everybody. Hey. So, I had a question on acquisitions also. You guys have obviously had a lot of margin increase over the last two years, but including this year. And I'm wondering if your targets are becoming tougher or having similar margin gain and less willing to sell. If you have any commentary on how the industry feels and whether people are still willing to come to the table with you?

Larry Silber, President and CEO

Well, look, yes, I think the pipeline that we already have for 2023 is pretty robust. We still see that there is ample opportunity for some further consolidation in the industry. And we think we're in an excellent position to continue what we've been doing. So, we really don't see much of a change from last year or the year before.

Mark Irion, Senior Vice President and Chief Financial Officer

There's a big opportunity out there, Rob, in the smaller deals, which we kind of feel that there's a bit more of an advantage for us. We are adding to a district where we need scale and being new to the M&A sort of gain. So, we feel that we've got a sort of advantage on these smaller type deals and that's where the volume of the opportunities are in the current market.

Rob Wertheimer, Analyst

Yes, the multiples have been great on that. And then just a small question, but I know you're trying to handle all the growth that's out there and all that you can. But if you had the opportunity, would you rather be doing a bit more replacement CapEx? Do you have a catch-up to do if growth ever slows? Or do you feel kind of comfortable with where fleet age is despite the COVID back and forth? And I'll stop there. Thanks.

Aaron Birnbaum, Senior Vice President and Chief Operating Officer

We started to, Rob, in the fourth quarter, obviously selling more fleet for replacement CapEx. And we believe as we go through 2023, as long as the supply chain cooperates, we'll get back to a more normal cadence. But we feel good about where we are right now. We're glad we started firing it back up in the fourth quarter and feel good about the flow of new and replacement in 2023.

Larry Silber, President and CEO

That said, we're still concerned about supply constraints in the year. While we've managed to develop a fairly normal cadence, there's still supply constraints from the OEM level that we're concerned about.

Rob Wertheimer, Analyst

Yes, thank you.

Operator, Operator

Your next question comes from the line of Neil Tyler from Redburn. Your line is open.

Neil Tyler, Analyst

Hey good morning everyone. Thanks. Larry, your answer to the previous question actually sort of brings us neatly to the topic I wanted to ask about, which was in terms of that supply and the growth CapEx number, I guess, if we see a similar pattern to the demand side of things, as we've seen over the last 12 months, namely the initial forecasts end up being raised during the year, and that translates into greater demand. Is there scope for you at this stage to add much more to your gross CapEx number? Or do you see that demand manifesting either in terms of you matching it with accelerated M&A or through rate? And which order do you think those things are likely to stack up in a better demand environment? Thank you.

Larry Silber, President and CEO

Yes, that's a great question with several aspects to consider. We anticipate receiving the fleet as planned, following a regular schedule throughout the year. Our fleet is flexible, allowing us to shift resources to areas with higher demand when opportunities arise. We do have some capacity in our capital expenditures if we decide to pursue it, but we're limited by the availability from the original equipment manufacturers and their constrained output as we progress through the year. They have made improvements, but we still cannot guarantee a consistent supply each month. We expect to receive certain materials, but delays and rollovers are still common. Thus, supply is more of a limiting factor than demand. Fortunately, as mentioned earlier, our equipment is adaptable, enabling us to reposition it as needed.

Neil Tyler, Analyst

Okay. Thank you. And is there any constraint on your sort of things? I mean, landing $1.5 billion of fleet into your business is obviously very different to the situation a year or even a year ago or two years ago, certainly, and how are the branches sort of able to cope with that and deploy it?

Aaron Birnbaum, Senior Vice President and Chief Operating Officer

Neil, it's Aaron again. The branches are doing a great job absorbing the fleet. We've really spent a lot of time in the past 18 months developing our teams, expanding our teams. The network is bigger through greenfields and acquisitions. And our sales force has been really developed very nicely to take that fleet, find new customers. And then over the top of that, you've got our national account team, which really has done a great job developing and nurturing the relationships we have on some of the larger projects in North America. So, we feel like all of our branches can continue to take fleet without any absorption issues in 2023.

Neil Tyler, Analyst

Got it. Okay, thank you very much.

Larry Silber, President and CEO

Thanks Neil.

Operator, Operator

Your next question comes from the line of Ken Newman from KeyBanc Capital Markets. Your line is open.

Ken Newman, Analyst

Hey good morning guys.

Larry Silber, President and CEO

Good morning.

Mark Irion, Senior Vice President and Chief Financial Officer

Hi Ken.

Ken Newman, Analyst

So, obviously, it sounds like demand visibility is very strong for 2023, it's driven by these large mega projects that we've all been talking about. I'm curious Larry or Mark, is there any way that you can kind of help us quantify just how much of that visibility can be framed by the new guidance? What's the guide kind of implying in terms of incremental infrastructure activity or opportunities versus reshoring activity?

Mark Irion, Senior Vice President and Chief Financial Officer

I think our visibility and revenue mix is quite specific. We are accounting for continued strong demand. These projects consume significant portions of our fleet when we engage in them, which gives us a certain level of visibility. However, overall, there is considerable variability in our revenues and their sources. We are not specifically aiming for growth in particular end markets, but there is growth across all those markets. Therefore, we will be focusing on that and seeking to capture our fair share.

Larry Silber, President and CEO

Yes, I think, Ken, I view the mega projects as being like the icing on the cake. The overall markets we serve are very robust, and the mega projects add to our efforts. Therefore, I don't see them as the primary driver of this increased demand. The base level of demand is very strong.

Ken Newman, Analyst

Right. I guess, maybe to clarify then. I mean just given how large these projects are still a huge competitive advantage. Is it fair to assume that you're going to punch well above your weight relative to your market share for these larger projects?

Aaron Birnbaum, Senior Vice President and Chief Operating Officer

Yes, I think that's accurate, Ken. There's certain things that these large projects want, right? They want a lot of fleet. They want a high level of service almost always an on-site type operation. They want technology solutions to manage the fleet and account management. And there's really only so many national large players in the rental space, they can provide all that. So, we do think we will, as others that are similar to us or big national players will be able to get outsized success on those big projects.

Ken Newman, Analyst

Yes. And then just for my follow-up question here. it seems like you are tracking much closer to that 5% market share target that you put out in your Analyst Day I think back in 2021. Obviously, the fleet still feels pretty tight from an industry perspective. Do you have any updated views on what you think market share gain capture could be relative to 2022? Or how do you think about longer-term market share?

Mark Irion, Senior Vice President and Chief Financial Officer

Yes, we are pleased to see progress being made. It has been a lengthy journey for the company, and we take pride in achieving another point in 2022. We will continue to invest in our fleet and resources to grow as quickly as possible, which should help us gain market share, and we are very pleased about that.

Operator, Operator

Your next question comes from the line of Sherif El-Sabbahy from Bank of America. Your line is open.

Sherif El-Sabbahy, Analyst

Hi, good morning.

Larry Silber, President and CEO

Good morning.

Sherif El-Sabbahy, Analyst

I just wanted to ask if you expect 2023 to involve a significant amount of capital expenditure and if you anticipate being able to achieve positive free cash flow. If that isn't the case, what steps will you take to reach that goal?

Mark Irion, Senior Vice President and Chief Financial Officer

Right. Yes. No, we're looking at neutral free cash flow, I guess, at this level of fleet growth with our current level of EBITDA expectations before M&A. While we're growing fleet in the high 20s that is a commitment of capital to growth and that does put a challenge on free cash flow. So, the trade-off is really how fast do you want to grow the fleet versus free cash flow. So, we are bidding on fleet growth and market share growth, and we're doing that with improved margins and improved utilization and creating shareholder value at this stage and that's the way we're executing on the strategy. But it should be free cash flow neutral in 2023 before M&A.

Sherif El-Sabbahy, Analyst

thank you.

Operator, Operator

Your next question comes from the line of Steven Ramsey from Thompson Research Group. Your line is open.

Steven Ramsey, Analyst

Good morning. I wanted to revisit the mega projects. Are you able to enhance cross-selling due to the nature of these projects along with your internal improvements? Or do you have any initiatives that might enhance what you're already doing?

Aaron Birnbaum, Senior Vice President and Chief Operating Officer

These large mega projects arise in various market types, sometimes being more rural than urban. With our national footprint, we are well-equipped to support them, and they typically require a comprehensive range of products. This includes our core fleet, which we are heavily investing in. As these projects develop, they often need significant climate and specialty solutions since many do not have short-term or permanent power at their facilities during the initial stages. Additionally, depending on their operations, they frequently require extensive climate control and air conditioning dehumidification until their permanent equipment is in place. Therefore, these projects are ideal for leveraging the full suite of services we provide.

Steven Ramsey, Analyst

Great. And then do these mega projects support greater growth in your national accounts versus local? And then to capture more of this mega project opportunity, do you feel like you could invest more in branches greenfield or acquisitions closer to where these projects are happening?

Aaron Birnbaum, Senior Vice President and Chief Operating Officer

The first question is yes. Typically, it's the larger national mechanical and electrical general contractors that handle these projects, but there are also local contractors involved. This presents a great opportunity to work with that customer base. You often find that local clients grow significantly and take on more projects in the surrounding area. Regarding your second question, I can confirm that we are indeed focused on new locations in some of these metropolitan areas where these major projects are happening. We have invested heavily in Texas, which is seeing a lot of this activity, and we will continue to strategically seek out opportunities that align with reshoring or significant projects coming online.

Larry Silber, President and CEO

Yes. And also Steve, if a project is out in a rural market, we wouldn't necessarily look to open a branch or do an acquisition in a rural market. What we would do is an on-site which would be for the duration of the project during its construction phase and operate from that type of a perspective. So, we're not going to chase flagpoles and chase customers to open facilities that would be permanent overhead. We would look to have temporary overhead in those locations.

Steven Ramsey, Analyst

Makes sense. Thanks guys.

Larry Silber, President and CEO

Thank you.

Operator, Operator

Your next question comes from the line of Seth Weber from Wells Fargo. Your line is open.

Larry Stavitski, Analyst

Hi guys, this is Larry Stavitski on for Seth this morning. Thanks for taking my question. I just wanted to ask about quarter-over-quarter, any evidence of cancellations or pushouts related to rising interest rates or macro concerns? You guys talked a lot about increased activity from infrastructure and construction and some of these mega projects. So, just wondering if any evidence of project cancellations that you've been seeing?

Aaron Birnbaum, Senior Vice President and Chief Operating Officer

By the nature of my job, I spend at least half of each month in the field, engaging with branches, customers, and our sales team. I pay close attention to any anecdotal concerns that may arise. So far, in every market I've visited in North America, I've seen strong activity with no cancellations or postponements related to interest rates. Most of the projects are significant planned investments, strategic reshoring, and public funding, and they are progressing as scheduled.

Larry Stavitski, Analyst

Okay. Thank you. I'll leave it there. Thanks guys.

Aaron Birnbaum, Senior Vice President and Chief Operating Officer

Thank you.

Larry Silber, President and CEO

Thank you.

Operator, Operator

Your next question comes from the line of Mig Dobre from Baird. Your line is open.

Mig Dobre, Analyst

Good morning. Thanks for taking my question. I want to follow up on that last comment about really not seeing any cancellation and momentum remains strong. What do you make of the ABI index being below 50? I mean obviously, you have that as a key indicator for your business. And I recognize that the mega projects are there, but what about the sort of regular mom-and-pop for lack of a better term of construction business?

Mark Irion, Senior Vice President and Chief Financial Officer

Yes, I mean, you can see on the chart that it's been below 50 since October. I mean, it's obviously coming off extraordinarily high readings before that. It's maybe an indication of activity 12 months to 18 months out. And we're focused on the activity that's in front of us. So, there's strong demand now. There's going to be strong demand in the next couple of quarters, and that's what we're focusing on. And we'll adjust this as necessary to what the ABI might not be telling us for the 2024.

Mig Dobre, Analyst

Understood. And then a clarification. I don't know if I missed this. How are you thinking about gross CapEx? And maybe can you help us understand in your current outlook, what the planned fleet disposals might look like in 2023?

Mark Irion, Senior Vice President and Chief Financial Officer

Right. So, yes, we're definitely going to return to a normalized level of fleet disposals. So, that will sort of pick up into that 2019-ish sort of range. We've been running maybe in the $200 million to $300 million zone of OEC for the last couple of years, and that will sort of pick up to the $500 million to the $600 million zone we expect. And the CapEx, the gross CapEx is rolling in faster than it was at the beginning of the year. And we expect to sort of see improvements throughout this year, but we're getting a steady supply. It's not as predictable as it is in a normal environment, but the supply is coming in and we expect to be able to get enough fleet to execute on the plan.

Mig Dobre, Analyst

Understood. And then maybe the last question. This is kind of going back to the answer that you provided to my first question that I understand that you guys are focused on the opportunity at hand here. But if conditions do change, right, if the ABI is actually telling us something valuable here, what are the things that you're looking for in your day-to-day business to make adjustments to either your CapEx or your cost structure as 2023 progresses?

Larry Silber, President and CEO

Yes. Look, I think we monitor on a daily basis, our dollar utilization across our districts and regions. We monitor our time utilization by category. We look at what the seasonality is to make sure that the planned seasonality movement is happening as we expect, whether it's going into the spring construction season, we'll monitor that closely. And then as we proceed into the hot weather to make sure we're seeing that seasonality adjustments happen with our specialty businesses and then rolling into the fall and winter. We have an adjustment there again in terms of seasonality. So, we monitor that and we monitor the things I just mentioned on a daily basis, not only at our level here, but our region executives also monitor that closely down to our branches and districts. So, we're very close to what's happening in activity on a daily basis, Mig, and we make adjustments accordingly.

Mig Dobre, Analyst

Very helpful. Thank you so much.

Larry Silber, President and CEO

Thanks Mig.

Operator, Operator

Your next question comes from the line of Brian Sponheimer from GAMCO. Your line is open.

Brian Sponheimer, Analyst

Hey, good morning everyone.

Larry Silber, President and CEO

Hey Brian.

Brian Sponheimer, Analyst

Just very curious about the entertainment business. You touched on pretty much everything I wanted to talk about, but this was an exciting vertical for you. I think it's gotten a little bit softer. Anything you can add there as far as whether organic or organic growth is something you might be looking at?

Mark Irion, Senior Vice President and Chief Financial Officer

It's clearly a significant aspect of our business. We've experienced some real fluctuations over the past few years. It was a major driver of growth and mix in 2021, but contributed less in 2022 as the growth rate slowed down. Nonetheless, we remain dedicated and enthusiastic about the various components of that business, including the studio and entertainment sectors. It plays an essential role in our mix, and we will continue to focus on it.

Larry Silber, President and CEO

All right. If we consider your current revenue and what might be a normalized capital expenditure, what would steady-state growth look like for a business of this size? What are your thoughts on that?

Mark Irion, Senior Vice President and Chief Financial Officer

We are definitely aiming to increase our market share and grow faster than the overall market. This strategy, which we outlined in 2021, has positioned us well to capitalize on early growth opportunities, and it's exceeded our expectations. However, sustaining a 30% growth rate throughout the company's lifecycle may not be feasible. A slowdown to around 10% to 15% towards the end of the cycle would likely be a more realistic expectation, and it would generate significantly more free cash flow than we are currently producing.

Larry Silber, President and CEO

Thanks Brian.

Operator, Operator

And there are no further questions at this time. Ms. Leslie Hunziker, I'll turn the call back over to you for some final closing comments.

Leslie Hunziker, Senior Vice President of IR Communications

Great. Thank you everyone for joining us on the call today. We look forward to updating you on our progress in the quarters to come. Of course, if you have any further questions, please don't hesitate to reach out to us. Have a great day.

Operator, Operator

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