Rush Enterprises Inc \Tx\ Q2 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to Rush Enterprises, Inc. reports Second Quarter 2021 Earnings Results. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker for today, Rusty Rush, Chairman, CEO and President. You may begin.

Good morning, and welcome to our second quarter 2021 earnings release conference call. On the call today are Mike McRoberts, Chief Operating Officer; Steve Keller, Chief Financial Officer; Derrek Weaver, Executive Vice President; Jay Hazelwood, Vice President and Controller; and Michael Goldstone, Vice President, General Counsel and Corporate Secretary. Now, Steve will say a few words regarding forward-looking statements.

Certain statements we will make today are considered forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Because these statements include risks and uncertainties, our actual results may differ materially from those expressed or implied by such forward-looking statements. Important factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements include, but are not limited to, those discussed in our Annual Report on Form 10-K for the year ended December 31, 2020, and in our other filings with the Securities and Exchange Commission.

As indicated in our news release, in the second quarter, we achieved revenues of $1.3 billion and net income of $58 million, or $1 per diluted share. We are very proud to declare a cash dividend of $0.19 per common share, which is a 5.6% increase over the last quarter. Our results were primarily due to the country's continued economic recovery, healthy activity for most market segments we support, solid demand for new and used Class 8 truck sales and increased aftermarket activity, along with our continued adherence to managing expenses contributing to our strong quarter. As we look ahead, component supply chain issues are delaying the timing of some new truck deliveries into next year. And those constraints are beginning to negatively impact parts and service revenues as well. Despite supply issues, we will continue to add back key personnel to meet market demand, as we believe our financial results will continue to be strong throughout the remainder of the year. In the aftermarket, our parts, service and body shop revenues were $445.5 million and our absorption ratio was 129.1%. Our aftermarket revenues increased 18% compared to the second quarter of 2020, which is primarily a result of the nationwide economic recovery. Our part sales are back to pre-pandemic levels and we experienced increased healthy activity in most market segments, particularly in leasing, refuse, over-the-road customers and independent service centers. Service revenues are recovering at a little bit slower pace than parts, impacted not only by supply chain issues but continued service technician staffing as a common concern in the industry. Looking ahead, we expect supply constraints will continue to impact parts and service revenues throughout the industry for the remainder of the year. That said, to mitigate those impacts, we are actively hiring key parts personnel and service technicians and focusing on our preventive and contract maintenance service offerings. Further, we leveraged our parts management technologies to help us effectively adjust to market demand and grew our expansive dealership network to help mitigate part supply constraints. Finally, we are also piloting final mile route optimization to help us gain efficiency in our parts deliveries to better serve our customers. We do believe demand for aftermarket services will continue to increase through the remainder of the year as the overall economy remains healthy. Turning to truck sales. In the second quarter, we sold 2,954 new Class 8 trucks, making up 5% of the total Class 8 US market. Our truck sales were fueled by a robust economy and strong freight rates, which resulted in solid activity across most market segments we support, particularly in vocational, construction, and over-the-road sectors. Although demand for new trucks stayed strong in the second quarter, sales were hindered by supply constraints affecting manufacturers' production capabilities. ACT Research projects US Class 8 retail sales to reach 259,000 units in 2021, an increase of 32.4% from 2020. We anticipate these supply constraints will likely continue to impact Class 8 truck sales through the third quarter or longer, presenting potential risks to the 259,000 unit forecast. As a result, we expect our third quarter Class 8 performance to be flat compared to the second quarter. However, we believe that Class 8 and our new truck sales may pick up later this year as manufacturers ramp up production when component parts become more available. Our Class 4 through 7 new truck sales totaled 2,825 units in the second quarter, representing 4.5% of the US market, and showcased a significant increase compared to the second quarter of 2020, largely due to heightened activity from leasing, rental, and food service customers. Nonetheless, some manufacturers we work with are still facing production shutdowns due to supply limitations, negatively affecting medium-duty truck availability, which is expected to persist through the third quarter. ACT Research forecasts that US Class 4 through 7 retail sales will be 257,000 units in 2021, up 11% from 2020. Looking ahead, while we expect Class 4 through 7 production growth to lag behind Class 8, demand remains strong, and we have the necessary teams and strategies to capitalize on every sales opportunity. Our used truck sales reached 2,094 units in the second quarter, an increase of 18.4% from the same period in 2020. The demand and values for used trucks remain high, primarily due to the production constraints of Class 8 new trucks. Although maintaining a healthy used truck inventory is becoming more challenging, we believe our third quarter used truck sales will align with our second quarter results. In June, we announced that we signed a letter of intent with Cummins Inc. for Cummins to acquire a 50% equity interest in Momentum Fuel Technologies. Cummins manufactures natural gas fuel systems. This letter of intent reflects our mutual belief in the long-term potential of natural gas fuel systems, drawing on our shared history as leaders in the natural gas market and our extensive service network capabilities across North America. The joint venture is expected to close later this year. As always, I want to thank our employees for their ongoing dedication to growing our business and delivering superior truck service to our customers. With that, I’ll take your questions.

Our first question comes from the line of Jamie Cook with Credit Suisse. Your line is open.

Hi, good morning and great quarter. My first question is for you, Rusty. Could you clarify about your truck sales being flat sequentially and the risks to the industry forecast? Is this risk limited to the third quarter? Will we make up for it in the fourth quarter, or will some of it be pushed into 2022? How much risk do you see for 2021? My second question is regarding demand. It's clear that demand remains strong, but we've heard from other original equipment manufacturers that they are hesitant to open their order books for 2022 due to pricing concerns. Could you share your thoughts on how that situation might unfold?

Sure. I'll be happy to, Jamie. If you had asked me 90 days ago, I would have said we would likely have resolved the component supply issue by now. Unfortunately, it has extended to this point. I’m hopeful from my conversations with the manufacturers that things will start to improve by the end of the third quarter, though I think there might be some improvement towards the later part of the third quarter. With just over 10 days left in July, I anticipate continued pressure for the next four to six weeks. I wish I had a clearer perspective myself. We all understand the chip issues, but the challenges extend beyond that, affecting various parts and components from Mexico and Asia. I believe everyone is aware of the challenges we're facing. Demand remains strong, so I don't want anyone to worry about that; the demand is present in the market, and I don't foresee it diminishing. It may be pushed to the fourth quarter and into early next year. Just because deliveries are delayed doesn’t mean that we won't fulfill our commitments made earlier this year, as those commitments were established before these supply issues arose. I'm expecting a lot of this to carry into the first quarter of next year, rather than everything being picked up in the latter half of this year. Regarding 2022 numbers, we are just starting to work on some of them. We've completed a few deals, though not many. I know that manufacturers are somewhat hesitant this year, but that doesn’t mean we aren't actively pursuing deals. It’s July now, and typically, we don’t start engaging with next year’s deals until September and October, given the current backlog which has people concerned about 2022. I think the first half of 2022 will likely involve a lot of catching up from 2021. If you examine our backlog at the end of Q1 versus the end of Q2, I’m not discouraged by the industry's current situation. Demand is still robust, and the last two quarters have seen record used truck orders, which reflects the hard work our team has done. Everything is likely to be pushed out a bit further. While we are not anywhere near record production numbers, achieving record earnings this quarter, despite these delivery challenges, indicates the evolution of our company over the past few years. I wish I had more precise answers for you, as I’m not a manufacturer and rely on second-hand information. I anticipate the situation will continue into the third quarter, and hopefully, in the fourth quarter, we can return to closer to our projected build rates. Production numbers for June may have been lower than expected for North America, and I’m unsure if that will change in July or August.

Sorry. And just one follow-up, Rusty. Obviously, the margin performance was very strong in the quarter on parts, but also sort of new and used. And I'm just wondering on the truck side, how much of that is used? And just given low inventory used in pricing, why wouldn't your margins be comparable in the back half of the year for the truck relative to what we saw in the first half?

Sometimes it's about the timing of specific transactions, whether they involve smaller or larger deals. I think the margins for used products were slightly below Q1 levels but still well above historical averages. I'm not suggesting they won't be close to those levels again. We moved a significant amount of inventory, which usually yields strong margins for us. Our inventory levels are fairly low, and we need to balance the needs of long-term fleet customers with others. That could be the only factor that might affect margins, but they will still remain strong. I can't be certain that new margins will stay at the current level due to the business mix, but we will see. I don't anticipate a significant decline. Across all segments—whether new, heavy, medium, used, or parts and service—performance was very strong for the quarter. We're satisfied with that, but it is largely driven by demand and supply dynamics. I don't foresee any drastic changes; perhaps a slight adjustment, but nothing alarming. I haven’t suggested that things will turn negative. However, there could be minor fluctuations in new margins due to a higher concentration of robust fleet customers and fewer individual inventory sales.

Okay, thank you. Congrats on a nice quarter.

Thank you, ma'am.

Thank you. Our next question comes from the line of Justin Long with Stephens. Your line is open.

Good morning, gentlemen.

Good morning, sir.

Wanted to start with a question on parts and service. Rusty, can you give a little bit more color on how much growth you're expecting in parts and service in the back half of the year and maybe you can talk about how much this outlook has changed as a result of the prolonged supply chain issues?

We are back to pre-pandemic levels compared to where we were over the last five or six months. Although we haven't quite reached the summer of 2019 yet, particularly because the oilfield was still active then, we are seeing a return to pre-pandemic levels in parts and service during the second quarter, with gradual improvements. While the numbers are solid, we could potentially do even better if it weren't for some supply constraints. We currently have a higher percentage of open work orders in the shops waiting for parts than we normally do, which does slow things down, but it's not a negative situation. We're continuously aiming for better results, even with the record numbers we've achieved. I anticipate that we'll see gradual increases in parts and services, though I’m not suggesting we’ll see significant daily jumps, as we continue to hire back to pre-pandemic staffing levels. This has put pressure on our organization, as the current job market is challenging, especially for certain skill sets. Nevertheless, the team has done an impressive job managing to deliver more with fewer resources, and I believe we will keep moving in that direction despite the supply constraints. The demand remains strong, and we will continue to strive for improved performance. Looking back, we could never have achieved those levels of unit deliveries before, and despite sales volume constraints, our performance from a margin perspective on the sales that we did achieve has been commendable.

And on the point of returning to pre-pandemic levels, I was under the impression that parts had recovered to pre-pandemic levels, but services had not fully recovered. Maybe you could just clarify that. And if that's true, how much room do we have to go in services to get to that full recovery?

That's a great question. I was looking at the overall situation. You're right; the mix is a bit different. Service hasn't bounced back as much as parts have. The combined total is there when you look at margins from both daily and monthly perspectives, but it has shifted more toward parts. We believe this is an opportunity because our technologies and initiatives are helping us gain more market share. Once we can hire more qualified technicians and integrate them into our workforce, we are confident that the work will be there. It really comes down to employment issues. I'm not alone in this; I've spoken to many people and everyone is aware of the articles circulating. It has been challenging to fill certain job positions due to factors like stimulus payments and unemployment benefits over the past year and a half. This is a reality. For example, I can show you how the time to replace employees has doubled. We have all the statistics to back this up. So, it complicates the hiring process because you have to consider both replacements and recruitment. This has made it tougher to increase our technician count. However, we are making progress. I appreciate that we are increasing our technician numbers gradually. A few years ago, we expanded too quickly, and our efficiencies and proficiencies weren’t where they needed to be. Now, I feel more confident about our improvements, even if we're not quite at the volume we strive for. We're doing a better job overall, like building hours per technician, although I won't get into all the details during this call. We're optimistic, but we definitely wish we could move a bit faster in bringing more people back. Nevertheless, the labor market is tough for certain job roles.

Understood. And maybe one last question for Steve. Any clarity on expectations for SG&A as we get into the third and fourth quarter relative to what we saw here in the second?

Yes. As we continue to increase our parts and service in Q3, SG&A is expected to grow as a percentage of that. We experienced about a 50% sequential increase in the G&A portion compared to the rise in back-end gross profit from Q2 to Q1, and we anticipate that trend to persist.

Yes. SG&A increased. Despite the decline in truck volume, the high margins led to an increase in SG&A for truck sales in Q2 as well. I anticipate that if we can sustain our current performance, SG&A will remain at similar levels, correlating with truck margins and gross profit.

Understood. I appreciate the time. And congrats on the quarter.

Thank you very much, Justin. You noticed how well Steve's voice is? It sort of sounds like mine today, doesn't it.

It does. I like it.

Thank you. Our next question comes from the line of Andrew Obin with Bank of America. Your line is open.

Yes. Hey. Good morning, gentlemen.

Well, good morning, Mr. Obin.

Can you discuss how, during COVID, the market is beginning to recognize the structural changes in your cost management? It appears that the recovery may involve more complexities than anticipated, such as supply chain constraints and labor shortages. Could you elaborate on your cost management strategies and what adjustments you might need to make in the near term to navigate this volatile environment? Rusty or Steve, whichever of you would like to respond. Thank you.

Certainly. From a cost perspective, there’s a lot to learn. We've gained valuable insights during the COVID year compared to last year. While our business naturally requires a hands-on approach, we're actively engaged in various tasks like selling parts and managing warehousing. We've realized that as the market recovers, we can potentially spend less than we historically have, thanks to new technologies and strategies we're implementing. This is evident in our recent performance, where our spending increased by over 150% of the gross profit rise from Q1 to Q2. If I can manage this effectively moving forward, I’d feel optimistic, and we anticipate this trend will continue into Q3. We've introduced new measurements that we hadn't used in the past, incorporated through training across different levels of our organization. This helps everyone, from general managers to regional managers, understand that we can operate differently. While we haven’t fully rolled out our delivery service optimization, we've implemented numerous revenue-generating projects over the past few years, allowing us to manage costs more effectively. I would advise trusting the numbers and our performance. Market demand has been robust, but translating that demand into revenue requires careful management from both sides. This is reflected in the current performance and what you can expect moving forward, regardless of the challenges with truck manufacturers or product availability. For example, on the sales side, we have a backlog that is 25% higher than what we had when adding to Q1, indicating strong demand. Although we face supply chain issues and parts shortages, we learned a lot last year and will continue to apply those lessons as we navigate these growth years.

But the thinking is that sort of the amount of cost deployed to get this extra dollar of sales is structurally lower this cycle still, right?

Yes, we believe that we don't need to spend as much. I've always mentioned that we need to invest a certain amount. However, when you analyze it over the cycle, you begin at one point and end up somewhere else. As the cycle reaches a plateau, your costs may not necessarily stabilize as well. We think we have implemented the right tools to better manage costs throughout the cycle, maintaining our revenue streams because we have experienced similar situations before. There are periods of growth followed by declines. Sometimes, it becomes challenging to maintain growth when things start to level off, just as it was difficult to sustain that growth during the COVID period. As we rebound, the growth in gross profit is happening more gradually than it did earlier this year or late last year. Therefore, we are confident that we will manage costs more effectively than we have in the past, which will lead to improved returns in the long run.

Got you. And you've been very useful in the past giving us color about your key end markets. Maybe you can just sort of take us around the country, key end markets like construction, oil and gas, what are we doing? Thank you.

Construction is currently doing very well, and we are seeing indications that it will improve further. The mixer market, although not large, is significant for us this year. Refuse continues to perform strongly, and we feel good about our position in this market and our relationships with various municipalities as well as key players on the private side. The over-the-road business is the biggest driver and is exceptionally strong at this time. We are working to fulfill the demand for trucks, which will extend into next year as we may have difficulty meeting prior commitments. Overall, I don't see any sector that is underperforming. While we have discussed oil and gas in the past, we are actually performing better now than when that business was more prominent. Our parts and service business saw a slight increase from last year, although it was previously depressed due to oil prices. There is some improvement, but I anticipate volatility in the future. I don't expect the oil and gas sector to return to its previous state, but if it does rebound, we will be well-positioned to participate as we have diversified our reliance on it. Medium-duty demand is also strong, and while some manufacturers may shift focus to heavy-duty trucks for better margins, one medium-duty manufacturer will be re-entering the market soon. Overall, the construction and over-the-road sectors have likely exceeded the expectations set six to nine months ago, while other sectors like refuse remain robust.

And you know, what, I usually don't do but I will ask you one more question. I'm talking about a carbon-free future. You do seem to be doing quite a bit more than people realize. Can you just talk about what have your interactions been with these emerging players, autonomous driving, electric vehicles? What kind of dialogue do you have and are there any potential opportunities longer term for you to work with these new emerging players and new emerging technologies? Thank you.

I believe our biggest opportunities lie with our own original equipment manufacturers as they emerge and invest. I've always maintained that most of our success will stem from the companies that have established their presence, although others can also be successful. One of our strongest advantages is our extensive distribution network and service capabilities, which are unmatched. While we don't cover the entire country, startups lack these capabilities; they can't compete with established technology or a distribution network. Opportunities continue to present themselves, and we are keen to explore new technologies that arise. Our internal resources, including our up-fit centers, represent a hidden potential for our future growth. I remain confident that a significant advantage for us will be market share gains by Navistar, which historically hasn't reached its full potential. With the Traton acquisition closing in July, their balance sheet has changed, likely altering their goals. I also believe that Peterbilt can increase market share using PACCAR's exceptional products. Regarding our joint venture with Cummins, I expect it won't yield immediate returns, but given governmental regulations, there will still be opportunities for natural gas growth, which I think will be sustainable long-term, as will diesel, particularly in the truckload segment. While electric vehicles will thrive in certain areas, I anticipate a long transition period to fully adopt these technologies. Our joint venture with Cummins positions us as the second-largest player in the fuel system market. I see growth potential for renewable natural gas, especially given the increasing environmental pressures we face. This transition from over a century of internal combustion engines to new technologies will present Rush with various opportunities, some of which are not yet known to me, but I am aware that they exist and we are monitoring them closely. Our experience in natural gas over the past several years has prepared us well to navigate the upcoming decade of technological change. I can elaborate further, but I will stop here.

That was a great answer. Thanks so much.

You bet.

Thank you. Our next question comes from the line of Joel Tiss with BMO. Your line is open.

Hey, guys. How's it going?

Very good, Joel. How are you today?

All right. Well, definitely, great expense management. I think you got to ease up on cutting Steve's pay so he can get his voice back.

Well, he's a little jealous of me. That's all.

Thanks, Joel.

I see. I wonder if you can talk a little bit about the implications of trading Navistar on your parts business. Are there going to be more global opportunities? Or are there going to be like Latin American opportunities with Scania or MAN? Or just any idea that you're starting to get that could have some impact in kind of like the five-year timeframe.

Honestly, Joel, those types of questions are a bit premature for me to fully grasp. The deal just closed around two or three weeks ago, and I don’t have enough familiarity with the team yet. However, I'm confident I will learn about them and explore what opportunities may arise for us. I believe our largest opportunity lies in reclaiming market share in North America. Gaining margin share can influence parts and service downstream, and while we work on that daily, it typically relates more to the shops and the OEM we represent. Currently, it's too early for me to assess those opportunities since I haven't engaged with anyone from the team. Until the transaction closed, interactions were limited. We are just beginning to understand what potential opportunities exist for us on a larger scale, and as a company, we always seek growth possibilities. As I mentioned earlier regarding emerging technology, we feel optimistic about our position in the marketplace and our ability to differentiate ourselves. So, at this moment, I can't provide a definitive answer since it's too new and I haven’t had discussions with the team yet.

Okay. And on another little philosophical direction, too. Can you talk about how you're thinking about how the dealership model is going to change as we go forward this 2024 California CARB, you're going to need to partner with charging stations or any other kind of ideas that are floating around about how the business might look in five years to 10 years.

Sure. It will integrate into the needs of the technologies we are dealing with. We just had a meeting where we approved plans for California. Over the past year, we've been deciding how to approach California as our first site to implement our strategies effectively. We are ready to meet the demands as manufacturers. While many units are being built, we want to ensure we don’t get ahead of ourselves. However, we have approved preparations for our California stores to comply with the 2024 CARB regulations and to meet customer needs. We are committed to understanding the market because we want to avoid doing excessive work only to later find out we missed the mark. We believe we have a solid plan. Recently, we approved a comprehensive rollout plan for the end of next year that includes all necessary charging infrastructure along with solar solutions, not just installing chargers randomly. We feel confident about this approach. Now, we are also exploring other areas for potential growth but will continue to focus on California as a leader in this field. We plan to monitor other regions where regulatory advancements may occur more swiftly than the EPA might anticipate. There are typically 15 states that align with California's regulations. I'm not certain they will implement changes simultaneously since they haven't completed all legislative processes, but it's likely these regions will follow, albeit possibly a year after California. These states represent roughly 30% of the market. I'm uncertain about the pace of their progress. The EPA is set to implement changes by 2027, which is approaching quickly, so all these requirements will soon be in place. This brings me to the joint venture I established with Cummins, which makes me optimistic. I doubt we will have enough electric capacity ready, whether it concerns the grid or not. Some outside our industry misunderstand that this transition is as simple as plugging in an electric vehicle like a household appliance. For example, California has already faced brownouts, highlighting challenges even with just a small percentage of electric cars. There is much work to do, but we are on our way. It's a transitional phase, and I prefer to be at the forefront rather than lagging behind. I assure you our dealerships will evolve to handle any emerging technologies across various market segments. I hope this provides some clarity.

Yes. You remind me, my wife only plugs in the hair dryer when I'm in the bathtub. I have a quick question. You're growing at a slower rate than the overall industry. Is that due to supply constraints or your regional positioning? Could you provide some insight into what's happening there? Then, I'm finished.

When you mention that, I assume you're referring to volumes. I believe our backlogs have increased a bit slower than others. However, my backlog is significantly larger now compared to a few quarters ago. Some of our customers may be transitioning, and we booked deals a bit later. We're currently facing supply constraints, but I’m optimistic about demand; it's not diminishing. Speaking with customers, they are still active. Regarding Class 4 sales, we have one OEM that typically sells around 2,500 units, which has been out of the market for about nine months, but they'll be returning in October with stronger sales. This absence has impacted our Class 4 to 7 sales, although we can't simply switch all of them to something else. We expect our market share to remain stable, as retail deliveries will not significantly increase in Q3. Retail deliveries usually lag behind production, and if production isn't meeting expectations, retail deliveries will drop due to low inventories. Many have sold out their inventories, and we were able to support operations through stock, but our inventories are currently very low. This presents some challenges. Nonetheless, I acknowledge that we lost some market share and plan to regain it; it’s just a matter of timing, and I have the backlog to support it.

All right. Thank you very much.

You're welcome, sir.

Thank you. I'm showing no further questions in the queue. I would now like to turn the call back over to Rusty for closing remarks.

I'd like to take a moment to mention that June 7 marked the 25th anniversary of when my father, our team, and I took our company public, making us the first car company to do so. It has been an incredible 25 years, and I want to express my heartfelt gratitude to everyone at Rush Enterprises who has contributed to our success across the country. As we move forward, I appreciate everyone's efforts now and in the future. On June 7, I found myself reflecting and feeling sentimental about our journey, especially after speaking with people in the industry. We remain the only public truck dealer, while many car companies entered the market later. It's been a wonderful experience, and I plan to continue this journey for a long time. I'm currently fine-tuning Steve's voice for our upcoming Q3 report, and it should be even more aligned with mine by then. Thank you all for your time; I truly appreciate it.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.