Rush Enterprises Inc \Tx\ Q3 FY2021 Earnings Call

Good day, and thank you for standing by, and welcome to the Rush Enterprises, Inc. Reports Third Quarter 2021 Earnings Results Call. Please be advised that today's call is being recorded. I would now like to hand the conference over to Mr. Rusty Rush, Chairman, CEO and President. Thank you.

Well, good morning, and welcome to our third 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 third quarter, we achieved revenues of $1.27 billion and record-high net income of $69.4 million or $1.20 per diluted share. We are proud to declare a cash dividend of $0.19 per common share. We continue to see economic recovery and a strong freight environment throughout the country, which created a widespread demand for new and used trucks as well as aftermarket products and services. Our profitability was largely driven by our diligent expense management during the quarter. During 2020, we made it a priority to implement new processes and tools throughout our organization to control expenses throughout the truck cycle. We believe these processes will allow us to effectively control expenses as we continue to implement our strategic growth initiatives and will continue to contribute to higher pretax profit margins than we have historically experienced. Looking ahead though, demand remains healthy for new trucks and aftermarket parts and services. Component supply chain issues continue to challenge the industry, pushing new truck deliveries into 2022 and impacting the availability of aftermarket parts. These supply constraints, coupled with normal seasonal aftermarket softness in the winter months and the fact that we have five fewer working days in the fourth quarter compared to the third quarter will negatively impact our earnings in the fourth quarter. However, we believe customer demand will remain robust and supply constraints will subside and that 2022 will be a strong year for the commercial vehicle industry in Rush. In the aftermarket, our parts, service and body shop revenues were $463 million, and our absorption ratio was 134% in the third quarter. Our aftermarket revenues increased 15.7% year-over-year, which is primarily the result of our continued focus on our strategic initiatives and the limited availability of new trucks, which helps drive demand for parts and services of vehicles that are in operation. Our parts sales are historically high, and we experienced healthy activity in most market segments. Service revenues are accelerating gradually, largely due to hiring more technicians and improving the proficiency of our workforce as well as our enhanced service offerings. We believe demand for aftermarket parts and service is strong, but we expect supply constraints to continue to impact the industry through the middle of 2022. We continue to focus on our strategic aftermarket initiatives and expect our fourth quarter performance to remain strong, though we expect normal seasonal decline over the next couple of months. Turning to truck sales, in the second quarter, we sold 2,537 new Class 8 trucks, accounting for 4.7% of the total U.S. Class 8 market. The healthy economy and strong freight rates led to widespread demand for new Class 8 trucks, but our results were negatively impacted by manufacturers' limited production capabilities. ACT Research forecasts U.S. retail sales to be 228,500 units in 2021, up 16.8% from 2020. We expect component supply constraints will continue to delay some Class 8 truck sales into next year, which will likely impact our performance in the fourth quarter. However, we believe Class 8 new truck sales will accelerate in 2022 when manufacturers are able to increase production. Our Class 4 through 7 new truck sales reached 2,792 units in the third quarter, accounting for 4.7% of the U.S. market. We experienced healthy activity for many market segments, particularly food service and leasing rental, but the limited production of new medium-duty trucks negatively impacted our results. ACT Research forecasts U.S. Class 4 through 7 retail sales to be 251,000 units in 2021, up 8% from 2020. As we look ahead, we believe Class 4 through 7 truck production will not increase as quickly as Class 8. We are pleased that Hino is back in production, but we do not expect the other medium-duty manufacturers we represent to significantly ramp up production for some time. That said, demand remains strong, and we believe our fourth quarter Class 4 through 7 results will be on pace with our third quarter results. Our used truck sales reached 1,712 units in the third quarter, down 16.7% year-over-year. Our unit sales were down compared to last year; used truck demand and values remained strong, largely due to production limitations of new Class 8 trucks. We expect used truck demand and values to remain strong in the fourth quarter and begin to normalize when new truck production catches up with customer demand. It is becoming more challenging to maintain a healthy used truck inventory, but we believe our fourth quarter used truck sales will be consistent with our third quarter results. Regarding network growth, this week, we acquired an independent parts and service facility in Victorville, California, that we will convert into a full-service Peterbilt dealership. We also have plans to acquire full-service Hino and Isuzu dealership and help grow in Illinois next month. Further, we entered into an agreement with the Summit Truck group to acquire full-service dealerships in several states, representing International, IC Bus, Idealease, Isuzu and other manufacturers. We expect that transition to close in December. Additionally, we plan to close our previously announced agreement with Cummins to acquire a 50% interest in Momentum Fuel Technologies later this year. It is important that I thank our employees for their unwavering commitment to growing our business and supporting our customers. In recognition of their hard work on the front lines during the pandemic, we are happy to issue a one-time discretionary $1,000 bonus to all employees in mid-December. This is one way for us to express our gratitude to our employees for their impressive work over the past year. With that, I'll take your questions.

And our first question comes from Jamie Cook from Credit Suisse.

Sorry, I was on mute. And good job on execution as usual. I guess, Rusty, the first question, you talked about Class 8 production ramping faster than 4 through 7. If you could just provide some color on that and how you think about production ramping in general in 2022? My second question is, can you sort of address the market's approach to pricing with the incremental costs? And then I guess, last, just any color you can provide on sort of the acquisitions in the JV that you announced and sort of incremental earnings accretion to 2022?

Okay, Jamie, I'll start at the top. When you compare Class 4 through 7 versus Class 8 and why did I say that perhaps 4 through 7 will ramp up slower, is mainly due to the fact that there are two large manufacturers that you will probably see Class 8 ramping because demand is extremely strong on the 8 side, right? Also, it is a more expensive, larger product. I think if you look historically, margins typically tend to be better on the 8 side. So when you are in a supply-constrained environment, which you are now, you have to pick and choose, right? Because there's a lot of the same components involved. So obviously, the 8 demand is stronger than 4 through 7 right now. Given the vehicles themselves, you have to make decisions because of the supply constraints we are dealing with. So I think we tend to favor the Class 8 right now due to the demand and also the profitability of the product. Because it cost twice as much, right? It only makes sense that margins tend to be better, but based on the revenue side, to begin with.

Do you see any evidence that people are worried about double ordering?

No, I don't feel that way about our order board. In my mind, what's happened is demand. Look how things ramped up since July of last year. I mean, the Company blew up, right, from a freight perspective. Everybody had money, we were buying everything. And so demand was there. We ended up running into the supply storages, starting in really March-April. By the time the year is out, you asked me, we probably pushed 40,000 or more Class 8 units that should have been built this year that are not going to be built. When you think about it, all you're doing is pressing that demand into '22. '22 is supposed to be a pretty good year. Then you run into '23, right? You've got Carb and pre-buy in those states, those 15 states. There's a lot of different numbers as to how much, but if they're going way up in '24. I don't see this thing slowing down until '24, unless there's some big economic issue, okay? Because I don't see that we're going to catch up to demand right now. Manufacturers are not meeting demand at the moment. So it just keeps pushing it out and pushing it out. Unless there's a significant economic downturn in the country, I don't see that demand going away because you're not really going to be replacing. The retail is running in the 220s now compared to last year's under that, obviously, like 190 or something. So, given the transit side let's look at GDP and freight, I don't see the double ordering. Our backlog at this time last year was about $1.1 billion, into Q2 it was $2.2 billion, and it’s $2.7 billion now. I can reserve a little bit, but I don't see any evidence base in there that suggests even if there's a little bit, our backlog is still big. We've got to catch up with what we've missed.

But then Rusty, with the $2.7 billion in backlog, can you just address how you're approaching pricing with the material cost price era?

I’m largely influenced by the OEMs. It's clear that costs have risen significantly. Both the OEMs and suppliers are facing challenges, and they are paying more. The prices of trucks are definitely increasing. It's hard to ignore the inflationary pressures present; some might mention them casually, but I perceive them as more pronounced, particularly in our business. When discussing pricing, it's evident that prices are up. The ongoing supply chain issues affect not just the OEMs, who are experiencing pressures in terms of supply and pricing due to classic supply and demand dynamics. That's the current situation. While I don’t have specific figures, these increased costs eventually get passed to the end-user, which either cuts into margins or is transferred in some manner. Due to the rapid changes, it can be difficult to pass these costs quickly. This situation didn’t arise overnight; it began last year and nine months ago. What you should be incorporating into your backlog from '22 should align with the pricing pressures experienced, as that's how it should ideally function. A larger backlog complicates managing commitments, and I’ll leave it at that.

My third question was just I'm just trying to figure out all the M&A that you're doing, what's incremental?

I enjoy discussing mergers and acquisitions. It feels like ages since I've had the opportunity to do so. The recent small deal we mentioned is a positive independent acquisition we completed. It's an add-on to our operations. The Summit deal signifies significant growth for us. Looking at it, it's the second-largest international dealer, filling in three states where we previously had no presence: Kansas, Missouri, and Arkansas, along with Memphis. Rush has about 17 or 18 stores there. It's like putting together a puzzle, and these three states fit perfectly into our map. We are thrilled about it. We're also very enthusiastic about the Cummins joint venture. We've had momentum in the fuel system business since 2014. You may recall that back then, natural gas was expected to account for 10% of the market by 2017, but it never exceeded 2%. Cummins must have a positive outlook on the future, and we share that belief. We think renewable natural gas will serve as a bridging technology as we advance through this decade. We're quite excited about that as well. Kent, it's time to move on.

Congrats on the quarter. So maybe to just put a bow on the fourth quarter. I know typically, you see a seasonal decline. Rusty, you called out five fewer working days, but is there any way you can help us think about the magnitude of the impact from five fewer working days in the fourth quarter?

Sure. It's two things. Look, these are just a little bump. Fourth quarter, we're going to have a good quarter. Point being, the way it falls out, we've got five less working days. Typically, the fourth quarter is about three, but the way the holidays have worked this year, we are pulling a holiday out of '22 and sticking it back in '21 because that's January 1, and we're giving off December 31. We did $2.6 million of gross profit a day in parts and service, so you can do the math, maybe $20 million of gross profit. But at the same time, everything should be running smooth and good, and we just want a better fourth quarter than last year. The third quarter is always typically our best quarter. '22 and '23 are set up well, and the acquisitions we’re plugging in should contribute positively as we get them integrated into the organization, things look great.

Well, and that's where I wanted to go with my next question as we kind of zoom out and look at the next couple of years. You talked earlier about the truck cycle being extended through 2023. Could you maybe expand a little bit more on the parts and service business? How you see that growing in the next couple of years? And then incremental margins as well because I think when you put together the truck cycle with parts and service recovering and incremental margins, that implies that EPS can still grow nicely in the next couple of years, but would love to get your thoughts around all of that.

Sure. I would agree with that. You’re looking at the same-store growth as M&A is integrating in. But I can tell you this, it's accretive. From a margin perspective, I see nothing that’s going to stay in the way of us continuing the parts and service side to continue to grow. We are targeting 8% to 9% growth rates next year, which I believe in parts and service are doable and achievable. We ran 134% absorption, which is a record for us. From a parts and service perspective, that's there.

So just go back to this comment on expanding margin and expense management, you sort of highlighted expense management statement early on in your prepared remarks. Do you see your approach to cost this cycle is a little bit different? Because historically, when things went up, you were very good at sort of keeping cost in control early on in the cycle. But as the cycle got going, costs came back. Can you talk more in-depth about your initiatives internally to sort of change your approach to costs this time around? Because execution seems to be superb.

Thank you, Andrew. I appreciate that. I won't go into too much detail, but we have implemented new processes and controls as we grow. We will limit our spending based on our growth. If our gross profit increases, we will spend accordingly. We refer to this as a salary cap internally; it's designed to prevent overspending. We are ensuring that we have the right staffing levels while managing our expenses. These controls will remain in place, and we will continue to invest at a suitable pace.

Could you just walk us through what you're seeing by key industry verticals, such as residential, non-residential, oil and gas, and corporate customers' waste across the country in terms of macro as you do have a unique footprint.

I don't want to say everything is good, but we’re seeing a slight pickup in oil and gas. The over-the-road business is great, extremely strong because if we’re 40,000 trucks short of demand, that means people are running their trucks longer. Housing and construction are still strong. Demand for garbage trucks is very strong; parts and service in those sectors are strong. Our leasing division has had the most outstanding year they've ever had. It hasn’t all been driven by gain-on-sale; rental utilization is strong, and leasing is going well. Municipal didn’t have fat; school buses were decent.

Can you talk a little about where your parts and service mix might be three years from now, like just sort of the flow of what you're looking at and what you've announced in terms of acquisitions and growth rates and all that? Just trying to give us a little bit of a guidepost.

The growth rates I gave you were on the current same-store bases. We’re going to target high single digits for same-store growth. We want to continue to take share; if the market is up 7%, we want to be up 9%. We believe our initiatives over the last two years should allow that. We have the tools and expertise in place, and we plan on maintaining our plans over the next five years to double our mobile service fleet.

Any unusual opportunities from all these trucking businesses being separated from their conglomerate parents?

I don’t see anything for us right now. My Class 8 OEMs are pretty set. I think there might be other opportunities with new technologies coming, but I'm comfortable with the OEMs. This will be a transition decade, and while transition can create confusion, it also creates opportunity.

Do you feel any need to get into the EV charging business or anything like that, or are you just waiting?

No, it’s not too early. By this time next year, every store in California will be solar and have all their charging stuff in place. We are learning with customers. We have sold electric trucks in various marketplaces. We look forward to doing more in this space, but it's going to be market-driven as to what technologies win out. There's a lot going on, and it's about adapting to whatever makes sense. Thank you. I appreciate everybody’s time. It will be a little longer time period until we talk in February, so I want to wish everyone happy holidays. Enjoy your families and the time that you get to spend with them. We will talk to you in February. Thank you very much.

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