Custom Truck One Source, Inc. (CTOS) Earnings Call Transcript & Summary

Good afternoon, everyone. We are here with the Nesco Holdings management team. Nesco is one of the largest specialty equipment rental providers with a growing electric utility, transmission and distribution, telecom and rail industries in North America. With us are Lee Jacobson, the CEO; and Dyson Dryden, who's a Board member. Lee has been with the company for nearly 20 years and -- sorry, Lee has nearly 20 years of equipment rental industry experience, having joined Nesco as CEO in 2012. Dyson is the Board member. He was the President, CFO and member of the Board of Directors of Capital Investment Corp. IV from inception until the completion of business combination with Nesco. Throughout the presentation if you would like to ask a question, you can do so by clicking the Ask a Question button on your webcast screen. With that, I'll turn it over to Lee.

Thanks, Chandresh. Thanks, everybody, also for joining us on the call today. I'll try to move this -- through this pretty quickly, so that we have an ample amount of time for Q&A at the end. If you'll turn to Slide 3. So Nesco highlights. I'll touch on a few. We think we address 3 fantastic end markets: transmission and distribution, telecommunications and rail. Between ongoing significant maintenance requirements of each of these 3 end markets, plus new initiatives that are driving significant additional investment and spend requirements, we see each of these markets as extremely stable as well as providing significant growth opportunities. And whether you look at electric utilities, replacing their aging grid, integrating new renewables, hardening to avoid the impact of storms or telecom with pending 5G rollout, the fundamental CapEx to support the freight and commuter rail situations, each of these end markets has a high stable level of maintenance and a significant opportunity through new investment. We're very fortunate as a business. We get to do business with a customer base that we've been able to nurture and develop over an extended time frame. Our top 10 customers have been with us on average of 17 years. And within our broad customer base, we enjoy 91% reoccurring revenue with those customers. We think that's a significant achievement. It really tells us that we have the right value proposition, and we're able to deliver it consistently and effectively to that customer base. In recent years, we've experienced really strong financial growth, and we're also able to realize very attractive unit-level economics. We've experienced a 17% compound annual growth rate 2016 through 2019 in our adjusted EBITDA as we grew from $79 million to $127 million. We're able to achieve a very high level of EBITDA as a percentage and that overall EBITDA performance because of our fantastic unit-level economics. We're able to realize on equipment as much as a 30% IRR from investment in that equipment over its rental life, and we'll talk more about that shortly. We've experienced this growth in an environment where we really haven't even been fully able to take advantage of the opportunities in front of us. We passed on thousands of new rental opportunities, 2017 through 2019, just simply because of a lack of equipment availability. We think as things adjust to normal that we'll see a return of that level of demand, and we have a tremendous opportunity to continue to grow organically, just providing the same type of equipment to that same customer base to meet unmet demand that we previously had to pass on. In addition to that, we have significant opportunity for sustained growth in our Parts, Tools and Accessories basis -- business. Parts, Tools and Accessories is a fantastic complement to Equipment Rental. Any customer has to really mobilize 3 things to execute their work on the job: Manpower, equipment and then parts, tools and accessories to outfit the equipment and the team. By entering into the Parts, Tools and accessories business a few years ago, we really strengthened our value proposition to our customers, and it's fundamentally a terrific business, I'll talk more about. If you would turn to Slide 4. As every company in America, we've made significant adjustments to mitigate the COVID-19 impact to our business. I'll touch on a couple of these. First, we have taken headcount reductions in growth positions as well as taken advantage of this situation to eliminate performance outliers. We've also frozen hiring, reduced nonessential costs connected with travel, discretionary spending and so on. Last, we've taken advantage of one of the only -- what we believe, the only federal program to be available to us, we've deferred our payroll tax payments out to 2021. The most significant changes we made are in capital spending. We've reduced our CapEx plan for 2020 by 1/3. Overall now, that will represent a 50% reduction from our 2019 realized CapEx. In addition, we've reduced our investment in inventory for our Parts, Tools and Accessories business. We had a very aggressive growth plan for 2020. And with a change in that overall curve and a delay in the growth opportunity, we've significantly reduced our investment in fleet and are seeing now a reduction in overall inventory levels. As we look forward, we've got a playbook for both scenarios that we could face. First, in the event of continued declines in the overall business environment or a quick reversal, we have a 3-phase program. We're in Phase 1, and additional phases, contingency planning in the case of adverse conditions in our marketplace. We've also begun to plan for what we expect to be a ramp-up in our markets. As I mentioned earlier, we think we address fantastic markets that are typically late into any recession. They have a high trough typically, and they're early out. We believe that will be the case this year, and we've begun to plan a ramp-up and return to more normal activity levels. Slide 5. Slide 5 is really probably the most exciting part of our story today. Nesco has grown significantly over the past few years. And with that, the demand and skill set of our senior management team have grown proportionally. Over the past year, we've been able to add significant top grades and additional personnel to deal with that overall growth in our business. And you'll see on Slide 5, a number of these. Rob Blackadar joined our business almost exactly a year ago. And as we moved our way along towards the merger with Capital and becoming a public company, this was a vital addition to really bring on expertise in the equipment industry and the rental market as well to give us the skill set to allow us to deal with the extra demands of being a public company. Just this week, we announced the addition of Josh Boone to our team. Josh will be joining us next Monday. Josh represents a terrific addition to our overall business. He's got experience as a CFO in a public company as well as great experiences in growth and M&A situations. And he's got a proven track record of building a successful finance function within a public company environment. We're thrilled by his addition and look forward to him joining us next week. We've also got some other additions, as you'll see on this slide. Overall, I'd comment on 2. Mike Turner has just recently joined us to take over as President of our Parts, Tools and Accessories division. Mike has 25-plus years at Anixter, a company that's deeply engaged in the distribution of parts, tools and accessories, including to our space. And so Mike is joining us from Anixter, we think, will be able to take that business to the significant growth plans we have and do it very effectively and efficiently. And second, joining us next week is Chris Hulse as a Chief Digital Officer of our company. Chris is joining us from a past assignment at Blueline Rental, where he very successfully deployed digital tools to that business and really upgraded the state of their technology. We're looking forward to the same thing as Chris joins us next week. So fantastic additions to we think now have truly a world-class management team addressing the specialty equipment rental space that we're in. If you now move to Slide 7. So just a quick overview of Nesco. We are a specialty rental equipment provider. As I mentioned, the 3 markets: transmission, distribution or utilities, telecoms and railroad. We do provide, by the definition of the government, critical infrastructure maintenance services. As a result of that, we've been able to operate daily throughout the coronavirus infection period with very minimal disruption to servicing of the equipment and servicing of our customers. We have taken all the necessary precautions with the employee base. But fortunately, we've been able to operate on a sustained basis. You'll see in the rest of the material on this slide, we had a couple of interesting diversifications of our business that have really been successful in accelerating our growth. We entered the parts -- excuse me, we entered the telecom and rail markets in 2016. We've developed that business to $151 million of OEC on rent and a $47 million slice of our revenue curve in 2019. Terrific gain. We entered these 2 markets because quite simply, we saw the opportunity to deploy same equipment across the broadened customer base, and we've done so successfully, we think, gaining 20% market share in the telecommunications space and 10% market share in the rail space just over a 4-year time frame. Also, at that same time, we entered the Parts, Tools and Accessories business. Our customers really do call out 2 things that they need from a supplier in their mobilization. They take care of manpower. They're looking for suppliers to provide equipment. And now we're able to be a supplier of that third leg, Parts, Tools And Accessories to outfit the crew, the job site and the truck. We've been very successful at that, building a business to $47 million in revenue line last year, compound annual growth rate of 52% and quite significantly, realized 32% of our revenue from rental. Interesting businesses all addressing those 3 combined markets, we really think we're in a great position to continue to grow with these excellent markets. Slide 8. A quick overview of our fleet. We had 4,600 units, 3.4 years of average unit life against a useful life of up to 25 years. This is unique equipment, not seen in the portfolios of the general rental companies. I say often that if we have a product line that's in the United fleet, Sunbelt fleet, et cetera, one of us has made a mistake, probably us. We continue to stick to highly specialized equipment in our business. Slide 9. I commented earlier on attractive asset level economics. You'll see here that for our most common product lines, 600 units out of the 4,600, we generate a 29% unlevered IRR through the rental activity for 7 years and then sale at the end of that 7-year period. Tremendous IRR and a 2.5x MOIC. That same asset can be remounted, the upfit, remounted onto a new chassis. We begin to experience an increase in our maintenance cost at about 7 to 8 years, and we look to either sell that unit or we can remount it in many product lines. That remount activity sustains at 29% IRR and produces a 3x MOIC. So awesome asset level economics within the fleet in the market we serve. Slide 10. I previously commented on our outstanding customer relationships. I'll just add this. You'll see on this page, the largest contractors or infrastructure sponsors in each of the 3 markets that we serve. Each of these are our customers in the top 10, again, 17-year average tenure and a significant amount of our business, we deliver the right value proposition consistently and well. Slide 11. This is our geographic footprint, quite different than general rental. Each of our locations is not a storefront. It's focused on the servicing of our equipment. Because of that, we're able to leverage both the low overhead as well as the footprint to take care of 100% business-to-business customers with an extremely low overhead and very effective delivery mechanism. You contrast that to the storefront, looking to serve both business-to-business as well as business-to-customer of general rental, quite a different model and one that we think is very fundamental to our production of a high level of EBITDA, low overhead facilities. Slide 13. So Nesco addresses 3 end markets that I've mentioned that on an annual basis invest in excess of $100 billion in annual CapEx. You'll see each of the respective contributions between T&D, telco and rail. Probably the most interesting things on this particular slide are the compound annual growth rate. 2001 to 2018, these 3 industries experienced a 7.7% compound annual growth rate, nearly twice what GDP is. And at the same time, these markets had a very low correlation to GDP, 0.5. If you turn to 14, we'll talk more about the impact of that. On Slide 14, upper left represents Nesco's industry -- end industry exposure. We have 81% of our 3 market revenue generated by T&D, 14 telecom, 6% rail. Two important points to make. We have less than 1% of our fleet deployed to the oilfield on March 1 of this year. We also have less than 1% of our fleet dedicated to general rental at that point in time -- or excuse me, general construction at that point in time. And if you look at the pie chart in the upper right, a significant difference between our sales and other specialty rental companies, 41% general construction exposure and energy of 5% overall fleet exposure. So we're very concentrated in these 3 end markets, and we think these 3 end markets are excellent for multiple reasons. The lower half of that page really portrays one, 2008, '09 and '10, the T&D market was up 0.1%, telecom off 4.5%, rail off 9.8%, and that compares to a 25% decline in general construction. So as we talked about on the last slide, we've got a very solid growth in excess of GDP. And we -- also, as this projects, we have a very solid floor. So again, we believe our end markets are late in the downturns. They have a high floor, and they're early out from a recovery perspective. Slide 15. I've talked a lot about our end markets. Just a couple of quick comments. There's significant investment beyond maintenance that's necessary in the electrical utility markets. First, replacement of an aging grid; second, integration of new generation sources, renewable and gas, displacing other fossil fuels; and then there's just generally, the electrification of our overall world and country. All significant drivers of growth opportunity for us, as projected in each of the 3 bar charts at the bottom, the compound annual growth rate in transmission projects, '18 to '20 of 12%, significant backlog growth for Quanta over this time frame. And from '17 to '19, significant growth in MasTec's backlog. In telecommunications, obviously, 5G is an exciting opportunity for all of us as a consumer or as a business. From our business perspective, huge opportunity. We essentially have not participated in 4G and prior technologies because we didn't quite have the right equipment. We have the equipment that's a dead-on fit to the needs of 5G. And with 5G representing 20x number of installations as 4G and fully a decade-long deployment, we see this as a fantastic opportunity, and we are just at the beginning of it. You'll see again, in this case, forecast of significant growth and investment, Dycom and MasTec both are showing significant rises in their overall backlog in this area. Next, on Slide 17, rail. Huge amounts of spend are committed to support growing commuter rail demands. In particular, you could look at Southern California. Over the course of the next -- nearly a decade, there'll be $16 billion spent to support the Olympics in 2028 in Los Angeles. When you take a look at other opportunities, Dallas to Houston, North to South of Florida, Northeast quarter rebuild and the Midwest, significant opportunities in rail, including commuter rail, and it's an area that we participate in fully and look forward to continued growth. On Slide 18. One of the phenomena that is working in our favor from a growth perspective, the growing use of rental as the supply source for equipment on job sites, complemented by the growing use of outsourcing, whether you're an industrial utility, telecommunications company or rail, you're growing your outsourcing to the contractor base, which uses rental as a fundamental equipment availability strategy. I'll move now to Slide 21. So our growth strategy really has these legs: first, invest in fleet to meet the excess demand out there. As I mentioned earlier, we've lost significant opportunities just due to a lack of equipment availability. And you can see '17 through '19, significant lost opportunities. We fully anticipate after we get past the impact of the virus to continue to grow our fleet and more importantly, in the near term to regrow utilization to levels we were at previously. And overall, there's obviously through '17, '18, '19 results, significant unmet demand and the potential for growth in our business. Next, on 22, our Parts, Tools and Accessories business represents a very significant growth as we look forward. We started this business only in 2016, excuse me. We have seen 2 acquisitions to really support the rental side of this business. We now are able to manufacture goods that we can either take to rent -- our rental fleet or to sail eliminating 1 layer of price competition in that. In 2018, we realized 17% penetration of our equipment rental revenue in our PTA business. In 2019, that grew to 24%, and we really see a significant level of opportunity to expand that growth and penetration over the ensuing years. On 23, over the course of my time at Nesco, we've done 7 M&A transactions, about 1 per year. You can see we've been very successful at negotiating favorable multiples of EBITDA, and then even more successful at taking those down to a 4x multiple after synergies. We see opportunities like this continuing as we see opportunities in more of the small and medium-sized acquisition deals within our core space. Dyson, do you want to cover the financials on Slide 25?

Yes. Thanks, Lee. So first, let's talk about the Q1 financial performance here on 25. Revenue growth was approximately 33% to $81.7 million in the quarter, and the adjusted EBITDA grew 5% to $32.1 million. Importantly, gross profit year-over-year increased 12% and rental gross profit increased 8%. So a strong quarter heading into the coronavirus. On the next page, we highlight the revenue growth over the past 4 years, which has been growing at about a 12% CAGR. We have 2 segments, if you're not familiar with NESCO. There's the Equipment Rental and Sales segment, highlighted in blue and the Parts, Tools and Accessories segment in gray. I think you can see to Lee's earlier point, just the nature of the faster growth in the PTA is that business, which just started a little over 4 years ago. At the end of 2019, for the full year, $264 million of revenue that represents an 81% average utilization, rate per day of $137 and on 4,172 units. I think one thing just to highlight is you see the average rate per day declined year-over-year. That was due to mix. As Lee mentioned earlier in the presentation, we've been growing the telecom and rail segment more quickly than we had grown the legacy T&D space. And those areas have lower OECs generally, so thus they have lower rates. And so although rate has been increasing, the mix overall looks like it's been flat or declining. On the next page, we highlight the significant EBITDA growth that's resulted in 17% CAGR over the same 4-year period, and margins have also increased up to 48% in 2019. As the PTA business does continue to scale at a greater rate than the legacy Equipment Rental business, you will see an impact to EBITDA margin over time. That said, the core margins of each segment remain robust. The other important point is just that the company has really completed its investment and its footprint. Really, it's SG&A. So there's a significant amount of operating leverage as we look forward to future growth in the business. And lastly, on Page 28. This business is a very attractive unlevered free cash flow profile. One point is the company does have $285 million of federal NOLs and $200 million at the state level as of the end of year 2019. But as you can see over the 4-year period, unlevered free cash flow has grown at about 17% CAGR. If you just point to the column on the right side of the page, which is 2019, I think important -- a couple of important stats here is, one, as you think about capital and maintenance CapEx versus growth, there was $37 million of maintenance and $73 million of growth CapEx. That was offset by $29 million of cash from the sale of used equipment. And so one of the things I would just highlight is the definition of maintenance CapEx. We define it as the estimated cost or a place equipment that was sold during that period in order to keep the fleet count constant. So really strong conversion levels in the high 80s over the last 2 years. With that, I'd try to leave a little time for questions. Maybe I'll turn the call back over to Chandresh to see if there are any questions.

Sure. Thanks, Lee, and Dyson. Just in terms of instructions in case if anyone has any questions, please click the Ask a Question button on your webcast screen. As we collect the questions, here's a couple to get started. So Lee, could you give an update on your dialogue with the contractors working for utilities on their activity levels for the rest of the year, including specifically for the contractors and utilities based in California?

Sure. Overall, our contractor customers are reporting a high level of backlog, whether it's distribution projects or transmission projects as activity that had originally been contemplated in the first half of the year has been deferred. We're not really aware of any cancellations of activity. And so there's the potential for a very robust second half if the utilities basically release that level of work that's pent up. As it relates to California, California, as you know, experienced a couple of years ago, very extensive fire damage, fires reaching out of control, significant property damage and fatalities. Each of the utilities, each of the large utilities, investor owns in California have made very aggressive proposals to the California Public Utility commission around vegetation management, hardening, replacement and just basically investing in their infrastructure to basically boost their overall returns as allowed by the CPUC. A lot of that activity has been deferred, again, because of the health crisis, and we expect a very robust level of activity picking up mostly in distribution actually in this second half of the year if the dialogue is -- translates into the action that the contractors expect with the utilities. We've also spent time with each of those leading utilities, and that is currently their expectation and plan.