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

Thanks for coming. This is day 1 here at the 2022 Industrials Conference here at Citi. I'm Tim Thein. I am pleased to have the team from Custom Truck One source with us. As you all will hear about a really interesting story. To my direct right, Brad Meader, the CFO; and then to his right, Ryan McMonagle, who is the President and COO; and Brian Perman from Investor Relations is in the audience. So with that, we've got some time to go through a little bit of prepared remarks, and then we'll get into Q&A. And if anyone has any questions as we go along, just raise your hand and I will hopefully see you. So over to you guys.

Great. Thanks again for being here, Tim. Thanks for having us. So we're glad to be a part of it. We thought we would take just a minute and talk a little bit about the story Custom Truck and then obviously open it up to questions. But when we talk about Custom Truck, we really talk about the fact that we are a one-stop shop platform. So that means that we rent equipment, we sell equipment, and then we do parts and service on the equipment as well. A couple of things make us really unique. As you get to know the team, you'll see that we are deep product experts with a lot of truck knowledge. And I think I want to highlight our end markets. So our end markets are a big part of who we are. I've got a page to talk about them. But I think there are really favorable dynamics in the end markets that we serve. And then as you hear about the story of how we've put the two businesses together, I think we're proven on the integration side when it comes to focusing on operations and pulling the two businesses together. And then as you look at the map on the top right, you'll see that there's still plenty of room to grow. So we're 37 locations today, and we're continuing to add to that footprint. And we talk in just a minute about the end markets, which I think are important. There really are four that we play in. The first is T&D or Utility. That represents about 58% of our revenue today. There are really strong tailwinds on both the transmission and distribution side of that business. So that's -- that is the core end market that we serve. Telecom and rail both represent about 5% of our revenue today. Telecom has great end-market dynamics because of the rollout of 5G. Rail is a steady performer for us when you think about that end market. And then about 20% of our revenue comes from infrastructure more broadly. All four of these end markets have very direct impact from the infrastructure bill. We don't see any immediate impact from the infrastructure bill this year in 2022. But at the end of '22 are really heading into 2023, we think that it will be very favorable for us. We talk about a very large addressable market. We think that overall, it's about a $30 billion addressable market for us today. About $15 billion of that is related to new sales, $5 billion is related to the rental fleet and $9 billion is related to parts and service. So there's a lot of room for us to grow. We'll talk about kind of our organic growth story, but we see organic opportunities to grow the rental fleet and to grow the sales side of the business. Rental is obviously core to who we are. When you look at overall rental penetration today, we're at about 25% penetrated. So again, we think it's a good macro tailwind that will allow us to continue to grow rental as you think about the opportunity to grow the size of that rental fleet. And the reason I'd highlighted is because our primary customer, the utility contractor are continuing to perform more work for IOUs and for power producers. And so as they perform more work for IOUs and power producers, we're seeing even more opportunity to grow rental as a portion of our business. When we talk about what makes us unique, it really is this idea of a one-stop-shop. So the first part of the one-stop shop is that we put our trucks together. So that's what we call our production capabilities. So we will buy our chassis directly from Freightliner or from PACCAR or from Ford. We'll buy our attachments directly from Terex or from Versalis, and we assemble those units. We think we have about a 10% cost advantage from doing that. And so for us, it's an important thing that makes us unique. We believe, though, that it's important to take care of the customer however they want to consume the equipment. So whether they want to rent the equipment, they want to purchase the equipment, or they just need help with parts and service. We think that's what really makes our business unique and allows us to really differentiate how we operate as a company. We're proud of our customers. You'll see that there's very good customer diversification here. Our top 15 customers represent about 16% of revenue -- and our largest customer is about 3% of revenue. So we've got very good diversification. You'll see the names on the page, but we're proud of the relationships we have with some of the largest utility contractors and some of the largest power producers and more broadly on the infrastructure and rail side with some of the leading names in these industries today. The branch network is important to our rental fleet. So we're at 37 locations today. We have about 350 service technicians across the country. About 85 of those technicians are mobile technicians so are in trucks and are moving to job sites to take care of equipment. But what you'll see on the map is that there's still plenty of room to grow. So the Northwest in particular, is an area that we're focused on. So Seattle and Portland down into Northern California and over into Salt Lake City. There's opportunity on the East Coast and the Carolinas and up in New York and New Jersey. And so we think that we will continue to open up new sites. Some will be greenfield sites. Some will be small targeted M&A opportunities as well. The two new dots on the location are two additional locations in Canada. We just announced the acquisition of high rail leasing, which is straight down the fairway of what we do. They're a rail rental company. And so very much aligned with how we operate, and we love having those locations on the map for us today. With that, I'll turn it over to Brad for a few comments, and then we'll just...

I just wanted to quickly highlight how we think and talk about the business, and Ryan alluded to you a little bit in terms of the revenue mix. But we do focus our business on our equipment rental solutions at ERS -- we have a truck and equipment sales business, TES and an aftermarket parts and service. And this really is how we manage and how we think about deploying capital and where our focus is day to day. From a rental standpoint, a lot of people are familiar with the common rental metrics, utilization, OEC on rent. The other one that we introduced and we think it really is important is on rent yield and it's our pricing metric. It's where we compare core rental revenue divided by our OEC on rent, and it really gives a very indication as we deploy capital, what are we getting as a return on that unit from just rental revenue standpoint. And then from a new sales standpoint, the one metric that we put out there today is our new sales backlog, which has continued to grow quarter-on-quarter. We'll touch on that in more detail here in a second, and then our aftermarket parts and service business. It's probably the one that's most nascent right now, where we have a lot of investment coming over the next couple of years. We haven't defined what the key metrics are going to be something that we're looking at because there are two, let's say, slightly different revenue streams inside of that. One is an true aftermarket parts business, the stuff that goes on the back of the truck or in the truck and then the tools business, which has an attachment rate relative to what we rent and sell but more to come on those. Quickly, I don't want to get into Q&A with Tim. But from a financial performance standpoint, I just want to highlight here how we've done over the last couple of quarters, really comparing Q2 or Q3, excuse me, of '20 versus '21 and then kind of year-to-date. What I'll highlight here is the up and to the right. Now it's not surprising in '21 versus '20 because COVID started to rebound. But what you'll also notice is margin expansion across the board, good growth across all of our revenue streams and how that revenue and gross profit then flows to an EBITDA standpoint. We have talked during our Q3 call around guidance, full year number of around 330, and we're still on track for that. And then lastly, is on the balance sheet and the strength that we have from a balance sheet standpoint, leverage and liquidity to execute the plan and a lot of things that Ryan talked about, both organic growth and inorganic growth. From a leverage standpoint, when we did the deal and combined with Nesco at the early part of 2021, leverage stood at about 4.6x. Every quarter since then, we've continued to move that number down into the right. We've put out a longer-term target of around 3x leverage. We still think we can do that within that 18 to 24-month time frame of when we announced the deal. So looking really kind of at the end of 2022 or the beginning of 2023. And from a liquidity standpoint, I'll highlight, we just -- we have a ton of capital available to us right now. And furthermore, so if we were to expand the ABL, our current borrowing base is outside the overall size of the ABL with one of the recent acquisitions that we've done. So plenty of dry powder to grow the business also provides a very nice cushion in the event that things were to go bump in the night. And then from a CapEx standpoint, this is the single biggest use of cash for us, and it's where we spend a lot of time focused on growing the business. And for us, on a quarterly basis, we're spending right around $55 million, $50 million a year, so net about $200 million. And you think about from an EBITDA standpoint, it does consume a lot of the cash generated there, but it's all accretive and we feel really comfortable with how we're deploying those dollars. And that wraps it up for the slides I'll turn it over to for...

Good. Maybe we circle back and start with some of the end markets and starting with T&D and you listen to several of the public utilities, they're all talking -- or most of them are talking about a step-up in CapEx, and there's a slew of initiatives, whether that's electrification, grid hardening, resiliency, -- how do you -- when you go through those buckets, what -- as we think about CapEx for utility customers? Is there -- are there initiatives or is there types of spending that's more favorable to custom than another? Or is it all kind of similar in terms of how that ultimately flows through in either sales or rental dollars for you?

Sure. No, I think, broadly speaking, it's all favorable for custom. There certainly are nuances to how the types of projects that they're talking about. So whether it's transmission focused on new transmission lines, which would be a lot of the renewable talk now is the solar is coming online and how that has to be connected into the grid. When you think about hardening and you think about the work that has to happen in places like California or the Southeast from the hurricanes, right? That's good for both transmission work and distribution work for us. So our primary customer is the utility contractor. So in addition to listening to how the IOUs are talking about their CapEx spend, we're looking at backlog for Quanta and MYR and MasTec and Dicom who are all publicly reporting their CapEx, and we're seeing the same thing, right? So they're talking about record backlogs or near-record backlogs in those cases, which is very good for us. And that's where we think the one-stop-shop also wins. So being able to sell them equipment or rent them equipment. In some cases, some of those contractors prefer to purchase more than they prefer to rent. In other cases, they'll use up their CapEx budgets first to buy, but then also need to rent additional equipment also. So overall, it's very good, and we're seeing really good demand on both the transmission side and the distribution side. Yes. I could think of -- when you're talking about the outsourcing to the contractors, I can think of one that I'm aware of anyway, in terms of an activist involved in a utility that owns a construction company saying, you shouldn't be in this business. So presumably, that's all kind of labor availability, all these things favoring a shift towards these -- your big contractor customers. That's right. Yes. And we think -- and overall, that's good for rental, right? It's that comment that we made that the universal rental fleet is growing in terms of the percentage of assets that it owns -- and then utility contractors have a higher propensity to rent than the IOUs themselves.

Got it. And maybe on telecom, I know not a huge market for you today, but presumably, as the big carriers and even like some new entrants like DISH are trying to race to deploy all the spectrum and get up to 5G capacity or get 5G up and running. What -- how does that -- I know in the past, there's been certain kind of nuances where some of the equipment didn't play to companies like yours. What does 5G mean just super generically mean for you in terms of the growth?

It means good demand on the sales side, and that is a more nascent rental market for us. But there's good demand on the sales side. That's where we work with. Terex doesn't have a telecom offering. They don't have a non-insulated product. And so we primarily sell VersaLift, and we sell PAs into those markets, Positives into those markets. And so we're seeing a lot of demand to quote on that type of equipment, and then we are adding more of that into the rental fleet right now as well. So it's very good demand for us there, too.

Got it. I'm jumping around here, but supply chain is going to come up in every meeting, obviously. And you guys have a good view on that. From a chassis perspective, I'm thinking of PACCAR is one of the names you mentioned had talked about some progress that they made in the fourth quarter in terms of getting out some of those red tag trucks. Where maybe from -- because of your scale, maybe you never saw issues. But maybe just from your perspective, what are you guys seeing there in terms of just chassis availability?

Sure. It is still challenged, right? So it is -- we wish that we had access to more chassis, and that's why you see our backlog grow as fast as it has grown. But we do think we're in a very good relative position. So -- and I would say chassis, we actually saw our chassis inventory grow in Q4, and we're seeing that it become less of an issue in Q1 on -- really across the board from Class 5 to Class 8 chassis.

Would you -- taking your scale out, just given how big you are in the vocational market, does an OEM favor getting a straight truck out to you versus an over-the-road truck -- or where would you fit in terms of -- is there a priority for them to -- if they get one chip coming in, where do you guys sit in terms of the priority for that?

Yes, it's a good question. Vocational trucks are about 15% roughly of the chassis market out there. And so I think we're in a good position because of scale. Some of the models of the straight trucks that we consume do use fewer chips, right? So there is an advantage as they're thinking about how they maximize chips. There are some of the models that do require fewer chips, which is a good fact for us.

Got it. It was interesting. I was talking about our utility analyst, and he was -- he had just met with a public utility, and they were lamenting how -- as you call them construction equipment. This was the utility target. The construction equipment was so tight and they couldn't get their hands on it. And because they were so much bidding from telecom companies that basically, whoever the contractor was were saying, unless you have predictable large projects, it's going to be tough for us to get to you. And when I hear that, then I see your utilization, I guess, it kind of makes sense. But just given how tight the rental market is.

Yes, I think that's right. So we're seeing -- and that's where you see really strong demand on both the rental side from a utilization standpoint. And again, as backlog grows. It's where our model is a little more unique, right, because we're purchasing roughly $1 billion of product to either rent or to sell. So we have some flexibility because of the one-stop-shop, which is different than if it was a pure play rental company or just the sales business. So we're seeing the advantage of that for now, for sure.

You mentioned -- and this is the third quarter. Here we are in quite some time has gone on. But when you say 81%, what is a -- and I know there's no hard and fast rule on this, but what is the theoretical max in terms of where you start running into inefficiencies or in terms of how much higher can that 81% theoretically go?

Yes. I mean theoretical max, we view as kind of like that mid-80 like 84%, 85%. Now -- I mean we do have some categories today that are running, and even in Q3, we're running high 80s, low 90s. So it's kind of a mix balance there. But I mean there are -- we are bumping up against kind of that theoretical number every quarter, which -- I mean, if we could deploy more capital, we would grow the business. What it does allow us to do those from a pricing standpoint because that pressure there allows us and you kind of alluded to it, right, if you wanted equipment right now, it's hard to get. It does allow us then to push the price number because if a guy needs it he is willing to pay a little bit more for it. And we've seen that come through in our margins as well, both on the rental side and on the new sales side.

It's interesting because Nesco used to talk about is going back some time where they were short equipment and they had to turn away business I don't know, after -- I mean, I don't know if you can look back on this, but you were competing with them. I mean, is that -- and they never got to 81%. So how do you square that in terms of -- they walked away from so much business because they were short equipment. And I don't know if it's worth commenting on.

I would say it's just an indicator of how strong demand is in the markets that we serve. So I think we are in a better position because we have assets, but look, there still are opportunities that we're not able to fulfill because of the supply chain, in particular. But I think we're in a much better relative position because we have inventory on the ground that we can quickly deploy into the rental side of the business, if that's where the demand is. But I think it's just another indicator of how strong demand is right now.

The other thing I'd add to it, I think it does reflect a little bit of a difference in the business model, right? And where we win because of it, historically, Nesco relied on an outsourced service model to maintain the fleet. And that's one of the things that we have found to be incredibly important is if you can control your fleet better by maintaining it, turning it faster, you can hold a higher utilization. It's one of the things that we've been focused on a lot over the past year, year-and-half is that turn rate on the assets and getting those quicker through the shop because the faster we can turn it, the faster we get it back out utilization stays at the higher level. So I think we've demonstrated to ourselves or the importance of having a large, well-established service network that you can control. That's why when you look at our map, right, where we're so spread out and where geographic presence really matters. Is the more places you have, the more technicians you have working solely on your own equipment, the better off you're going to be from a utilization standpoint, which is not something that Nesco had in their -- the previous model.

You mentioned rates. What is -- I guess, from a positive side, you're going through in kind of revamping your -- maybe revamping is the right word, but going through with a new pricing strategy at a time when the market is as tight as it is, maybe just a word or two there in terms of what was the impetus for it? What is the goal in terms of what you hope to achieve with this new pricing strategy? -- you're getting higher rates.

Yes. I think there's two things to it. One, the impetus of it was -- there's two parts. One was a recognition of the supply-demand imbalance that existed. So just kind of the natural way of things, right, the tighter the supply with increasing demand, you can charge more for the products. So we recognize that, push that through. But I think there's a more fundamental component to it and a lot of it was data-driven as we better understood the performance of both of the fleets and looked at the customer breakdown, the customer mix, the rates that we are charging and the disparity kind of between those, it forced us to take a step back and say, let's recognize tiers, kind of who's running more, who's renting less and drive rate through a tiered strategy. And we always had it, to some extent, but this is a much more formalized way and I think it has greater sticking power than just the fluctuations in supply-demand. and it really has started to take hold. And we implemented that in late Q2, early Q3, we started to see some really quick wins for us where rates -- new rates were going out in high doubles -- excuse me, high singles, low double digits above their predecessor rate. For us, to get it through the financial performance, though, our average contract duration is one of the benefits to us. Our average contract duration is about 11 to 12 months. So it takes us historically about a full year to turn over existing contracts. We have learned several times in the past, right, you don't raise rates on customers on existing units. It is a bad way and it is a really bad taste. They don't mind paying more for a new unit going in, but raising the rate on an existing contract, they've already made plans around that. So again, that's why it takes us a full 12 months to cycle through. The important comment there is if contract duration starts to stretch, right, that turnover cycle is going to take a bit more time. We know the rate increases are real and they're happening, but the pace at which it will cycle through is all dependent upon the turnover rate. The good thing if to keep mind, too, is if the rate -- the turnover rate doesn't increase, then you're still benefiting from higher utilization because the unit doesn't come back to us to have to touch. So we may not get rate improvement immediately. We're reducing our repair and maintenance costs. So we still see the kind of the overall P&L impact. But we do think it's still another 12 months or so before we'll see the full effect of the rate increases.

Got it. And is the -- I mean, that's something where you talked about in terms of using more -- a higher level of data management and just as you think about the general equipment rental segment, I mean that's something that going back several years now, the industry would say, "Hey, we got smarter on rate, but there were some scars to show for it." Do you think the level of sophistication in the industry and what you're competing? Is that still to come in terms of how widely used is this? Or is it still a lot of local decisions being made by local salesperson that may not be -- there may not be as much control over that as you're managing it in-house or at the corporate level.

I think we've tried to bring a lot of the pricing decisions internally. It's centrally managed, just so that we've got better standards as we're thinking about how we take care of customers kind of across the country. So we're doing our best to internalize and to centralize more of those manages.

I'll pause there. I don't know if anyone has any questions or, yes, go ahead.

[Technical Difficulty]

Infrastructure bill, the plan.