REV Group, Inc. (REVG) Earnings Call Transcript & Summary

Good morning, everyone, I am Courtney Yakavonis, Morgan Stanley's U.S. Machinery Analyst. And next up, we have REV Group. But before we begin please note that Morgan Stanley Research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. So REV Group is a designer, manufacturer and distributor of more than 30 specialty vehicle brands, including fire truck ambulances, buses and RVs. We're pleased to have with us today, Rod Rushing, CEO; Mark Skonieczny, REV's CFO; and Drew Konop, Head of IR. Rod, Mark and Drew, thank you guys so much for being here today.

Thanks, Courtney.

Thank you.

So I'll kick it off with some questions, but we do have a live webcast where you can submit questions, and I would encourage you to do that via the question box on the portal. So maybe just starting off, Rob, if you can just comment, you joined the company about 18 months ago after a long tenure at JCI. And were tasked with turning around this business in the midst of the pandemic. What were your key priorities? And what actions you've been taking to simplify the business over this time?

Yes, sure. So it's interesting when you walk into the situation, you have an idea what you want to focus on, what do you want to do, what you think, you want to go validate some things, but certainly walking into this situation, arguably right in the middle of the launch of the pandemic, things change. So getting -- we quickly -- and the team has already wrapped around this when I walked in the door, making sure that we had a working environment that was as safe as possible, was obviously the #1 priority, Courtney. And so understanding, taking the guidance and trying to realize that down into our plants. So we are providing a safe working environment in alignment with the recommendations that were given. But also that balance with the fact that many of our businesses I should say most of our businesses were designated as essential. And so we had a responsibility to keep up because we're producing vehicles that we're actually observing the front lines of protecting the citizens of the country. So that balance of protecting our employees while keeping things operating was something that was really, really important to us at the time. So that took a lot of the early time thinking. So once we kind of got through that, there were some obviously, some underlying business considerations around liquidity and things we were managing through as we were a little challenged that time. Our leverage was around 6:1, which was not where we wanted to be. So we had all hands on deck to make sure we were doing that as well. And then as we emerge from COVID, or I should say as COVID began to stabilize, and we got to more of a reasonable operation, we quickly got the team aligned around where are we going to go? What are we going to do? And it was a lot around understanding what the charter was going to be in terms of turning this business around operationally what the strategic charter was going to be around how we're going to grow this business and then really how we're going to organize and execute and run this business together and getting the team aligned. And obviously, with that, there was a lot of transition in roles, there's a lot of transition in people. And there was certainly a change in how we were running the business day in and day out in terms of the priorities. And we focused over the last 15 months, say, on those things. And we're in a much better path, best better spot right now with our one data point, our leverage ratio now is below 2:1, like 1.7, 1.8:1. So we've been able to emerge from this much stronger, much -- in a much better spot, much more execution-focused, with great backlogs and great strength in our margins and in our backlog as well. So we're pretty pleased with where we are in the business relative to the progress we've made in the 15 months in the face of a pretty significant set of challenges. So a long answer, I apologize, but that's kind of the story.

No, that's a great launching point. And I'm sorry to say I'm going to dive into some of those challenges next. Just on the supply chain margins, everyone across the machinery complex is seeing significant challenges over the past couple of quarters. You've called out some conductors, furniture, wiring harnesses, chassis. Can you just give us an update on the situation where this pressure is most acute right now? We got an update from you guys a couple of weeks ago. But if there's anything additional that you can comment on about how the supply chain situation is progressing.

No, there really hasn't materially been much changed since our conversation that we had on our Earnings Day. I mean we're still facing the challenges day-to-day of component level challenges that are in the industry, be it RV, be it in our emergency businesses. We -- obviously, chassis is an underlying, probably the one that we talk about the most because it's the biggest scaled issue we have and it also prevent starts and starts are really, really important in the business. We can always build and hold. We don't want to do those things that we want to keep continuous flow. But if you can get the start, at least you can generate a product and try to keep on schedule for a customer. When you don't have a chassis, that's a higher order of problem to have because you can't actually start anything until they have that. So I would say, but nothing materially has changed in the last 1.5 week to 2 weeks, Courtney, over what we kind of talked about in the earnings call. We're still battling there. Our purchasing organization, our materials folks in our businesses are working very closely with our suppliers to keep flow and keep our businesses running and delivering product to our customers. But the challenges are still there, and we're working through them every day.

Maybe just on the chassis side. obviously, several of your OEM partners have announced that they're idling production because of some of these chip shortages. Can you just help us understand which of your product lines use source chassis from which auto OEMs and then also the ones that you produce your own chassis for?

Yes, I can take that one. So from the commercial side, as we talked about, our Collins Bus, we use about 90% of our buses are built by the GM chassis. We use GM and Ford in that business. And as you referred to, Courtney, GM has been closed for the facility that provides our chassis. So we announced in our earnings call that our Collins facility, our Class A bus business would be closed because of that because we haven't received any chassis since the end of July. And then likewise, in the Ambulance business, it's more or less the opposite where we rely on Ford significantly for vans as well as for the E-Series type chassis that go on our ambulance business. And then in RV, it's a mixture of Mercedes and Ford, a lot in our Class B business, which is the small Sprinter that are built. Those are built on Mercedes Sprinter chassis. And then we have our gas chassis, which are forward board-based products. And then the larger, obviously, are tied to Freightliner, Volvo and those sort of larger -- but we tend to talk more about the domestic OEMs as well as Mercedes because those are the higher velocity units that we are producing. So those are the ones that Rod referred to that would cause a problem. And we quoted that we have $50 million dollars of revenue that hasn't started in the quarter in Q3 because we did not have a chassis in order to start the flow of those products. So it's really a mix, but the 3 biggest ones would be Ford, GM and Mercedes.

And then I would add to that, Courtney, on your kind of chassis we build, obviously, in our Class A RV business, we build those chassis in our transit bus business, ANC municipal transit buses. We build those chassis. We built chassis in our capacity business, which is terminal trucks. And we also build our chassis in the fire business, although we do also build on commercial chassis in the fire business. It goes to the Freightliner, the larger, and it's a commercial product offering that's in the fire business as well, but it's a smaller part of the volume. But in those businesses, we primarily make our own chassis.

Maybe switching on then to material inflation since you do make some of your own chassis. I think we've largely thought about steel as being a pass through on some of the chassis that you source. But can you talk about how much exposure you do have to raw steel. And I would imagine it's highest in those segments that you just mentioned or in those product lines you just mentioned? And what other materials are you seeing significant price inflation in currently?

Yes, I think when we look across -- and again, when you look at our $1.5 billion sort of spend, about $0.5 billion is in chassis, which you referred to as a direct pass-through to the customer. So we're talking really about that $1 billion of spend that's left and the level of magnitude on raw commodities, steel and aluminum is about $40 million, steel is just short of $20 million. So the actual raw material components aren't that significant compared to the whole $1 billion, most of our exposure is to the component supply where we buy subcomponents and then our suppliers are exposed to inflationary pressures on those raw materials. But we've been very happy in the last couple of quarters not only with the price increases that we've passed out to the market and surcharges, but the fact that we've been able to offset some of the inflationary pressures as well with either resourcing or doing e-auctions, things that we talked about in our Investor Day around things that hadn't been done previously over the last few years as far as diversifying our supply base. And we gave examples where we're actually seeing reductions even in this inflationary period. But the steel, plywood, aluminum are the typical ones that we would see that are higher content from a raw material perspective, we are seeing. I think everyone's starting to see plywood come down a little bit in pricing, but we're still seeing the aluminum in steel. But at the end of the day, our price/cost has been positive over the last 2 quarters. So we continue to outpace inflation through commercial pricing surcharges as well as peer to peer savings reductions that our procurement team has been able to deliver.

That's encouraging. You talked that your price cost has been positive. Can you just help us understand how much has been via pricing versus some of these actions that you talked about. So what pricing are you getting in your key products? And then given the size of the backlogs that you have today, how should we think about pricing going into 2022, given the level of the backlog? And would you be willing to reprice it if we continue to see some of these pressures?

Yes. We wouldn't be able to reprice, and we've talked about this. On the municipal side, obviously, we benefit from a work cap perspective that our customers have a budget and then give us a lot of deposits on those units. So that's when we went to go out and reprice the backlog on our Ambulance business. We have come out with proactively with increases, but then also surcharges tied to those increases. On the RV side of the business, we have been successful in repricing the backlog, so the dealers are taking repricing of the backlog in orders and then passing it on to consumer. So we've been happy there so from that perspective. And so I wouldn't look at repricing that and then commercial side where Rod was talking about where we make majority of our chassis other than in the Class A business. We have tied increases as well as surcharge. So we're starting going two-pronged approach. We've passed on our normal calendar-type increases with our peers and then also done surcharges where we have seen commodity inflation. So -- but the good news is we have spent a lot of time in the last 6 months looking at how we quote our product and what our cost of our product is, what the inflationary pressures are that we need to look ahead when you're delivering 12 months later. And for instance, in the fire business, you need to make sure you have appropriate inflationary factors there. So as we looked at our backlog and the work that procurement is doing in the savings, we believe will still be positive at a cost price analysis through our current backlog -- what's in our backlog.

Understood. Maybe just on labor. You talked about some of your plants are seeing some significant employee absenteeism. Can you just talk about how turnover is? And what impact wages and productivity are having on the P&L?

Yes. So on the labor side, as we exited last -- our absenteeism and our turnover right now is running very similar to what it was last year during kind of the peak COVID time, maybe slightly below that, but it's also very localized. I mean last year, it was more broad spread in terms of what we were seeing. So when you look at turnover, though, against historical averages, we're not that different than where we've been historically. And those numbers, we don't typically talk about exactly what those numbers are, but we're right about where we've always been. And on an absentee side, we know that it's really localized. Florida has been hit pretty hard. We've had some challenges in Indiana recently, but a lot of our plants are actually doing quite well in this relative to the COVID. We don't have seen a lot of cases in some of our plants. So it's very similar to last year, Courtney, I don't think there's been -- it's been very localized as well. It comes. The huge impact it really affects flow and then -- and then it's gone, right? It's kind of one of those things that we're seeing.

On the P&L side, it's really a double-edged sword because we're short 400 people, what we would say to get our line rates, but we can't get our line rates up right now because of the supply chain challenges we're having. So that trapped labor that we would have experienced had we had the components or if we didn't have the components, would have hit the P&L. Right now, we don't have the people there. So it sort of neutralized itself. But obviously, we'd like the supply chain to catch up. And then our bigger challenge, I think, going forward, will be getting the labor as the supply chain wanes here. Getting the people to increase our throughput to eat through the record backlog that we're sitting on right now.

Maybe you can just comment a little bit about guidance. Obviously, you took a significant raise earlier this year, tweaked it down slightly because of some of the factors that you talked about. I think your sales expectation came down about $150 million last quarter. Can you just aside from the Collins impact from the GM chassis, can you talk about what the other components of that $150 million were and when you would anticipate them resolving?

Yes, I think from that perspective, it's really around timing. And as we exited our Q1 heading into Q2, and I think the OEM saw a momentum where they were starting to get their chips, and we are being communicated that our deliveries would hit in Q3 and Q4. We saw that up through our June period in July. We had a significant amount of chassis cancellations from our supply base. We're still hearing that, that's heading into a '22 type of time frame from our suppliers. But when you look at the 150 miss other than Collins, which was $30 million, $25 million, $30 million we quoted. We did have $65 million within the quarter that is really component charges, not the fact that we don't have the chassis that moved right within the quarter. And then we had $50 million of starts that obviously, we don't start in Q3 with our lead times, you're not going to deliver it in Q4. So there's about $110 million there and $30 million or so for the Collins closures. That's sort of how you wrap your head around the $150 million of revenue. With that said, we've been very happy with the conversion to the bottom line and our ability to still deliver 7% sequentially, both in Q2 and Q3. So really -- some of our operational disciplines are really taking hold, and we're able to even with the revenue drop that we're seeing, still deliver quality earnings and then our cash flow, as you saw in our earnings call, has been very good. So our cash is well ahead of the 90% long-term conversion rate that we're looking for. And that's really twofold. One is the inefficiencies I've been talking about for the last year on our balance sheet, making sure we're ordering inventory when we should. We're working with our customers to get paid on time and then work with our supply base to make sure our payment terms are market competitive. So we've been working all those angles on the balance sheet as well.

Maybe you can just talk a little bit about your Investor Day targets from your Investor Day, this past spring, you talked about expectations for sales to compound through 2023 and reach about $180 million of EBITDA. I think it's -- the assumption would be if these supply chain issues are gone by 2023, all those targets should still be in. But can you just talk a little bit about the drivers of the consolidated target and then also the individual segment targets?

Yes. I mean, as we talked about in our Investor Day, and personally, I do agree with what you said, Courtney, I think we're holding and maintaining what we talked about in a day in terms of our 2023 view of the things. But a lot of the discussion we've had from day one until -- and certainly at the Investor Day was much of our store around value creation is around improvement inside the backlog that we have now. So it's getting more efficient at what we do using leveraging, purchasing as an opportunity for margin expansion for us, certainly on the peer-to-peer basis, but obviously there's price cost as well. The other piece of this is there's a significant opportunity for us from a design standpoint, a little longer to get to when you think about VAB because it takes engineering changes to get to some of the material and labor opportunities. But those cost elements of the business are a big part of that. That's really around just executing our backlog more efficiently. The other piece, we'll be executing our backlog more quickly, which is our flow through. We think that throughput, the velocity of our business that with the right type of lean activities that we can get much better on how we give products through our plants, which will ultimately lead to us using -- going through our backlog workload and giving us better lead times which I believe will be a growth lever for us as well because if you can give industry-leading lead times, a lot of these markets are very responsive to that, and we think that's a differentiator for us. That's not something we focused on historically as well. But I think that's something that will help us not only from a customer standpoint, but more throughput, more volume across fixed cost, more margin. So there's a big operational piece of this. There's a piece of growing in market. But I also think that there's -- we continue to see opportunities through innovation in some of the markets where we have a lesser position that we think that we actually have an opportunity to grow and gain some share in those being our markets like the RV market, transit markets, things like that. And then finally, as we -- I think the thesis behind the company at the beginning was these are largely fragmented markets that we participate in, and we are kind of the default natural consolidator, and there are several opportunities for us from a tuck-in standpoint here in the near term that I think we can take advantage of that we just got to go get through it and work with a potential partner to get that done. So it's largely an operations execution story. It's large around disciplines around those elements to get the margins where they need to be, but there's also opportunity for growth here that I think is most organic and inorganic. And it is all this while we continue to work to be more effective and more efficient on our cash and whatnot, Mark, I don't know if you have anything you want to add to that.

That's right.

Maybe moving on to electrification and alternative propulsion. At a high level, what are your views surrounding how 0-emissions vehicle penetration will progress within your different product types? You obviously announced the Lightning eMotors partnership for some of our product lines. But help us get a sense of how you're thinking about whether it's by the 2023 targets, if you're going to have any significant electrified business product lines or beyond that?

Yes. So I think the key thing for us, the foundational piece for us is that each of these end markets are -- operate somewhat independently and are more or less attractive to the transformation or transition to EV. From an early adopter standpoint, you certainly go to transit because transit's, the routing, the use case, these federal subsidies to enable it. It will be, in our view, an earlier adopter, and it already is a leading adopter of EV and alternative fuel cell type technologies. Then you go to -- maybe go to a school bus scenario. In the school bus space, you have the larger school buses, which is what people are more used to, which is a Type C. We don't build the Type C. Those are typically diesel. There's federal subsidies for that as well. We build the Type A, which is the smaller school buses, which are typically gas. There we -- that's the one in particular that we've talked about with Lightning that we have a partnership with. And we're starting to see greater demand there, but it will be secondary in that school bus market to see. We also have a lot of development activity in the capacity terminal trucks. We have a partnership there with Hyster-Yale that we're very excited about, and it will give us both a battery electric vehicle, but also an alternative fuel cell vehicle. And that end market is also very well suited for EV application, given the routing and given the loading and given the high torque requirements, it's perfectly suited for that. So those are probably the markets that we kind of view as being earlier adopters. Then you get into markets like -- probably the next would be opportunities around -- when you get into use cases that have more of an emergency field to them, making sure you have the secondary source of power becomes more important. So Ambulance is one we've actually have some conversions going on there as well that we have partnerships in. And then also we have -- we announced here recently, we are building an EV fire truck that will be available in 2022. So both of those are probably going to transform or transition more slowly. But our view has kind of been -- we need to be in the forefront of all of our markets kind of figuring out how this is going to be done, so we can lead that effort having the right partnerships is where the applier and technologies and having the right kind of technology partner to help us enable that. Ultimately, in some of the spaces, you're working with converters like Lightning, what will become clear as we move forward as the OEMs kind of get into the space and build chassis on a native type EV power frame that will take a place and think about going back to the Type A school buses that will probably be something you would see there as they become scaled up in EV. But right now, the industry is kind of converting internal combustion chassis to EV chassis for the secondary markets and specialty vehicles. The one I left out was RV. And I think that kind of remains to be seen. We've seen some folks talk about early developments they have going on in there, but we just haven't seen the demand right now. We're so busy making model years that are -- models that are selling through before they landed a lot. The development of EV really hasn't been focused as much there. So lots of activity there. We have it on all fronts, and we are seeing increased interest, but the conversion curves for each of these businesses will be different.

Can you help us also just think through when you're thinking of a partnership with someone like Lightning eMotors, who else are you talking to? Are those usually exclusive relationships? And does it really come down to the tech that, that partner has? Or is it about the service and the relationship with you? What are the main differentiators in choosing the partner?

Well, I think the first thing, there's -- it's kind of a blend of things. You're looking for someone who has the technology capability, has enough IP in the space they needed. Most of these folks are dependent on a secondary source for batteries and they package them, they put controls over of it and they add some services behind it. So they've got to -- in the converter role, they have to be capable of both the application side but also the technology side. And they have to obviously have to produce that as well. The infrastructure piece and being able to support, especially in transit, around standing up infrastructure. So our end use customers can enable themselves to charge, if you will, their centralized service platforms on EV. So that's another element to it. But you're looking for someone who has technology capability, if it's an upgrader application capabilities, production capabilities, some level of scale. I mean I can tell you with Lightning, I went out myself and toured their facility. I want to make sure that they had the right combination of things between technology, on the aftermarket side, data and analytics to look at the performance of their equipment that might yield itself well into some of the applications that we would add to the vehicle, be it an ambulance or a fire truck or what the case might be. So you're looking for a combination of those things and the -- because there's a lot of folks out there in one way, shape or form that can do some of it, but they're -- you have to be careful that you don't get into someone who can't fit the whole bill because you need a partner that does what you don't do that you can collaborate with to meet that end-use requirement. And that's what we found. I think we found -- and the partnerships we've identified, some of which are public, some are not. I think we're doing a nice job of finding the people who are credible that can actually deliver on what we need for our end-use customers.

You talked a little bit about -- is the right way to assume that the current models are built on these diesel chassis? It's not a totally reengineered design. It's really putting a battery into -- or trying to fit it into an existing design. And...

I would say -- go ahead.

No. And then I guess the question is, what does this mean for when GM and Ford start producing electrified chassis? How do you have to then rethink the path forward for these products? And why partner with Ford or GM with their Ultium technology or whatnot?

Yes, I'll answer that question first. I mean we do have engagement conversations with the OEMs around the end use cases for these markets that we serve. So they're very attentive to making sure what they're doing for their designs or include forward thinking around the things they need for the markets that they serve us in as well. So there's lots of activity on that front as well. But kind of this middle ground of how do you serve an end market that wants it before maybe some of those things are ready is also a big part of what we're doing. I think that the first question you asked around upfitting. The things like we're doing with the terminal truck that is going to be a design for use. It's going to be a chassis that's built around the use case for EV or fuel cell. When you think about transit, it will be a journey, a Generation 1, Generation 2 type thing, but you start with what you build today, you pointed out for what the use case for EV would require and then you'll move into a design that's fit for those applications. And then same thing with fire trucks right now. You're right, the fire truck we announced has a secondary diesel. So it's got both element, has got battery and diesel and then so you've got capabilities to serve both. So on the custom things we do, we'll probably -- the custom chassis we build, we'll probably get to a purpose-built type scenario on the EV more quickly because really on the commercial side, you're going to be waiting on the OEMs to produce those platforms and EV till you get a design build. Because a lot of things that they released so far have been still an IC chassis that they substituted an EV power frame on. But we know -- all know they're working as they've been publicly about most of them have that they're building purposeful chassis for EV as well, and we're supporting those discussions with them. So lots of activity there. It's pretty exciting.

Maybe switching over to Recreation, that's an area where your margins are trending well above the '23 targets even despite all of these challenges that we talked about earlier. Can you just comment on some of the main drivers of the strength in Recreation? And how we should be thinking about mix could impact those margins heading into 2022?

Yes. I think we've been pretty clear that Class A still is a significant portion of our product offering, and that one is one that I think from an industry perspective, doesn't get to double digits, but it's important to have in the portfolio. What you see right now, as we said in our earnings call, our other businesses in our mid-teen businesses, our Bs and Cs are taking advantage still of the ability to batch build a lot of these like the Sprinter bands when you have the same one going down the line, you're able to take advantage of all the leverage you get there that the workers doing the same band all day long versus having to do a custom changes like you see in the Class A, where there's different options and whatnot. So I think from that perspective, it really comes down to mix, and we have that every quarter discussing how much Class A is as part of the mix. In this last quarter, Class A was down. As we talked about, we had diesel chassis. We didn't have the gas chassis available because of some shortages there. So they made up less of that segment this last quarter. And then we're expecting to see some increase. We do have some gas chassis that come online. So we'll see a pick up a little bit. But I do believe we'll still be in that double digit. When you look at our mix overall, we're definitely running at that greater than 10%, not at the 11% we did this last quarter, but you're right. I think we're at the 10%. But again, we're trying to make sure that we're managing this business to a trough type level so that if we do see a downturn in a cyclical business, we don't have a bunch of fixed costs or trap labor when the downturn happens. So we're managing that appropriately to make sure that we're holding that 10%. We're not adding fixed costs or variable costs that's harder to exit as things come out.

On F&E, that's an area where your backlogs were up, I think, 90% in the quarter. A couple of months ago, we were -- it's -- kind of nervous about municipal budgets. Can you just talk about how much of this was driven by some of the stimulus versus more sustainable demand? And how we should be thinking about the recovery of F&E post the last recession in '09?

Yes. Honestly, I think the orders were the ones that's book-to-book, it was up 70%, 80%, which I think you're referring to Courtney. But honestly, we don't believe the stimulus has had a major impact on the order rates that we've seen. Now there may be some pent-up demand from orders that didn't happen last year, but I don't think the funding or the mechanisms for funding have completely made their way down in the municipalities to where it's creating an additional demand. That's something that we're working with internally. We're working with our dealer network or with a third party to figure out how we might enable that. But right now, I think our growth or our bookings have largely come through good work from our dealer partners, new product innovation and also some recapture possibly some share loss that happened over the prior 18 to 24 months in the business. So our shares in the last 6 months have gone up, and they're moving back towards where they were historically coming off of a bit of a share loss for a period of time. So that's what I think we're seeing.

Great. Well, that just about gets us to time. So Rod, Mark, Drew, thank you guys so much for joining us today, and thank you to everyone who is listening on the webcast. Enjoy the rest of the conference.

Thank you, Courtney.

Thanks, Courtney.

Thank you. Take care. Bye-bye.