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

All right. Looks like the perfect timing. So thanks, everyone, for joining us. My name is Angel Castillo, I'm the machinery analyst here at Morgan Stanley. It's my pleasure to be joined today by Amy Campbell and Drew Konop from REV Group. I appreciate the time. Before we dive into some of the Q&A, I just want to start with a quick disclaimer that we have to read. So for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representative. So Amy, again, thank you for joining us today. Would love to just start with maybe a quick little overview for those that may not be as familiar with REV Group in terms of who is REV Group.

Sure. Yes. So REV Group had historically been a business separated into 3 segments that we consolidated down to two earlier this year when we diversified our Collins Bus business earlier in the year. And so we have 2 segments. One is called specialty vehicles, which has -- the primary business in there is our Fire & Emergency business and have fire trucks and ambulances, fire apparatus and ambulances. And then smaller businesses, we have a terminal truck and street sweeper business, but it's a small kind of high single-digit percent of that total portfolio. And then this year, the municipal transit bus business is still a component of specialty vehicles. But as we announced when we exited Collins, we're also exiting that municipal transit bus business. And so we will ship the last bus out of E&C, which is headquartered here in Riverside, California here in the fourth quarter. So that's about 75% of our portfolio, our specialty vehicles portfolio. And the other 25% of our portfolio is recreational vehicles, mostly motorized. We cover Class A, Class B and Class C motorized vehicles and then we have a small camper towable business branded Lance, that's also a piece of that portfolio.

Perfect. No, that's a great place to start. And you mentioned maybe where you talked about specialty vehicles, that's particularly the F&E business, that's been very much core in an area that you're a market leader within. So maybe just start there. As we think about, had great performance over the last few quarters and great kind of trajectory into that double-digit margin place, so I just want to unpack that, what you're seeing a little bit more, maybe at a high level, how are you seeing demand unfold? I think that's an area, particularly within fire apparatus is where the backlogs are out 2, 3 years. So are you seeing that slow down in terms of how much you're kind of still receiving orders versus the last couple of years?

Yes. So let me step back. So if you look back over the history of fire apparatus sales, they have historically been, we said around 4,000 to 4,500 units in the fire apparatus that we participate in. And that's been a pretty historical average. It's not a very cyclical business. We did see a spike in demand coming out of 9/11. So '04 to '08, the industry saw high demand. And then as the fire and ambulance business is largely funded through municipal funding, post the Great Recession, when property values dropped and municipalities had some more funding challenges, we saw a period of decline there, kind of, call it, '09 through '12. And then we've recovered from that back to that kind of 4,000 to 4,500 units. And then during the pandemic, '21, '22, '23, we saw demand go back up closer to that 6,000 units above kind of historical demand levels. Now I would say, speaking about fire apparatus, but also ambulance, we have and we have said we expect demand to start to normalize. And we have seen some normalization further along in our ambulance segment than it is in our fire truck segment, but they are starting to see some normalization there. We continue to see good book-to-bill -- with a book-to-bill of 1.0 in terms of units in the year-to-date through the third quarter and 1.3% in terms of dollars. Fire is a little ahead of that. So it's continued to see strong demand overall. And we think some of that comes from just the quality of our brand, our dealer network as we continue to see good demand here through the cycle.

Yes. No, absolutely. And maybe to that point, can you just talk about where aged fleets after, I guess, this wave that we've had, will that kind of get the replacement cycle and the aged fleets in a kind of better place? Or is there still pockets where you see that, again, as we get into '27, '28, people are just saying, I don't need to put the order in today, but I will do eventually replacement around '27, '28, so what's kind of shape of that?

Yes. I mean, I think it's difficult to predict, right? And there's the number of fire departments across the U.S., very dispersed from small rural volunteer fire communities where their equipment will get much aged, but I think I saw a metric that 40% of fire departments are in communities with less than 5,000 people, two large cities who are on a regular replacement cycle. So as we look at that replacement cycle, I would actually think that what we're seeing right now is customers, they're working through their municipalities or they are going to get votes by the city councils and the village councils to get these approved. And so I don't think you're seeing people hold back on orders because there hasn't been any signs that we're going to see the backlog come down. So if they know they need a replacement of that fire truck in the next few years. I suspect that they're working on those orders right now and taking those out to bid.

Got it. And maybe just to kind of continue on the backlog dynamics. I think one very interesting kind of part of the narrative for REV Group is just how -- what that backlog ultimately means, right? It's not just purely volume, it's also the fact that you're able to get better price, better margin on some of that kind of product that's down over the next few years. Can you just describe that? How are you seeing perhaps your ability to continue to drive incremental pricing on those incremental orders?

Sure. So we've talked about -- we took 9 price increases from the start of '21 through the end of '23 for a cumulative price increase of 40% over that time. And we are in fire and ambulance -- or excuse me, fire probably in the fourth or fifth inning, about halfway through those price increases and an ambulance the fifth or sixth inning. So we still have significant price to harness in the backlog halfway through in fire and maybe a little bit more than that in ambulance. But we still continue to take price increases. So we announced another annual price increase this year, and I would expect that to continue. So a combination over the next couple of years as we harvest the price that's in that backlog that secure, right, these are encumbered funds from municipalities. So those orders are secure, will drive those double-digit margins up, and then the next wave of margin expansion will come from efficiency and throughput improvements, simplification efforts that we have across the portfolio.

And that's a good segue, I guess, as we think about the margins, so you've already achieved your double-digit target, right? But what's maybe as we get through to -- let's fast forward to 2026 or so, what do you see as kind of the normalized or structural margin of this business longer term? Because as we see it today, it seems like the backlog alone has just a continued step-up in margin through the next few years.

Yes. So I would say we haven't achieved our target. We achieved the first step, which is double-digit margins. And then now we step through those double-digit margins as margin expands. And so over the next few years, that price, we expect to largely drop through to the bottom line. We think we can get our margins to be competitive in the marketplace with others that compete in this marketplace. And so as that price drops through, obviously, there will be some inflation, but we drive our teams to offset that inflation through purchasing initiatives, through labor efficiency initiatives and VAVE and Lean and OpEx. And so as we drive to offset those inflationary headwinds, for the most part, we expect that price to drop through. And so we should see continued margin enhancement here just from price for the next 2.5 years as we work through that backlog. And then on the other side, as I said, starting to take advantage of simplification initiatives, which are kind of really in the early days right now.

Yes. No, and that's actually perfect because I wanted to ask you about simplification, right? Because I think that's something that's maybe a little bit of a heavier lift and maybe almost take the baton from the pricing as we get to the back of the backlog or the end of the backlog in terms of really seeing the benefits of every aspect of your strategy around simplification. So if you could just unpack that a little bit more? What investments or changes you need to make to your business? And how quickly can we start seeing that flow through in terms of the P&L, in terms of the margin?

Yes. There's multiple elements of it. I mean we think about 3 key pillars of simplification. Rationalization, standardization and process optimization. And the businesses are at different points in their cycle through that. So one is rationalization, and that is taking stuff. So we may have 27 options of door handles that you could order on a fire truck today. And looking at 80/20 and reducing that down to 3 to 5 options and taking complexity out of assembling those door handles on a fire truck would be one example of rationalization. Standardization is looking at standard door designs and how a door is assembled into a fire truck, so that there's more consistency and more efficiency for an assembler to put that together. Looking at our engines, we right now have our engine configuration, so that we cannot swap them between different brands of fire trucks. And so making sure that we're engineering and designing in a consistent configuration, so that if one plant has got a supply problem, they can help support another plant that doesn't. So some of that is standardization, also standardizing options. So one of our ambulance plants has implemented what they call a yes. But where, yes, we'll do that, but we need to go back and understand what the implications of that are for complexity. And do you want to pay for that complexity? Or this is -- we think this is a better option. And then process optimization, as you do that, really, this standardization starts. It starts with the design options that are available. And then it works all the way through, as you're quoting, it really starts there quoting to the customer all the way through ordering parts and then assembling. So we've seen, in terms of process optimization, where our S-180 fire truck, which we talk about, which has got a 6- to 9-month delivery time, the time to engineer those orders has gone from an average of 200 hours a truck to 20 hours a truck because there's such fewer options deliver. So it's kind of across that spectrum. We talk to the S-180 is probably largely where we expect it to be ambulance as much further along on this journey. And then fire trucks, a lot of our fire truck brands are really early days and starting that rationalization standardization of parts and ability to configure to go forward. I do want to stress though that we still are and we still will be a custom fire truck business. So it's finding that right balance, driving customers to what makes sense, taking out non-value-added stuff that doesn't add value to the customer, but drives complexity on our side and then delivering the truck that the customer wants.

That's very helpful. And I think to your point, I think one of the -- when I look back at a fire truck, right, the amount of customization, I'm always blown away by just the amount of the options that you guys have. But just as you think about the preference or the amount of loyalty that the customer has for the brand, and you guys, I think, have that that differentiates you versus the other top competitors is you have multiple brands, right? So can you talk about maybe the ability to drive some of the simplification or maybe the reductivity from customers to having more standardization in the product as they've kind of gotten used to like a brand for a particular reason?

Yes. Well, first of all, it starts with taking out complexity that doesn't drive value to a customer, right? If those of us in the room had 27 options of door handles, we might all pick a different one. If we had 5, we might all still just be as happy and we'd pick 1 of the 5 on. So it starts with taking out the complexity that doesn't -- if the customer doesn't value, doesn't see it may be in the internal mechanics that they also don't see. And then I would say it's offering -- having offerings that cover the spectrum. So what we would call a semi-custom fire truck where the options are very limited, but we can get that to you quicker. It's predesigned, it takes us 20 hours. We can go from quote to final order in a very short time frame to a full custom fire truck. But even in that full custom fire truck taking out the complexity that's under the hood that nobody sees and taking out the complexity that ultimately doesn't drive value. So it's really having across that spectrum, what I would call a semi-custom limited option truck, a large percentage of our portfolio that will still be custom fire trucks but more standardized options, more preengineered configurations and then still offering custom fire trucks to those customers. That's what they want and mean.

And can you talk about maybe the flip side of this? Because one, obviously, you're doing a lot in terms of initiatives to reduce that cost and the standardized things. But on the flip side, you also have a lot of demand for this product, right? So the desire perhaps to increase capacity or to try to get more throughput. Can you talk about maybe what investments need to go into that? Or do you feel like you need to make any investments around capacity throughput labor and maybe quantify those if it is possible?

Yes. I mean investments in additional, what I would call additional throughput, not additional capacity are somewhat limited. They are there. The businesses bring Mark and I ideas for new laser cutters, new paint booths that all remove bottlenecks, enable us to maybe reduce outsourcing initiatives. A key part of throughput is getting the balance and the flow of product correct through the plant, which given the customization of these fire trucks, it's not always easy to predict how much time is going to be needed in one cell to the next because there may be more assembly required. Getting production right the first time built-in quality, make sure you got the right part at the right time. Again, the complexity drives some of that. So the real focus is around driving throughput and efficiency that goes with it much less than, I would say, driving overall capacity. I mean when we look at the industry, we believe that we're either within or especially with our S-180 have leading delivery times. And so we believe that lead times are a competitive advantage and that we'll continue to stay focused on that. But right now, we believe that we are within those. Now certainly, we want to drive throughput improvements, efficiency improvements because we know those units that are on the other -- towards the end of the backlog. There's a lot of price and margin to harvest from those. So being able to get more trucks out is advantageous, but not to the extent. Again, this is a GDP plus kind of growth business, and it does have obviously some peaks. But generally speaking, it's a pretty level business. And so we want the right level of capacity for that overall industry demand.

Perfect. And you talked about lead times. So maybe just kind of an update on how you see the supply chain. Are there any pockets that you're still kind of working on? Maybe also fold into that, you dual sourcing strategies that you started to implement during COVID learnings from that. And how much of that have we already kind of seen in the P&L versus how much of that might be incremental kind of on top of pricing on top of everything?

Yes. So I think the supply chain is in much better shape. And I've never been in a business where every month, we have our strategic op reviews. And every month, we're talking about a potential part or component where there's a fire at a plant, there's a strike at a plant, whatever and you're working through those. I mean those challenges always exist. But I would say that the supply chain right now is stable, supply is good, labor is also good. So that is really pretty steady right now and not driving the headwinds that it would have been a couple of years ago. But -- and then when we think about the opportunity, therefore, to get some procurement savings, we would probably largely been underserved and the opportunity there, and it's still there. We started in the pandemic. I think we had 120 projects to -- we were sole sourced, to move from sole source to dual source, and we've worked through 100 of those projects. So we're very far along in that initiative. But we still believe that there's opportunity out there from material cost reduction to offset inflation, there's going to be natural inflation that's ahead of us.

That's very helpful. And if there's no questions on the audience, Amy, I would love to pivot a little bit to the recreational side, right? I think that's been a little bit more of a challenge, so -- maybe some COVID overhang there. There was a little bit of a stepdown this last quarter. Can you just kind of give us the latest to what -- how you kind of seeing that? And maybe speak to kind of the near-term dynamic as well as kind of the medium and longer term, how you kind of see that business evolving and how quickly we can get back to what was actually pretty attractive margins in that?

Yes. So when you look at the recreation business, it has been. I mean, it was lower than we anticipated it to be in the third quarter, and we've guided it to be about flat from here on out. I mean, I think we are really proud of the team's ability to deal with the level of market demand that's out there right now by delivering decrementals that are better than our 15% target, margins have stayed above 6%. So given the difficult market dynamics I think the business is performing well and our expectations. As we look forward, one of the things we've seen over the last year is that dealer inventory is down significantly, down 20% year-to-date back to pre-pandemic levels. So we think that the dealer inventory levels have gotten much healthier, look at industry inventory turns for the dealers. You look at our particular inventory turns for the dealers, and they're back to pre-pandemic type of level. So we feel like the chain has gotten much healthier. And so now it is -- we need the consumer demand to improve. When does that occur? I'm not going to predict the data of that. I think that there are -- some of our business lines are doing well, like our Class C business continues to perform well. But I think as we go forward, anything that would happen to interest rates, these are high-dollar discretionary funding type of purchases. So if we start to see interest rates come down, I certainly think that that would be a driver of to see that recreation market start to improve. But I think it's gotten -- it's largely gotten through its -- the dealers have gotten through their inventory challenges and from here on out, we just need to see the consumer, I think, get healthier and more focused on those large purchases.

And maybe just from a broader industry perspective, are you seeing others in the industry also start to feel like they're in a better place and not perhaps do as much discounting or put pressure on the pricing side? Or is there maybe from a broader industry perspective or a competitive standpoint, maybe a little bit more challenges than others where you might be in a better place.

So when we look across the whole industry, we are performing, I would say, better than the broad industry and certainly competitors are performing differently across that space. I would say the discounting has been -- it's been high. Dealers are very focused on moving old model year '23 and older model year inventory and have been discounting to get that inventory move. So I think that's also a potential tailwind at the time that that happens is that discounting should come back to more normalized levels than what we've seen in the recent past.

In terms of the model year '25, what's kind of the latest -- I think you talked about it a little bit on the conference call. But just in terms of the willingness or the desire to kind of take on some of the newer products?

Yes. So from our kind of perspective and as we've had discussions with dealers, they are hesitant to place those midyear '25 orders until they start to see more consumer retail demand. And so they are slow to place those orders. They're taking delivery typically very late at the end of the month. And so it has not picked up yet. Now we talked about the Hershey RV show, is taking -- started yesterday, taking place this week. We've got the manufacturing open house here in a couple of weeks. So that may start to give us some indication if we're starting to see end-user demand. And then the next big, I think, indication as we're going to hit the winter months here would be in the Tampa show early next year.

Perfect. Well, we look forward to hearing more about those then. I wanted to switch maybe to the -- from a portfolio perspective. So you mentioned at the beginning, the Collins, the A&C shift. Where are we in terms of Rev Group's kind of portfolio transformation? Is there more pruning or places where either you want to get out eventually or potentially do small tuck-ins in terms of bolstering the portfolio?

Yes. So what I would say that we're going to bring in our December when we have our fourth quarter call and add on to that a virtual type of Investor Day pretty focused on forecast, will come with it a refreshed capital allocation philosophy. We regularly review the portfolio. Mark has been clear that he wants businesses that have double-digit margins over time. Can businesses that aren't there, do they have plans, they have fix it plans to get them to double-digit margins or then what makes sense for them to be in the portfolio? And so those are ongoing discussions that we have. We'll continue to have those, and I think we'll give some more color when we get to the December.

Perfect. And I guess maybe -- yes, so we'll definitely get more color, I guess, in December. I'm trying to think about it from the perspective of the business was perhaps created as a little bit more of a role of strategy and a number of kind of pieces together. As we think about areas that you might be interested in, you mentioned some of the metrics that maybe you're focused on. From areas of business, is there the potential to look into or the willingness to look into adjacencies or areas that maybe there's some kind of cross maybe not necessarily cross-selling, but perhaps some ability to implement things across -- from a cost or operational. How are you thinking about this opportunity?

Yes. I would say -- I think as we should do, always discussing, as we look at ideas, we look at opportunities, I would say everything is on the table. Everything may not be a great idea, but different ideas are certainly talked about and debated. But I'm going to hold off kind of guiding there until we get to that December meeting.

Got it. And maybe not to go back to, I guess, the specialty business. You mentioned terminal, you mentioned a couple of the other assets that you have there. So the thermal trucks have been under a little bit of pressure, but it sounds like that's stabilizing somewhat. So I wanted to touch on that. Like, I guess, how do you see that asset kind of continue to perform from here? And then also kind of the core nature of that over time?

Yes. So the terminal is a very small piece of the total portfolio. It saw very strong demand, highly correlated to the build-out of distribution warehouses with the supply chain and post-pandemic port activity. So really highly correlated to distribution warehouse construction and port activity, dealers, inventory, not unlike recreation got a little heavy, demand pulled back. And so we've spent the last -- really most of this year kind of as dealers have gotten their inventory levels more healthy, which we've seen that. So we think we're here at the bottom of that. We've seen some more quoting activity, more interest here in the recent past. We would expect it to recover back to more normal levels, I'd say, next year. But still, it's going to be a very small piece of our total portfolio, delivers kind of mid-single-digit margins currently. It's got a nice parts business. The Street Sweeper business has got a nice little parts business.

Got it. Is that mid-single digits kind of the way you see that longer term? Or do you kind of -- is that more reflective of kind of the online that we've seen?

Well, that mid-single digit is what it's performed in the past. I mean it certainly falls into that category that I talked about, which is, does it have a plan to get itself to double-digit margins and efficiency improvements, material cost reductions or what makes sense. But it's a part of that constantly reviewing the portfolio, driving businesses to get to those double-digit margins.

Perfect. I do want to check in and see if anybody in the audience has any questions. If not, I just wanted to touch base, maybe more from again, I know you're going to touch base on some of this in December. But in terms of dividend strategy and shareholder returns, we'd like to ask, I guess, how is kind of -- at least the current thinking on that?

Yes. I mean if you look at cash return to shareholders since 2020, which is when Mark joined the business, REV Group has returned $424 million of cash back to shareholders, about half through regular and special dividends, about half through share buyback. So we've been, I think, a very strong contributor of delivering cash back to shareholders. Debt was also $400 million kind of in 2020. We'll exit the year with it at less than 1x. So we've also really improved our liquidity and leverage ratio. And so I think as we go forward, I'm not going to get ahead of and preguide what we're going to say there. But I think we have a history of being kind of all of the above type of capital allocation strategy.

Yes. That makes sense. I try. Maybe just to kind of close that one final question. Just we get -- particularly on the commercial vehicle side, a lot of questions around electrification, how that's playing into areas that perhaps might get penetrated sooner. How do you think about that within your business in terms of both investments that you might be making as well as the ability of electrification to penetrate both RVs and specialty vehicles to a better degree.

Yes. I would say if you look at kind of our 4 products, we've got fire apparatus, ambulance, terminal trucks and recreation. There's really been no end market interest in electrification for recreation vehicle. I would say essentially none as well in the ambulance space. So where there's been some interest in electrification from the -- in the end consumer has been in fire trucks and in terminal trucks. If you think about a terminal truck, it stays within a pretty tight zone, it's not on the road, -- the customer can build the infrastructure that it needs. So we have programs in place around electrification for terminal trucks. And then we have an all-electric fire truck as well. Demand is -- it is -- there are large cities where there's interest in that, that product offering is out there. But again, you go back to 40% of fire departments are in rural communities with less than 5,000 people. I think large fire departments in some cases, the infrastructure and an old -- if you think about an old firehouse to build the infrastructure they would need, I think this is going to be a very slow transition if at all, to any kind of large demand for electrification and fire trucks, but there is some, and we participate in that, but it's pretty small in terms of total numbers.

Perfect. Well, that brings us the end. Again, Amy, Drew, I appreciate the time. So thank you.

Thank you.