Custom Truck One Source, Inc. (NYSE:CTOS) Q1 2024 Earnings Call Transcript

Custom Truck One Source, Inc. (NYSE:CTOS) Q1 2024 Earnings Call Transcript May 3, 2024

Custom Truck One Source, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Ladies and gentlemen, thank you for standing by and welcome to Custom Truck One Source’s First Quarter 2024 Earnings Conference Call. Please note, this conference call is being recorded. I’d like to hand the conference call over to your host for today, Brian Perman, Vice President of Investor Relations for Custom Truck One Source. Please go ahead.

Brian Perman: Thank you. Before we begin, we would like to remind you that management’s commentary and responses to questions on today’s call may include forward-looking statements, which by their nature are uncertain and outside of the company’s control. Although, these forward-looking statements are based on management’s current expectations and beliefs, actual results may differ materially. For a discussion of some of the factors that could cause actual results to differ, please refer to the Risk Factors section of the company’s filings with the SEC. Additionally, please note that you can find reconciliations of the historical non-GAAP financial measures discussed during the call in the press release we issued today. That press release and our quarterly investor presentation are posted on the Investor Relations section of our website.

We filed our first quarter 2024 10-Q with the SEC this afternoon. Today’s discussion of our results of operations for Custom Truck One Source Inc., or Custom Truck is presented on a historical basis as of or for the three months ended March 31, 2024 and prior periods. Joining me today are Ryan McMonagle, CEO and Chris Eperjesy, CFO. I will now turn the call over to Ryan.

Ryan McMonagle: Thanks Brian and welcome everyone to today’s call. Custom Truck continues to see robust demand in our infrastructure, rail and telecom end markets, which all contributed to strong performance in our TES segment in Q1, and helped the segment delivered double digit revenue growth for the sixth consecutive quarter. As we discussed on last quarter’s call, our core T&D markets continue to have favorable macro demand drivers, namely data center investment, electrification and required grid upgrades. However, these markets have been meaningfully impacted in the short term and specifically in Q1, as supply chain issues, regulatory approval and ownership and funding details contributed to project delays, resulting in lower rental revenue and rental asset sales in the quarter.

Overall, we delivered revenue of $411 million in Q1. We continue to believe that the slowdown in the utility end market is temporary and anticipate a return to growth later this year and heading into 2025. Despite the current headwinds affecting transmission and distribution, our team continues to execute well and to demonstrate the value of our business model with our ability to pivot between product categories and between selling and renting equipment as the markets dictate. Our TES segment delivered 15% revenue growth in the quarter versus Q1 of last year, keeping us on track to meet our 2024 revenue guidance for the segment. We’ve seen growth across the board in the TES segment, which we have been able to meet as product availability has improved and certainly led by increased spend in our infrastructure, telecom and rail end markets.

Segment gross margin saw a 170 basis point improvement versus Q1 of 2023, which highlights the continued strong demand environment, as well as the progress the team has made in continuous improvement in our production capabilities. The entire TES team performed extremely well and continues to deliver production near record levels, something the entire organization is very proud of. As we’ve discussed previously, our significant inventory investment last year has positioned us to meet the continued resilient customer demand for new equipment sales, as well as allow us to quickly serve our customers rental and rental asset sales needs, when demand returns to our core utility end markets. We are closely following the upcoming chassis emission regulations and are well positioned for the anticipated demand increase, resulting from the change in emission standards, that is coming between now and 2027.

In our infrastructure end market, we continue to experience high levels of demand for certain products, like our specialty dump trucks, roll off trucks, hydro excavators and water trucks, which supports our belief that demand is beginning to be positively impacted by the early stages of the deployment of federal infrastructure investment and Jobs Act dollars for infrastructure projects. As we’ve discussed before, approximately 60% of our revenue comes from the utility end market, which includes both distribution and transmission work. We continue to see favorable increases in electricity load growth driven by manufacturing on-shoring, AI data center development and the current electrification trends. The amount of incremental power and grid enhancements required to meet this forecasted load growth, as well as the deferred maintenance that is required on our aging grid, creates significant demand momentum in the sector.

Transmission line development and regional interconnection continue to be the bottlenecks in meeting this future energy demand, and there is a significant backlog of transmission projects that are ready to go. As I said earlier, work on these projects is advancing slowly as supply chain, regulatory approval and ownership and funding details get resolved, but provide strong tailwinds for future growth across the entire business. Chris will walk through the details of the performance of our ERS segment, which continue to see strong utilization rates in the mid-70% to high-80% range for all end markets other than the transmission portion of utility. Our rental CapEx plan for the rest of the year reflects investment in our fleet to meet demand across our in-markets, with a focus on those sectors where we are seeing particular strength.

We are confident that the tailwinds that support the ERS segment are robust and will continue to provide significant growth in the years ahead. The breadth of our vehicle product offering and our ability to meet customers’ rental and sales needs uniquely positions Custom Truck to capitalize on the future tailwinds created by the sustained demand, particularly as these transmission projects advance. We continue to invest in geographic markets where Custom Truck is underrepresented and which we believe offer compelling long-term growth opportunities for our business. In addition to the new branch openings in Casa Grande, Arizona, Sacramento, California, and Salt Lake City, Utah that we discussed on last quarter’s call, we subsequently announce two small acquisitions.

First, we acquired SOS Fleet Services in Alexandria, Louisiana, which strengthens our presence in the Gulf Coast region. We also acquired the business of AMD Maintenance and Repair on Long Island, New York, which significantly expands our presence and service capacity in the greater New York City metro area. We’d like to welcome the employees of both businesses to the Custom Truck family. These recent branch openings and acquisitions brings our location count to 40, up from 35 at the end of Q3 last year. We expect all these locations to be fully operational later this year. With respect to our 2024 guidance, while we continue to have confidence in the long-term strength of our end markets and the continued execution by our teams to profitably grow our business, our updated outlook reflects the risks associated with the near-term challenges for our rental customers in the T&D sector, resulting primarily from the delay in transmission projects and lower rental use sales demand, which we now expect could persist through the balance of the fiscal year.

As such, we are lowering our revenue guidance for ERS by $50 million to $680 to $710 million. Regarding TES, supply chain improvements, healthy inventory levels, and continued strong backlog levels continue to improve our ability to produce and deliver even more units in 2024. As a result, we are reaffirming our revenue guidance for TES of $1.115 to $1.255 billion, which reflects another year of double-digit revenue growth, as well as our revenue guidance for APS of 155 to $165 million. Consolidated revenue guidance is now $1.95 to $2.13 billion. Given these changes, we are also lowering our adjusted EBITDA guidance range to $400 to $440 million. While we are reducing our consolidated revenue and adjusted EBITDA guidance for the year, we continue to focus on generating meaningful free cash flow in 2024 and are reaffirming our target to generate more than $100 million of levered free cash flow.

In closing, I continue to have the highest degree of confidence in the entire Custom Truck team and our ability to navigate the current softness in the utility end market and to deliver profitable growth and long-term value to our shareholders. With that, I’m going to turn it over to Chris to talk through the details of our first quarter results.

Chris Eperjesy: Thanks, Ryan. For the first quarter we generated $411 million of revenue, $134 million of adjusted gross profit and $77 million of adjusted EBITDA. Our first quarter results were significantly impacted by a decline in average utilization of the rental fleet to just over 73% from almost 84% in Q1 of last year, which was historically higher than our average levels. In addition, average OEC on rent in the quarter was $1.07 billion, down from $1.21 billion in Q1 of 2023. These declines reflect the impact of the slowdown in transmission utilization that continued in the quarter, which Ryan mentioned. On-rent yield was 40.5% for the quarter compared to 39.6% for Q1 of 2023. Given the trends in utilization and average OEC on-rent, the ERS segment had $136 million of revenue in Q1, down from the all time quarterly record of $206 million in Q1 of last year.

Adjusted gross profit for ERS was $82 million for Q1, down from $106 million in Q1 of 2023. Adjusted gross profit margin was 60% in the quarter, up from 51% in Q1 of last year, largely because rental revenue, which has a higher margin associated with it in rental equipment sales comprised a larger percentage of total ERS revenue in this quarter than in Q1 of 2023. We continue to invest strategically in our rental fleet and sell certain age assets in the first quarter and our fleet age remains steady at three and half years. Net rental CapEx in Q1 was $15 million. Our OEC and the rental fleet ended the quarter at $1.45 billion, down marginally versus the end of Q1 of last year. We expect to continue to invest in the fleet in 2024, but have the flexibility to pivot our CapEx spending plans in 2024 depending on the trends we’re seeing in our end markets.

In the TES segment, we sold $240 million of equipment in the quarter, a 15% increase compared to Q1 of last year and a record for the first fiscal quarter. Gross margin in the segment was 18% for the quarter and approximately 170 basis points improvement versus Q1 of 2023, which we attribute to the ongoing production efficiencies resulting from our high level of production, as well as an improved mix related to higher specialty and vocational truck sales. In line with our expectations, TES backlog continued to moderate, ending the quarter at just under $538 million. Record levels of production and continued strong new equipment sales in the quarter allowed us to make headway toward reducing our backlog to a more normalized level, which currently stands at more than six months of TES sales.

This is down from a peak of more than 12 months in early 2023, but still above our historical average of four to six months. Our strong and longstanding relationships with our chassis, body, and attachment vendors continue to be an important driver of our record TES production. Our intentional inventory build throughout 2023 and into 2024 position us well to meet our production, fleet growth, and sales goals for 2024 and beyond. Our APS business posted revenue of over $35 million in the quarter, down slightly from $37 million in Q1 of last year. Adjusted gross profit margin in the segment was 26% for Q1, down from a little over 27% in Q1 of last year. Overall in Q1, the APS business was impacted by a decrease in rentals of tools and accessories, which were affected by the utility end market softness.

Borrowings under our ABL at the end of Q1 were $552 million flat versus the end of last quarter. As of March 31st, we had $195 million available and approximately $332 million of suppressed availability under the ABL with the ability to upsize that facility. With LTM adjusted EBITDA of $399 million, we finished Q1 with net leverage of 3.79 times , achieving net leverage below three times remains a primary and important goal. However, given year-to-date performance and our current expectation for the rest of the year, we expect to achieve net leverage of less than 3.5 times by the end of the fiscal year. With respect to our guidance, what we expect 2024 to be another year of growth. Given the current conditions and the utility markets, we continue to expect TDS to be the primary growth driver for 2024.

We believe our Europe segment will continue to experience near-term pressure in demand, in the utility market as a result of supply chain, regulatory and financing factors affecting the timing of job starts. These headwinds in our utility end-markets are driving lower OEC on rent in our core ERS segment. We now expect to grow our rental fleet, based on net OEC by low-single digits versus the mid-to-high-single digits, we discussed on our last call. Regarding TES supply chain improvements, healthy inventory levels and historically high backlog levels continue to improve our ability to produce and deliver even more units in 2024. As a result, we are reaffirming our 2024 revenue guidance for TES which reflects another year of double-digit revenue growth.

Our outlook for our APS segment remains unchanged, while this all combines to reduce our consolidated revenue and adjusted EBITDA guidance for the year. We continue to focus on generating meaningful free cash flow this year and are reaffirming our target to generate more than $100 million of levered free cash flow in 2024. Updated guidance for our segments is as follows. We expect ERS revenue of between $680 million to $710 million. TES revenue still in the range of $1.115 billion to $1.255 billion and APS revenue of between $155 million and $165 million this results in total revenue in the range of $1.95 billion to $2.13 billion or growth of 5% to 14% versus 2023. We are projecting adjusted EBITDA in the range of $400 to $440 million. In closing, I want to echo Ryan’s comments regarding our continued strong business outlook.

Despite some temporary demand weakness in certain utility markets, we continue to be optimistic about the long-term demand drivers in our Industry and our ability to deliver strong revenue and adjusted EBITDA growth to hold or expand margins, to produce significant levered free cash flow and to reduce leverage all while providing the highest levels of service to our customers. With that, I’ll turn it over to the operator, to open the lines for questions.

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Q&A Session

Operator: Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from the line of Justin Hauke with Baird. Please go ahead.

Justin Hauke: Yeah. Hi. Good afternoon, everyone. So I guess…

Ryan McMonagle: Hi Justin.

Justin Hauke: Hi. So I guess I wanted to start just what — what has changed I guess in terms of the utility your customers’ communication and in a sense to kind of the beginning of March. I mean, is it a whole bunch of project delays? Or I guess I’m just curious, how that conversation kind of developed over the last several weeks? And then, I guess the second part of the question is, even with the ERS guidance taken down here, I’m assuming that 2Q is still going to be pretty negative revenue decline is implying the back half of the year has pretty strong growth like high-single digits if not closer to 10. And I guess just the visibility you have thus far out to kind of have that embedded assumption?

Ryan McMonagle: Yeah. Justin thanks for the questions, and happy to talk through it. But I’ll start with the first question of really how’s the message with our customers. I think that is continuing to see good macro trends. So they know the work is there. We’re just not — they’re just not starting the work yet. And so that message is continuing still talking about opportunity later in the second half of 2024, which is kind of a lead to your second question there as well, Justin, but still know that the work is there. There’s just this temporary delay in the work starting, which is most prevalent on the transmission side, and shows up most in the transmission equipment that we sell, but is also showing up in the first quarter from some of the rental asset dispositions that we had some of the rental asset sales that we had in the first quarter.

So, still good macro environment of demand, but just a short-term headwind that’s certainly carried in Q1 and is likely to be in place through Q2 as well. So, and then the second half is, yes, we do — we still expect that the second half of the year will have growth. There is some normal seasonality in there, Justin. Q4 has always been our best quarter historically, and so we are expecting that. And then that also does imply some growth in OEC on-rent or rental revenue for us, which is based on our conversations with customers. I will say that our conversations are getting more specific to when equipment is going to be going out versus kind of general comments of it. It should pick up later this year. So I think that gives us some positive indication of why things are going to improve in the second half of the year.

Justin Hauke: I guess, I mean, how much lead time do your customers typically have? Like if they’re going to start a job in three months, do they need to rent it now, or are they kind of just-in-time deliveries?

Ryan McMonagle: Yes, I mean, our typical customers, the utility contractor, utility contractors, and certainly when you get into some of the smaller utility contractors are just-in-time delivery. So that’s where it’s important to have availability. That’s where we think the one-stop shop model really allows us to keep inventory. Obviously, we have underutilized rental equipment right now, and it’s ready to go. We’ve got a position where we think it makes sense to be positioned and where our customers are asking for it to be positioned, but it is on the rental side of the business, it is much more just-in-time. On the sales side of the business, we do have backlog that is still sitting north of six months that gives us some good visibility on that side of the business.

Justin Hauke: Okay. And then, I guess, my final question here before I jump back in. It looks like the purchase price in the cash flow at least was pretty modest for these two acquisitions. Was some of that, I guess, kind of an asset purchase where it showed up in the CapEx, or I’m just trying to understand kind of the size of how big these two locations are?

Chris Eperjesy : Yes. No, you said — this is Chris, Justin. You said it right. And so it shows up in the acquisition of business there. Although, I would point out that is only the first acquisition, the second acquisition occurred post the end of Q1. So, that would just be the first acquisition you’re seeing there, the $1.4 million.

Justin Hauke: Okay. Okay. All right. I’ll back in the queue and I guess, thank you.

Ryan McMonagle : Thanks, Justin.

Operator: Your next question comes from the line of Tami Zakaria with JPMorgan. Please go ahead.

Tami Zakaria: Hi. Good afternoon. Thank you so much.

Ryan McMonagle : Hi, Tami.

Tami Zakaria: So, my first question is — hi. So, my first question is on the ERS segment guide. You lowered it by about $50 million, it seems. So that would suggest, there’s been a use factor ramp through the rest of the year versus the first quarter performance. So, am I thinking it right in terms of modeling that 2Q should see a notable step up, and then 3Q sort of stay similar, and then again another step up in the fourth quarter? Or is it more like 2Q doesn’t see that much of an acceleration but then the back half sees a notable step up? So if you could just give some color on how to think about the next three quarters for ERS?

Chris Eperjesy : Yes. This is Chris, Tami. In our guidance, you should assume a more modest step up in Q2, and then a more meaningful step up in Q3 and then into Q4, again, is how you should model that.

Tami Zakaria: Got it. Okay. That’s helpful. And then, going back to the previous question that was asked, I wanted to ask in a different way. And so you expect utility end market to improve as we head into question five, but is the expectation for an improvement in visibility and market predicated on a Fed rate cut? Or is there something else that makes you our new supply chain getting better or something? Is that what is going to drive the pickup in the automotive end market?

Ryan McMonagle: Yes it’s a great question Tami, and happy to talk about it. But I think there’s so much pent-up demand kind of in the space overall for the work to be done. So it’s really more of what caused the short term. Yes from a CapEx spending perspective when you think about data centers, when we think about AI as kind of a new short-term demand driver we think about electrification. When you think about grid upgrades to me those are all clear long term macro demand drivers, that are all really compelling for YT and D makes sense. We are managing through the short-term blip. We really do think it is a combination of some of our customers’ supply chain challenges. What I mean by that is making sure they have all the supplies needed to build the power lines in the case of transmission work that might be generators that might be superstructure might be all sorts of things, right that are needed but they want to make sure those are all in place before they sent crews to work.

A lot of those are supplied by the power producer or the IOU in many cases. And so we’ve got that dynamic and then we’ve got regulatory that seems to be holding up. And obviously, there’s a lot of press out there right now with what the Department of Energy is doing and what FERC is trying to do as I tried to accelerate approvals of some of these lines. I think that will be an unlock as those improve. Those obviously take time. That regulatory process takes time but I think those are the biggest two. And then the third would be as IOUs finalize CapEx plans and as they make their decisions on rate base increases and then as they make their decisions on how that CapEx will be spent between transmission and distribution, that’s also kind of the funnel unlock for us as those plans are finalized.

And as that CapEx dollars spent that’s the work that our customers utility contractors are primarily doing. And so I think it’s unlock of all three of those.

Tami Zakaria: Got it. Okay. Thank you.

Ryan McMonagle: Thanks, Tami.

Operator: [Operator Instructions] The next question comes from the line of Michael Shlisky DA Davidson and Company. Please go ahead.

Michael Shlisky: Yes, hi. Good afternoon and thanks for taking my question. I wanted to ask on ERS first, did the sales of used units in ERS surprised you at all. And can you maybe share if pricing was a driver in this quarter’s result at all?

Ryan McMonagle: Yes. It did come in lower than we expected and some of that is just a function of as our customers are deploying their CapEx and when they expect to buy. So it did come in lower than expected for the assets that we sold. We still saw some very good residual values but in the used equipment market right now, yes we are seeing some pricing pressure on there, but we are still able to sell and generate kind of compelling gross profit. But Mike yes, it absolutely came in lower than we expected in the year. And as we’ve talked about in the past that’s always the hardest part of our business to forecast. And so we’re going to continue to refine how we do that and get better at it. But yes, it did come in lower than expected to answer your question.

Chris Eperjesy: And Mike, this is Chris. Maybe just a little more color there. The comp year-over-year was going to be a tough one. If you look back at Q1 of last year, which tends to be more of a softer quarter. It actually is our highest quarter by I think 40% in terms of magnitude. And so it was a very unusual Q1 of last year. Some demand moved from Q4 of 2022 into Q1 of 2023. And so we were going to have a tough comp and we knew that that was clearly wasn’t in the cards to be at that level. So it was a really tough comp. We don’t have the same kind of comp situation in Q2.

Michael Shlisky: Okay. Got it. And also wanted to touch on some of our projects that you’re tracking are they being pushed out on the calendar or is it centers on there being canceled? And I guess just I’m just trying to kind of figure out what do we need to be increasing our end of 2024 or probably 2025 numbers. What may not have hit the P&L this quarter or last couple of quarters or if we just have to adjust even for end of end of this year because they’re being pushed out or just 2024 get pushed to 2025 and then 2025 get pushed to 2026 and so on. Just sort of a sense as to what’s not being put in the ground today, kind of what period should that revenue eventually hit?

Ryan McMonagle: Yes. No, it’s a great question. And we are not hearing of cancellations. We’re hearing of delays. And so I think it’s an important question, right? So that will push — the work still has to be done. The macro factors are still what they are. In fact, I would argue the macro forecasts have even gotten more compelling, but the work in the short term is just getting pushed. And when I listen to what our customers are saying, and you listen to some of the other public companies in the space, it seems consistent that the expectation is later this year, those will begin and they should carry well into some into 2025 and even in 2026.

Michael Shlisky: Okay. Maybe one last one for me. Can you maybe update us on the cadence of fleet utilization as we go through the rest of the year? And maybe, can you update us on at this point, what do you think is the kind of sweet spot utilization? Has it changed at all, given recent developments? Are you still feel free content maybe it’s in the 70s or high 70s where you can get you best result?

Ryan McMonagle: Yes, I’ll start and Chris, can give some more color on cadence Mike. But yes, look I think it’s an important question because we talked about last year, we were running kind of at a very high utilization numbers, when we were running in the mid 80s or even in the upper 80s. So even in a quarter like this quarter, we’re running in the low 70s from a utilization standpoint, which is very good in the grand scheme of rental businesses. If you look across a broader portfolio of rental, it is meaningfully down from where we ran in Q1 of 2023. But Mike, I think you’re right that still running in the mid 70s, is certainly where we should shoot for and can achieve as you think about steady state. And so, there’s a little bit of this is we’re just comping off very hard utilization numbers that we talked about, a year ago.

We talked about 18 months ago, as well. And so there is a bit of that that we’re dealing with. So even when we’re seeing this delay, and the rental fleet is where — you were seeing this delay and we’re seeing the slowdown on the transmission side of things, and yet the entire rental fleet is still running in the low 70s. In the grand scheme of the store performance, it’s still not at a bad number. It’s still a good number. And in the grand scheme of rental businesses more holistically, you have still very compelling kind of lower end that we’re running toward it.

Michael Shlisky: Great. And again the cadence Chris, you wouldn’t mind giving us a little update, how you think — probably I guess [indiscernible]

Chris Eperjesy: Yes — I guess – its obviously it’s hard to predict on some of the variables that Ryan just went through. But clearly, on the high end of our EBITDA range, we would expect to see more meaningful increase in OEC on rent, as we progress through the end of the year. The lower end would see a more modest increase. And so I think I’d leave it at that, in terms of any guidance we want to give.

Michael Shlisky: Okay. Thanks. I’ll pass it on. Appreciate it.

Operator: [Operator Instructions] There are no further questions at this time. I will now turn the call back over to Ryan McMonagle for closing remarks. Please go ahead.

Ryan McMonagle: Thanks, everyone for your time today and your interest in Custom Truck. We look forward to speaking with you on the next quarterly earnings call. And in the meantime, please, don’t hesitate to reach out with any questions. Thank you again, and have a good evening.

Operator: Ladies and gentlemen, that concludes today’s call. Thank you all for joining and you may now disconnect.