Herc Holdings Inc. (NYSE:HRI) Q3 2023 Earnings Call Transcript

Herc Holdings Inc. (NYSE:HRI) Q3 2023 Earnings Call Transcript October 24, 2023

Operator: Good morning. My name is Aldra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Herc Holdings, Inc. Third Quarter 2023 Earnings Call. Today’s conference is being recorded. [Operator Instructions] At this time, I would like to turn the conference over to Leslie Hunziker, Senior Vice President, Investor Relations. Please go ahead.

Leslie Hunziker: Thank you, operator, and good morning, everyone. Welcome to Herc Rentals’ third quarter 2023 earnings conference call and webcast. Earlier today, our press release, presentation slides were furnished and 10-Q was filed with the SEC, all are posted to the Events page of our IR website at ir.hercrentals.com. Today, we’re reviewing our third quarter 2023 results with comments on operations and our financials, including our view of the industry and our strategic outlook. The prepared remarks will be followed by an open Q&A. Now let’s move on to our Safe Harbor and GAAP reconciliation on Slide 3. Today’s call will include forward-looking statements. These statements are based on the environment as we see it today and therefore, involve risks and uncertainties.

I would caution you that our actual results could differ materially from the forward-looking statements made on this call. You should also refer to the Risk Factors section in our annual report on Form 10-K for the year ended December 31, 2022, and our quarterly report on Form 10-Q for the period end September 30, 2023. In addition to the financial results presented on a GAAP basis, we will be discussing non-GAAP information that we believe is useful in evaluating the company’s operating performance. Reconciliations for these non-GAAP measures to the closest GAAP equivalent can be found in the conference call materials. A replay of this call can be accessed via dial-in or through the webcast on our website. Replay instructions were included in our earnings release this morning.

We have not given permission for any recording of this call and do not approve or sanction any transcribing of the call. This morning, I’m joined by Larry Silber, President and Chief executive Officer; Aaron Birnbaum, Senior Vice President and Chief Operating Officer; and Mark Humphrey, Senior Vice President and Chief Financial Officer. I’ll now turn the call over to Larry.

Larry Silber: Thank you, Leslie, and good morning, everyone. Please turn to slide 4. Our third quarter results were driven by our strong business base improved operating leverage and continued M&A initiatives. Total revenue and adjusted EBITDA were third quarter records, driven by a 6.9% increase in rental rate and above market volume growth. Additionally, we ramped up fleet dispositions in the quarter to adjust to higher OEM shipments in the first half of the year and to take advantage of the healthy used equipment market. Use fleet sales carry lower margin than rental revenue, but if we exclude fleet sales from the equation, rental EBITDA or REBITDA as we call it, generated a significant margin and flow-through improvement in the quarter.

Of course, as expected, and as noted on the slide, EBITDA margin in the quarter was impacted by the sale of nearly three times more fleet at OEC and continued disruptions from labor strikes in the studio entertainment industry. In the third quarter, our capital allocation strategy focused on profitable growth investments, supported an incremental increase in ROIC compared with last year. On slide 5, we’re working in a favorable operating environment as the equipment rental market continues to benefit from strong demand across a variety of end markets and geographies. And we continue to outpace market growth as a result of our premium assets, national footprint, broad-based capabilities, and expert services. Our third quarter rental revenue grew another 8% on top of the 35% growth last year.

Excluding studio entertainment, rental revenues increased 13% over the prior year quarter. The studio shutdowns continued into the fall as the Actors Guild joined the screenwriters on strike, making the first time in 63 years that the Hollywood writers and actors were striking at the same time. While the writers finally resolve their dispute, the actors remain on strike, keeping most productions idle. Total revenue got a boost in the latest quarter as we significantly increased sales of used fleet. The supply chains recovery in certain equipment categories allowed us to begin addressing the pent-up rotations from the last two years. We headed into the fourth quarter with our fleet better matched to demand after successfully managing through a wave of equipment deliveries in the first half of the year.

If you turn to slide 6, in addition to leveraging our scale as a market leader, the successful execution of our growth strategies also contributed to our outsized performance relative to the overall industry. We are increasing revenue in our core categories through fleet investments as well as acquisitions and new greenfield facilities that support branch network optimization. Revenue from our high margin, ProSolutions specialty business grew double digits again in the third quarter, incrementally benefiting from cross-selling synergies, customer wins, and expanding fleet new products like trench shoring. And our innovative customer-facing digital capability called ProControl NextGen continues as a catalyst to new project wins, especially at the national account level.

As always, we’re committed to responsible operating practices built on a strong cultural foundation, a safety first protocol, and a pledge to continue to work hard to do more for our employees, customers, and suppliers. In the third quarter, we were a recipient of the 2023 HIRE Vets Medallion Award that recognizes employers who successfully recruit, hire, and retain veterans. We were also named among the Best and Brightest Companies to work for by the National Association for Business Resources. We’re honored to be recognized for these awards as a fan of the testament to our unwavering dedication to our team members and the importance we place on having a best-in-class culture. Finally, between fleet investments, strategic M&A, dividends, and opportunistic share repurchases, we are strategically allocating capital to drive long-term growth and higher returns.

Now, before I turn it over to Aaron, let’s move on to slide 7, where I’ll give you some background on our plan to explore strategic alternatives for our studio entertainment business, which we announced in the press release. Let me start by clarifying that our studio management and lighting and grip offering is branded in the TV and film industry as Cinelease. In January 2012, we acquired Cinelease to expand our product offering and our footprint in another fast-growing specialty rental market. Cinelease is one of the largest lighting and grip rental companies in the United States with a scales studio platform. Over the past few years, the industry for renting, lighting and grip equipment to studios has evolved as investment firms began purchasing sound stages and physical studios as attractive ways to diversify their real estate portfolios.

These new owners want to offer a single point of contact for studios, studio management, and lighting and grip equipment, thereby making it less of a rental model and more a permanent part of their in-house business. As a result, in order for us to continue to grow the Cinelease studio management and lighting and grip business, Herc would need to add fixed-cost studio real estate to our portfolio offering. And that capital requirement would be a departure from our core rental business model. So at the beginning of the year, we began discussing strategic options for Cinelease that will enable it to continue to maximize its potential, either with Herc or on its own. We determined that exploring external opportunities was prudent, and so that process has begun.

As you can see on the slide, our Herc Entertainment Services business will continue to rent our rolling stock equipment to both on location studios, off location productions for TV and film, and live entertainment venues. Mark will share with you our financial performance here today, excluding Cinelease, to give you some perspective on the very strong performance of the go-forward business base. Finally, I’ll just say that Cinelease has been a great business for us. It’s a high-margin, seasonally steady growing platform business with a loyal team of product and service experts, and it open doors for Herc Entertainment Services to continue to flourish in this robust and exciting end market. We are confident that the strategic actions we are announcing today will help ensure that Cinelease and the incredibly strong and dedicated group of colleagues that comprise it are on the best possible trajectory moving forward.

And that Herc resources and focus remain on its core strategies for profitable long-term growth. With that, I’ll turn it over to Aaron to share the high-level operational drivers in the third quarter. Aaron?

Aaron Birnbaum: Thanks, Larry and good morning, everyone. The solid performance of our operations and field support teams, combined with steady demand across our end markets, continue to provide a favorable environment for us. Thanks to the hard work of Team Herc, we have demonstrated continued progress in our journey to build scale and market leadership through flexibility, efficiency, strategic network, and a customer first mindset. Turning to slide 9, our day starts with safety, which is at the core of everything we do. As you know, our major internal safety program focuses on perfect days. That is days with no OSHA recordable incidents, no at-fault motor vehicle accidents, and no DOT violations. We strive for 100% perfect days throughout the organization.

In the third quarter on a branch by branch measure, all our branch operations achieve at least 97% of days as perfect. Equally notable, our total recordable incident rate remains better than the industry benchmark of 1.0, reflecting our high standards and commitment to the safety of our people and customers. On slide 10, let me shift to a progress update on our growth strategies. One of the key initiatives of our urban market growth strategy is expansion through greenfield locations and acquisitions. In the third quarter, we added eight locations to our network, four greenfield locations and four locations from two new acquisitions. As you know, we focus on acquisition opportunities and high growth markets that complement our current branch network and fit our strategic, financial and cultural filters.

Of the acquisitions in the quarter, both were general rental companies. One was in Southern California, which includes the largest metropolitan markets in the U.S. and the other was Houston, a top 10 market. These acquisitions support our strategic goal of increased density and resilient urban markets. Moreover, many of the mega projects being announced are in the geographies where we have focused our acquisitions in greenfield locations like Phoenix, Houston, Austin, Detroit, and the Midwest. Through September 30th, we’ve invested $332 million in net cash on acquisitions. Multiple remains steady as we pay a little less for general rental companies and a little more for specialty rental companies. We targeted up to $500 million of our core acquisitions this year and have a strong pipeline of prospects.

As always, we’re being disciplined to ensure acquisitions meet our criteria and can add strategic and cultural value. Our acquisition process is now a core competency for us. We are quickly integrating these new businesses and are excited to welcome their teams to Herc while creating value for our people and our customers. On slide 11, in addition to acquisitions, growing our core and specialty fleet through new equipment investments is a key strategy to expanding our share and keeping up with the increasing demand opportunities. Let me start with demand drivers. Revenue growth from both local and national accounts remains strong in the first three quarters of 2023. Opportunities across end markets continue to increase. We are seeing it throughout our network and it’s supported by third party data.

An overhead shot of a ProSolutions employee in the process of delivering equipment to a construction site.

The exception, of course, is Cinelease where the duration of the labor strikes couldn’t have been predicted. This weight on our performance, masking the underlying strength of our core business this year. Studio entertainment represents just 1% of our rental revenue in the third quarter compared with about 5% a year ago. While the only fleet truly dedicated to those types of projects, especially lighting and grip equipment, we also rent power generation from HVAC equipment and material handling and aerial equipment. In July, we started moving that fungible fleet from the studio operations to other local customers. Although the writer striker is over, we don’t expect that to move the needle much in the fourth quarter since the actor strike is ongoing.

Moving on to fleet investments. As we told you on our call in July, our goal for the third quarter was to absorb the unusual wave of fleet deliveries we received in the fourth quarter of 2022 and the first half of this year. I couldn’t be more proud of what the team delivered. By the end of September, we’d significantly close the gap between fleet growth and revenue growth by capitalizing on seasonal volume and generating $124 million in sales of used fleet. The team did an outstanding job of rapidly adjusting to the supply chain recovery. On slide 12, you can see how fleet expenditures and disposals have been trending. Our fleet expenditures at OEC totaled $274 million in the third quarter, about 12% lower compared to last year. Most of that had to do with the fact that supply is still extremely tight for the highest demand equipment classes, like aerial and reach forklifts for example, which caused our suppliers to push out some of those 2023 orders into 2024.

On the flip side, we dispose of $309 million fleet at OEC. From an OEC standpoint, that’s almost three times more than in last year’s similar period. The substantial amount of dispositions in the single quarter had us utilizing the auction channels more than we typically would, and that reflected in the proceeds and sales margin. At the same time, the amount of fleet at OEC that was sold to retail and wholesale customers was a quarterly record for the company. So we are continuing to gain traction on our capabilities in those channels. Where we originally planned for fleet rotation of about $600 million that we see for this year, we will probably sell about $800 million by yearend based on the amount of new fleet deliveries we’ve received year-to-date.

And the typical seasonal de-fleeting we’ll be able to do in the fourth quarter. From our 2024 fleet planning discussions with vendors, we believe deliveries will return to our more normal seasonal schedule now that supply chain inventories and capabilities are improving. But I will reiterate that the highest category classes for supply continue to be those with the highest customer demand. So while availability in many CAT classes has improved, it’s clear we’re going to have another challenging year getting all the gear we’d like for certain categories. Fleet planning considerations for 2024 CapEx include incremental demand for mega projects, infrastructure and manufacturing reshoring, as well as local market growth and replacement fleet needs.

In addition to building a best-in-class fleet, you can see on slide 13 that we have a diverse well-balanced customer mix made of a large national accounts and local contractors operating in North America with a wide range of equipment needs across a variety of end markets. About 36% of our revenue is tied to non-residential construction with 26% related to our industrial customers and 15% coming from infrastructure and municipal projects. Local accounts, which represented 58% of rental revenue in the third quarter, are growing due to Herc’s penetration through our acquisition and greenfield strategy, as well as regional growth in infrastructure, education, maintenance and repair and local utilities. For national accounts, we are capitalizing on what we see as a booming large project pipeline with the federal and funded mega projects, large infrastructure jobs and manufacturing facilities.

These mega projects represent the beginning of a multi-year flow of dollars into the industrial and infrastructure space. As one of the largest players in the rental industry, our fleet capacity, digital capabilities, on-site management expertise and broad location networks set us up to win substantial more than of our share of the market’s growth. I want to thank team Herc for their commitment to operational excellence and safety. Their professionalism shows up in the execution of our services to our customers every single day. It’s a valuable differentiator for Herc. Now I’ll pass the call on to Mark.

Mark Humphrey : Thanks, Aaron, and good morning, everyone. I’m starting on slide 15 with a summary of our key metrics for the third quarter. Larry and Aaron touched on many of these line items, so I’m just going to provide some additional color. For rental revenue, about two thirds of the growth was organic, and a third came from acquisitions. DOE and SG&A as a percent of rental revenue improved 250 basis points in the quarter, supporting improvements in adjusted REBITDA margin and flow-through of more than 76%. The adjusted REBITDA margin of 49.3% was a record, exceeding our previous peak margin by 200 basis points. Additionally, net income grew 12% while diluted EPS grew 18% to $3.96 per share. Let’s walk through some of the other performance drivers on slide 16.

Here, you can see the rental revenue and adjusted EBITDA walks year-over-year. In the revenue chart, rental rate was up 6.9%. Fleet on rent increased 11.5% and mix and lower re-rent revenue was unfavorable by 9.9% compared with the third quarter a year ago. The decline in Studio Entertainment revenue is calculated in mix as is inflation, which together accounted for approximately 90% of the mix impact. Additionally, ancillary revenue was impacted by reduced re-rent revenue in the quarter, primarily reflecting better fleet availability, which positively impacts adjusted EBITDA and REBITDA margins. The catch-up in supply deliveries and the added season mix of fleet received in the first half, combined with the drop-off in Studio Entertainment revenue resulted in dollar utilization of 42.1% in the third quarter, versus 45.3% last year.

As Erin mentioned, we work through the quarter to right size the fleet and feel good about where we are heading into the fourth quarter. Additionally, we saw sequential improvement and dollar utilization every month this quarter following the seasonal demand trend. Moving to the adjusted EBITDA waterfall chart on the right, profit benefited from higher rental revenue and significant leverage from lower operating expenses as a percent of revenue but the Studio Entertainment’s top line weakness on its fixed cost base was a partial offset. Adjusted EBITDA margin was impacted by the higher sales of used equipment at OEC and the higher use of the auction sales channel in the recent quarter. On slide 17, we’ve added a summary P&L to the deck that excludes Studio Entertainment in order to give you a better sense of how well the base business has performed in the recent quarter and year-to-date.

From this table, you can see the strength of our core rental business when we exclude Studio Entertainment from both periods. For example, rental revenue growth would have been approximately 500 basis points higher in the third quarter at 13.2% and adjusted EBITDA would have grown 26.2% at a margin of 46.5%, a 130 basis point improvement. Also, our already record level REBITDA margin was stronger by another 170 basis points at 51%, with flow-through at 73%, a more than 2,000 basis point increase over the prior year. The base business results reflect strong demand, favorable pricing, benefits from operating leverage and record margin performance. A full reconciliation of performance metrics, excluding Studio Entertainment, can be found on slide 28 and 29 in the appendix of our presentation.

Shifting to Capital Management on slide 18, you can see we have no near term maturities and ample liquidity to fund our growth goals as we continue to allocate capital to invest in our business and drive fleet growth into the cycle. We remain confident in our business model and are committed to increasing shareholder value. In the third quarter, we declared a quarterly dividend of $0.6325, which represents $2.53 per share for the year. Net capital expenditures exceeded cash flow from operations in the nine months ended September 30, with cash outflows of $196 million before acquisitions. Our current leverage ratio at 2.5x is well within our 2x to 3x target range and in line with our expectations as we invest in growth. Moving on to slide 19, you can see the continued strength in our primary end markets.

In the upper left, the ARA estimate for 2023 North American rental industry revenue is growing to $76 billion based on ARA’s recently revised estimates and is forecasted to grow at a 4% CAGR and over the next three years due to its diversified end markets. On the bottom left is the Architectural Billing Index, which reported below 50 in September, it’s not unusual to see the billing index along with its counterparts, inquiries and design contracts be choppy in the back half of the year. We saw a similar trend in 2022. ABI is just one indicator of future construction activity. We will continue to monitor it in conjunction with other data points over the next 12 months. Two of our key end markets are industrial and nonresidential construction both continue to show strength for 2023.

Combined, these end markets reflect about two third of our customer base and both are likely to outperform other consumer-driven end markets due to new mega project construction as the reshoring of U.S. manufacturing capacity continues to gather steam. Taking a look at the industrial spending forecast on the top right, Industrial Info Resources is projecting $409 billion of spend in 2023, the highest level on record and a 16% increase over 2022. In the lower right quadrant is Dodge’s forecast for nonresidential construction starts, you can see in 2023, starts are estimated to be another $429 million on top of last year’s peak $445 billion. Of course, these are also just starts of new projects of multiyear construction builds that will continue into ’24, ’25 and beyond.

The dotted line on these charts reflects growth over pre-pandemic levels. You can see that last year and the next three are projected to be the strongest periods of activity that this industry has ever seen. Additionally, there’s another $306 billion in nonresidential non-buildings or infrastructure projects slated for 2023. That’s a 20% increase over 2022. These projects are supported by federal funds approved in the infrastructure package, the Chips and Sciences Act and the Inflation Reduction Act. The current strength in mega projects and infrastructure activity is not particularly sensitive to short-term interest rates and clearly has a structural tailwind. These large projects benefit rental companies of scale with larger, more diverse rental fleet and is one of the leading North American rental companies, Herc stands to benefit more favorably from this trend.

We expect to continue to outpace market growth at a rate greater than 2x. As we head into the last quarter of the year, we are fine-tuning our guidance for 2023. This is on slide 20. We’ve narrowed our adjusted EBITDA forecast range to $1.45 billion to $1.5 billion, which represents growth of 18% to 22%. This is on top of 37% growth in 2022. We assume the incremental benefits from opportunistic M&A this year would help offset the significant impact from Studio Entertainment and fewer weather events than originally projected. However, while the pipeline for M&A remains robust, the cadence of the closing activity is extending into Q4 and Q1 of 2024. Dollar utilization in the last quarter of 2023 is expected to be slightly down sequentially from Q3 as the benefits of our realigned fleet are offset by the studio entertainment impact and the probability that we won’t see a big weather event this year, compared with incremental volume from Hurricane Ian in last year’s fourth quarter.

And our target for full year 2023 REBITDA flow-through tightens to the mid-50s, which represents continued benefits from operating leverage year-over-year. We’ve also tightened our net fleet CapEx range to $1 billion to $1.1 billion to reflect the lower end of our original guidance, as noted last quarter. The revision is based on a roughly 33% increase in our original plan for used equipment sales at OEC and the fact that some of our planned 2023 growth CapEx was pushed into 2024 to account for OEM supply constraints in certain categories. Interest expense was up 82% in the third quarter year-over-year, reflecting the accumulation of Fed rate increases in our M&A funding. Finally, we expect our leverage ratio to be at the midpoint of our 2x to 3x target range at yearend, we are experiencing all the trends consistent within industry in an up cycle and intend to continue to address the needs of our customers as we execute on our growth strategy.

With that, I’ll turn the call back to Larry.

Larry Silber: Thanks, Mark. Now please turn to slide 21. Everything we do really starts with our vision, mission and values and a purpose statement that focuses on equipping our customers and communities to build a brighter future. We do what’s right, where it fit together, we take responsibility, we achieve results, and we prove ourselves every day. Now before moving on to Q&A, I want to remind you that we’ll be hosting our next Investor Day on November the 2nd. The event will take place here in Bonita Springs, Florida and will be available via webcast. With market opportunities significantly growing for Herc and having already achieved nearly all of our three-year targets that we set back in 2021, this will be an opportunity to set new guideposts for the future of our growth trajectory. I hope you’ll be able to join us. With that, operator, we’ll take our first question.

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Q&A Session

Operator: [Operator Instructions] We’ll take our first question from Rob Wertheimer with Melius Research.

Rob Wertheimer: Thanks and good morning, everybody. So my question is really on demand. And I think you’re pretty clear on the big picture outlook. But I want to narrow it down into, I guess, this quarter and last, where you sort of saw rental revenue grow at a slower pace than the fleet. And I wanted to ask if that’s because you didn’t see the pockets of demand you thought you would have for the fleet that was coming in or whether it’s largely an effect of the fact that you’ve got more fleet transition as you’re selling more and bringing more in a seasonal pattern. So really, is it demand didn’t quite show up like you thought? Or is it just transitional cost?

Aaron Birnbaum: Yes, Rob, demand landscape is still really good. And even as we look out over the next couple of quarters, it looks good. The fleet revenue balance and what we did in Q3 really was to kind of reset that balance because of the fleet, as I put in my remarks, they came in last year and then the first part of this year with the supply chain that got corrected. And so we wanted to correct our balance and that’s what we did in Q3. But the demand outlook is still good.

Rob Wertheimer: Perfect. I think you’re pretty fair on excuse. So does that imply then that as you get to a more normal season or a more normal pattern of fleet coming in and fleet going out that drag of — transitional drag goes away and you kind of revert on some of the time [inaudible]

Aaron Birnbaum: Yes, precisely. And we’ll continue to get the operating leverage of the business as that equation with fleet of revenue stays balanced. And that’s how we’ll plan for next year’s fleet adds. And that’s the visibility we see going forward for the next several quarters.

Operator: We’ll go next to Jerry Revich at Goldman Sachs.

Jerry Revich: Yes, hi. Good morning, everyone. I’m wondering if you could just talk about the pricing environment into October. It’s nice to see a positive variance in pricing in the quarter, I think versus most expectations even with utilization softer. Would you attribute that to the interest rate environment? And any context that you can provide on how the leading edge is tracking in October, if you don’t mind?

Larry Silber : Yes. I mean I think the way I would answer that, Jerry, is one, I think that the industry has remained extremely disciplined throughout the first three quarters of this year. And then I think secondarily, right, it’s also an extremely healthy environment. And so I think we’ve posted 7 through the first 9 months of the year. And I think that I would direct you as you sort of look into October and fourth quarter, that would be a mid-single digit sort of pricing lift for fourth quarter.

Jerry Revich: And Mark, maybe just to put a final point on that. I mean, normally, seasonally, pricing is up 50 basis points sequentially, October versus September, are we on pace for that normal seasonality?

Mark Humphrey: Yes, I would say that all seasonal trends are being followed.

Jerry Revich: Okay, super. And then Larry, in your prepared remarks you spoke to just the cadence of CapEx this year versus normal seasonality as we think about that cadence continuing into the early part of ’24, is it fair to expect CapEx to be down year-over-year in that 15% to 20% range in the first half, just given the timing of the deliveries? Or any comments that you would make about the capital budget for ’24, please?