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Good day, and welcome to the H&E Equipment Services Third Quarter 2021 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded.
I would now like to turn the conference over to Mr. Jeff Chastain, Vice President of Investor Relations. Please go ahead, sir.
Thank you, Chuck, and welcome, everyone, to this review of third quarter 2021 results hosted by the management of H&E Equipment Services. We appreciate your interest in the company. A copy of the press release covering our third quarter results was issued this morning and can be found along with all supporting statements and schedules at the H&E website and at www.he-quipment.com. Our discussion this morning is accompanied by a slide presentation, which can also be found at the H&E website under the Investor Relations tab and Events presentations.
If you proceed to Slide 2, I'll introduce those who are joining me today, which include Brad Barber, Chief Executive Officer; John Engquist, President and Chief Operating Officer; and Leslie Magee, Chief Financial Officer and Corporate Secretary.
Moving to Slide 3. And before I turn the call over to Brad, I want to remind you that today's call contains forward-looking statements within the meaning of the federal securities laws.
It's about our beliefs and expectations and statements containing words such as may, could, believe, expect, anticipate and similar expressions constitute [indiscernible] involve unknown risks and uncertainties, which could cause actual results to differ materially from those contained in any forward-looking statement. A summary of these uncertainties is included in the safe harbor statement contained in the company's slide presentation for today's call and also include the risks described in the risk factors in the company's most recent annual report on Form 10-K and other periodic reports.
Investors, potential investors and other listeners are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The company does not undertake to publicly update or relies any forward-looking statements after the date of this conference call. Also note, we are referencing non-GAAP financial measures during today's call. You will find the required supplemental disclosure for these measures, including the most directly comparable GAAP measure and an associated reconciliation as supporting schedules to our press release and in the appendix to today's presentation materials.
With those details out of the way, I'll now turn the call over to Brad Barber, Chief Executive Officer of H&E Equipment Services.
Thank you, Jeff, and good morning, everyone. I'd also like to welcome you and express my appreciation for joining us on today's call as we review the third quarter results of H&E Equipment Services. Before I begin my comments on the quarter, I want to welcome our President and Chief Operating Officer, John Engquist, who is joining Leslie and me on the call. John has held many positions within the company over the last 19 years and was promoted to the role of President and COO earlier this year. John will be joining the team on all future calls.
I will begin this morning stating how pleased I am with our excellent third quarter financial performance, which included impressive year-over-year and sequential improvement. The improved performance was especially evident in our equipment rental business and was indicative of outstanding operational execution during a period of strong activity. Also, with the crane business sale completed, we recognized a significant milestone in our transformation to a pure-play rental business model.
Closing this transaction strategically strengthens H&E's competitive position for the future. Proceed to Slide 4. I'll provide more detail on both our financial performance and the sale of the crane business in a moment. In addition, I'll identify some of the important drivers of business activity that led to our impressive third quarter financial results and what we might expect as 2021 draws to a close. Finally, following our successful efforts to intensify our focus on the equipment rental business, I want to explain our strategy for penetrating our existing geography as well as expanding our geographic footprint and why we expect the strategy to position H&E to benefit from the strong environment market environment.
Leslie will then follow with a more comprehensive review of third quarter financial results. Then we will take your questions. Slide 6, please. I will begin my discussion on the third quarter financial results with an explanation. Our agreement to sell our crane business required that the operations of this business be reported in discontinued operations. To avoid confusion, the financial highlights on Slide 6 are consolidated, presented as both continuing and discontinued operations. For the remainder of our presentation, results and information presented as continued operations and exclude the crane business, unless otherwise specifically noted, as discontinued operations.
As I mentioned earlier, financial metrics for the third quarter of 2021 were decidedly improved compared to the same quarter in 2020, which were in part diminished by the effects of the COVID-19 global pandemic. However, our industry has demonstrated both discipline and a steady rebound from the pandemic-induced declines that dominated 2020. On a consolidated basis, total revenues in the third quarter of 2021 of $319.4 million improved 10.4% when compared to the same quarter in 2020.
In addition, adjusted EBITDA grew to $119.1 million and up 20.6% while posting a margin of 37.3%, an improvement of 320 basis points over the period of comparison. Slide 7, please. With regards to continuing operations, total revenues improved to $275.4 million or 9.3% when compared to the third quarter of 2020. This favorable outcome was largely due to a 22.1% increase in total rental revenues to $197.2 million. Also, adjusted EBITDA in the third quarter improved to $112.3 million, up 24.1% over the period of comparison, equaling -- equating to an adjusted EBITDA margin of 40.8% or 490 basis points better than a year ago quarter.
On to Slide 8, please. Our rental business showed outstanding results for the third quarter. When compared to the third quarter of 2020, rental revenues increased 21.6% to $176.7 million with a gross margin of 50.9% or 660 basis points ahead of year ago quarter. The combination of higher physical utilization and strengthening rental rates contributed significantly to the quarter's performance gains, which included a 600 basis point increase in dollar utilization to 38.9% compared to the year ago quarter.
Slide 9, please. Multiple factors produced a strong outcome. Customer demand for our diverse mix of rental equipment remained vigorous throughout the third quarter as nonresidential construction projects intensified. This elevated demand drove our average physical utilization to 71.9% or 840 basis points ahead of the year ago period and improved 320 basis points on a sequential quarterly basis. This represented our highest utilization since the fourth quarter of 2018. At the same time, rental rates continued their positive trend and finished the third quarter of 2021, 2.6% higher on a sequential quarterly basis and 2.9% ahead of the same quarter last year.
Such strong financial results would not be possible without our focus on operational excellence, which remains a core component of our success. Since the close of the third quarter, our physical utilization continued to reflect outstanding operational execution and strong customer demand, reaching a peak of just over 75% in October. While we're enjoying the momentum continue -- coming into the final quarter this year, we still expect to see utilization levels moderate as seasonal factors emerge during the second half of the quarter. As we enter the final quarter of 2021, I remain enthusiastic about the future of the equipment rental industry.
Strong evidence of a broadening construction market remains in place. It's led in part by nonresidential construction activity, which is H&E's primary end market and accounted for 68% of revenues over the trailing 12 months from September 30, 2021. The customer inquiries remain elevated, and all industry indicators continue to hover at near record levels. As evidence of the company's growing confidence in expansion of our primary markets, H&E expects to disclose strong fleet growth plans for 2022 with a growth investment -- gross invest that is expected to significantly exceed our total expenditures of any of the previous years of our 60-year history.
We will disclose our final capital expenditure spending plan for 2022 following the completion of our evaluation and thereafter, begin offering quarterly capital expenditure guidance. On to Slide 10, please. Before I turn the call over to Leslie for the financial review, I want to offer some brief remarks on how we're positioning H&E for future success as we enjoy strong cyclical recovery in our industry. First and foremost, we have completed significant steps that clearly advance H&E's transition to a pure rental business.
These include the sale of the crane business, which closed on October 1 as well as the mid-September 2021 sale of 2 earthmoving distribution branches. These steps and other future initiatives will establish a pathway to higher and more sustainable revenue growth as well as margin appreciation throughout the business cycle. Proceeds from the crane sale will facilitate continued investment in our rental fleet as we evaluate the expanding needs of our customers while improving the mix of our fleet, which remains one of the youngest in the industry.
Slide 11, please. Also, proceeds will be used to support further development of our branch network. Warm starts and greenfield branch expansions remains an integral part of our expansion plans, and we continue to evaluate acquisition opportunities. Thus far in 2021, we have opened 10 new branches, including an October -- new location in Ogden, Utah placing H&A in 24 states across the U.S., and we plan to establish no fewer than 10 new branches in 2022.
To conclude, next month, H&E will celebrate 60 years in business. As we approach this milestone, I'm very confident in the company's ability to capitalize on growth initiatives that should further enhance our competitive position. reinforcing my confidence of factors such as our young rental fleet and diverse geographic presence. Also, the strength of our balance sheet, our ample liquidity and our robust scalable digital customer platform. And last, but certainly not least, the ability and experience of our leadership team as well as our growing group of dedicated employees across our expanding branch network.
Taking each of these factors into account, I believe H&E is ideally positioned to capitalize on our future growth initiatives.
With that, please proceed to Slide 12, and I'm going to turn the call over to Leslie Magee. Leslie?
Good morning, everyone, and thank you, Brad. I'll begin today's financial review on Slide 13. As Brad explained earlier, our third quarter and year-to-date financials report the results of the crane business as discontinued operations. With this in mind, on Slide 13, we present a summary of key financial measures for the 3 and 9 months ended September 30, 2021, to convey an understanding of what was given up and more important, what we gained.
Our financial measures are presented as continuing and discontinued operations or consolidated results, discontinued operations or the crane sale and continuing operations Referring to the 3-month period, the crane business, which represented approximately 3% of our OEC, had revenues of just under 14% of consolidated total revenues with an adjusted EBITDA margin of 15.5%. The key point from this table is the accretive nature of the transaction on the continuing operations of H&E.
The company's go-forward margins experienced meaningful appreciation as illustrated on the slide. The table also notes the September 2021 sale of 2 earthmoving distribution branches located in Arkansas. We reported an approximate $5.3 million gain on the sale of these Arkansas branches, which is included in the total $6.2 million continuing operations gain on the sales of property and equipment. Further, the operations of these branches are included in continuing operations through the date of sale and did not qualify for discontinued operations.
Collectively, these transactions support H&E's transition to a pure rental business, where we expect to benefit from higher and more stable revenues and margin appreciation. Slide 14, please. Moving now to continuing operations. Our results for the third quarter, once again, included improvements in physical utilization and rental rates, along with additional fleet growth. Revenues in the quarter improved $23.5 million to $275.4 million compared to $251.9 million in the third quarter of 2020.
The 9.3% increase was driven by further growth in our rental revenues, which closed the third quarter at $176.7 million or 21.6% ahead of the third quarter in 2020. Within the rental segment, physical utilization on an OEC basis averaged 71.9% for the quarter, up 840 basis points from the year ago measure and was up 1,290 basis points from the pandemic-led lows seen in the second quarter of 2020. Higher fleet utilization drove further gains in rental rates, which improved 2.9% from the year ago quarter and 2.6% on a sequential quarterly basis.
The rate improvement was both meaningful and encouraging when you consider the second quarter 2021 year-over-year comparison remained unfavorable by 0.2%. Also, we continue to grow our fleet in the third quarter, expanding by 5% when compared to the same quarter in 2020 and 8.4% fleet growth since the end of 2020. Looking at our other business segments, used equipment sales declined 14.2% in the third quarter to $31.1 million, with the decrease due primarily to lower sales of earthmoving equipment caused largely by the strong rental demand.
Also year-over-year sales of new equipment were down 30.4% to $19.4 million due principally to supply constraints, which led to fewer sales of new earthmoving and new other equipment. Our parts and service business segments reported aggregate revenues of $26.1 million or 5.4% better than the year ago quarter. When compared to the same quarter in 2020, total gross profit improved 20.9% -- 29.4% to $113.9 million. The increase, which resulted in a gross profit margin of 41.4% or 650 basis points ahead of the prior year third quarter was primarily due to higher margins from rentals and used equipment sales in addition to a favorable revenue mix.
Reviewing our business segments, gross margins on rentals improved to 50.9% or up 660 basis points compared to 44.3% in the year ago quarter, with the improvement due primarily to higher utilization and rental rates. Used equipment margins were 37.6% compared to 30.4%, led by higher margins on material handling and earthmoving equipment. Margins on new equipment sales were 12.4% compared to 11%, resulting from better margins on earthmoving equipment.
Pure rental fleet margins improved to 39.7%, up of 31.5%. And finally, margins on parts finished the quarter at 24.5% compared to 26% in the year ago quarter, while our service margins were 65.2% in the third quarter compared to 67.5% a year ago. Slide 15, please. Income from operations for the third quarter of 2021 totaled $45.7 million or 16.6% of revenues. The result compared to income of operations of $25.4 million in the third quarter of 2020 or 10.1% of revenue. Third quarter 2021 margins were supported by the improvement in rental gross margins, favorable mix of revenues and higher gain on the sales of property and equipment and partially offset by higher SG&A expenses.
Gain on the sales of property and equipment were $6.2 million in the third quarter of 2021 and $2 million in the third quarter of 2020, with the third quarter 2021 increase due to the $5.3 million gain on the sale of Arkansas distribution branches. Proceed to Slide 16, please. Net income was $24.7 million or $0.68 per diluted share in the third quarter of 2021 compared to $8 million or $0.22 per diluted share in the third -- in the year ago quarter.
The effective income tax rate was 24.7% in the third quarter of 2021 and 30.4% in the third quarter of 2020. Slide 17, please. Adjusted EBITDA improved to $112.3 million in the third quarter of 2021 compared to $90.5 million in the year ago quarter, an increase of $21.8 million or 24.1%. Adjusted EBITDA margins improved to 40.8% in the third quarter compared to 35.9% in the year ago quarter. The combination of favorable revenue mix, better rental margins, higher margins on used equipment sales and higher gain on sales of property and equipment drove the margin improvement and partially offset by higher SG&A expenses.
Next, Slide 18, please. SG&A expenses totaled $74.4 million in the third quarter of 2021 compared to $64.5 million in the year ago quarter. The $9.9 million or 15.3% increase was due largely to a $9.1 million increase in employee salaries, wages, incentive compensation, payroll taxes and related employee benefits. Also, $0.9 million in higher facilities expenses and a $0.6 million increase in professional fees. Branch expansion costs accounted for $3.3 million of total SG&A expenses in the third quarter, largely representing the addition of 10 branches to our network since the conclusion of the third quarter of 2020 and includes initial expenses associated with our new location in Ogden, Utah.
Slide 19, please. Next, I'll cover fleet capital expenditures and cash flow for the 3-month period ending September 30, 2021. And our gross fleet capital expenditures were $110.9 million, including noncash transfers from inventory. Net rental fleet capital expenditures for the 3-month period were $79.7 million. Gross PP&E capital expenditures for the third quarter were $8.5 million, while proceeds from sales of PP&E exceeded our gross expenditures by $1.4 million.
Our average fleet age as of September 30, 2021, was 39.6 months, which compares to the industry average fleet age of 52.7 months. Free cash flow for the 3 months ended September 30, 2021, was $44.2 million compared to free cash flow of $66.2 million over the same 3-month period in 2020. Slide 20, please. At the end of the third quarter, the size of our rental fleet based on OEC was approximately $1.8 billion, an $88 million increase or 5% greater than a year ago. Our OEC was up $141 million or 8.4% since the close of 2020.
Our average dollar utilization was 38.9% compared to 32.9% a year ago and driven predominantly by higher physical utilization and rising rental rates. Slide 21. Addressing our capital structure, we ended the third quarter of 2021 with net debt of $1 billion and net leverage on a trailing 12-month basis of 2.7x, which was a modest improvement from the previous quarter. We have no maturities before 2028 on our $1.25 billion of senior unsecured notes.
Slide 22, please. With regards to our liquidity position, we have no borrowings through the first 9 months under our amended ABL facility. Our total liquidity position remains healthy at $976.3 million representing the sum of cash on the balance sheet of $235 million and borrowing availability under the ABA facility of $741.3 million. Our excess availability under the ABL facility was approximately $1.1 billion at the end of the third quarter with a minimum excess availability as defined by the agreement of $75 million.
By definition, excess availability is the measurement used to determine if our springing fixed charge is applicable. With excess availability of more than $1 billion, we continue to have no covenant concerns. And finally, we paid our regular quarterly dividend of $0.275 per common share of stock in the third quarter of 2021. While dividends are always subject to Board approval, it is our intent to continue to pay the dividend.
Slide 23 please. In summary, our third quarter financial performance reflects H&E's strong operational execution across an expanding branch network and our success with capturing the growth opportunities increasingly evident throughout our end markets. Our rental operations delivered strong performance in the quarter, capitalizing on improving fleet utilization and rising rental rates while growing the fleet 2.9% in the quarter and more than 8% for the year.
Year over rental gross margin improved 660 basis points to 50.9% was one of our excellent quarterly metrics. And with the sale of the crane business completed, we are now better positioned to execute our growth initiatives while benefiting from higher and more stable revenue growth and margin appreciation as we intensify our focus on the rental buses. And this concludes my review on the quarter. Operator, if you would please provide instructions to our call participants today.
[Operator Instructions]. And the first question will come from Stanley Elliott with Stifel.
Quick question for you all. Nice to see the margin lift ex the distribution business. You -- structurally have you thought about or could communicate kind of where you think the margins can go, 40.8%, very good, but a lot of good tailwinds, 36% for 9 months is still very good, too. Any sort of color or direction that you guys could share on that front?
Sure, Stanley. We believe that 40% mark is kind of a good indicator with our business mix and profile. Obviously, that could be a little impacted with season -- more seasonal quarters, Q4, Q1. But generally, it's probably in the range of where we're going to be performing at currently. That stated, our view is that we're going to continue to improve our rental performance primarily. Maybe some utilization. Certainly, our view is that we will continue to increase rates. We believe we're improving the mix of our assets that deliver better returns. So given time, we believe that, that number will continue to incrementally improve as we go forward.
And you mentioned utilization. 75% in October is fantastic, but probably not sustainable over the long term. How are you all thinking about kind of a more ideal sort of level operating into next year? And curious thoughts there.
Sure. Yes, we're proud of that 75%. In the company's history, there was a time we actually hit 77% several years ago. We talked a lot about operational excellence and the initiatives we have internally. And so I would not want to lead anyone to believe that we're going to average 75% in a quarter. That's not realistic. You saw what the quarterly average was. I will tell you that as we go forward, we believe we have room to improve our annual utilization incrementally.
So if there's something more specific, John or myself would be happy to respond to it. But we're proud of what we achieved in Q3, but what we achieved in Q3 on average is not necessarily the best we can do in other peak periods.
That's great. And then lastly, in terms of CapEx need for the business, you have a young fleet, obviously, a lot of OEMs are facing supply chain issues. Do you all feel conversations you've had with them thus far that you'll be able to get the fleet that you're -- you would want, given the demand book that you see building into next year?
We feel very confident. We stay in contact. We have excellent relationships with our manufacturers. We've been, what I would call month more intense planning for the last 6 months, and we have got verification with -- we're wrapping up our 2022 planning with our operations right now. Based upon what our expectations are, we believe we're going to receive 100% of the products that we need. Maybe more importantly, going to be able to do so without any large inflationary headwinds. So we're expecting low single-digit increases on average.
So the answer is yes, we can get the product. It should be further supply chain disruptions, and we all hear from the manufacturers. Well, then my comments would change. But we're hearing direct from them. Our orders are placed, and we feel very good about our ability to grow.
[Operator Instructions] Our next question will come from Steven Ramsey with Thompson Research Group.
I wanted to follow up on the fleet commentary there to make sure I understand it. To first clarify getting 100% of the fleet you would like to have for next year, will the timing of that coming in to you and your branches be ideal? Or will it come in later in 2022 than you would get in a normal year?
Steve, we're working on fine-tuning that right now, but the vast majority of our planned purchases for next year are already slated for not only quarters, but specific months. We're asking the manufacturers to verify their ability to make deliveries to our requirements. And they're telling us they're going to get us the equipment when we want it. We'll certainly be able to talk in more detail. As I just mentioned, we're going to move to give quarterly guidance on CapEx starting next quarter because we're going to have significant fleet growth next year, and we think it's important that we communicate that.
We'll try to make sure when we give that guidance, we try to context the cadence. But today, as we sit here, our manufacturers have supplied us delivery dates that absolutely fit into what our planning calls for.
Excellent. Okay. And then thinking about your long-term ambitions in specialty equipment, I guess if there are any updates on this front? And do you think you can grow this at the desired level? Or do the manufacturers' production challenges slow down the ability to execute this over? Or maybe just a little slower than what you originally hoped for?
I think there are 2 things on the specialty front: number one, there's always acquisition opportunity, and we continue to be active in pursuing and reviewing opportunities that are out there; number two, we organically started and announced a trench safety business. Obviously, the steel pricing currently is a headwind to us, and it stifled our desire to purchase product at current steel pricing. So that's not detracting from our desire to enter that business or grow it. We can grow it fairly significantly.
That being said, outside of a larger acquisition, specialty is going to remain a very small piece of our overall revenue for the foreseeable future. But we plan to get back to growing that organic startup that we've spoken about just as soon as the pricing makes better sense for us.
Fair. Okay. Okay. And then on the rate front, certainly flip positive in a major way. How much of that is easier comps? How much of that is pricing initiatives? And then thinking about rates going forward, given the tight fleet in the industry, do you expect it to be positive to this magnitude going forward? And then are rates strong broadly? Or are some geographies lagging or leading in a major way?
Yes, Steve, let me let John Engquist respond to that.
Yes, sure. So look, I can say Stephen, our rates are consistent across all geographies. We've seen consistent gains across all geographies. With respect to 2022, we do feel that 2022 is going to be a positive environment for us to continue to raise pricing. So we're optimistic about that. And I think next year is going to certainly support additional pricing increases.
[Operator Instructions] And this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Jeff Chastain for any closing remarks. Please go ahead.
Thank you, Chuck. We're going to go ahead then and conclude today's call. We appreciate you taking the time to join us today and for your continued interest in H&E Equipment Services. We look forward to speaking with you again. And Chuck, thank you for your assistance with today's call. Good day, everyone.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.