Custom Truck One Source Inc
NYSE:CTOS
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Custom Truck One Source Inc
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Good morning, and welcome to Nesco Holdings' Second Quarter 2020 Earnings Conference Call. Please note, this conference call is being recorded.
I would now like to turn the call over to Mr. Preston Parnell of Nesco Investor Relations. Sir, you may begin.
Thank you, operator, and welcome everyone to Nesco's Second Quarter 2020 Earnings Conference Call. Earlier today, we issued a press release announcing our second quarter results and filed an earnings presentation to accompany our prepared remarks, both of which are available on Nesco's Investor Relations website at investors.nescospecialty.com.
I would like to remind you that management's commentary and responses to questions on today's conference 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 the 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 our filings with the SEC. Additionally, please note that you can find reconciliations of the historical non-GAAP financial measures discussed during our call in the press release issued today.
I will now turn the call over to Nesco's Chief Executive Officer, Lee Jacobson. Lee?
Thank you, Preston. Good morning, everyone. Thank you for joining us. I hope you and your families are safe and healthy. Nothing is more important in these times. I'm excited to share that with me -- with me today is Josh Boone, our new Chief Financial Officer. As you know, Josh joined the Nesco team in June. He was previously the chief financial officer of Patrick Industries, a public company with over $2 billion in annual revenue. We are thrilled to have Josh join the team and look forward to achieving key milestones and increasing shareholder value together.
On today's call, I'll focus on 4 key themes, and Josh will provide a detailed review of our financial results. Those key themes are as follows: 1, our top priority remains the health and safety of our employees, while continuing to provide uninterrupted service to our customers; 2, despite the challenging economic environment, our second quarter performance was solid, and we achieved ample cash generation; 3, we have significantly enhanced our senior leadership team, driving strategic execution and transforming the company into a stronger organization; 4, we are well prepared to benefit from near-term tailwinds, while positioning the company for the long term.
I will begin with an update on COVID-19's impact on the business. We continue to serve our customers and operate with little to no business disruption despite the current economic environment resulting from COVID-19. Mandatory shutdowns and social distancing measures put in place to mitigate the pandemic's impact have changed the way we go about doing business. However, as an essential service provider, we remain committed to serving our critical electric transmission and distribution, telecom and rail customers, and all of our service and distribution locations have remained open for business.
We could not have responded to the pandemic, the way we have without our team. Being a provider of essential services is beneficial from a business perspective, but it can be challenging for employees. It's natural to feel anxious at the thought of going to work during a pandemic. That said, our team could not have done a better job. They have taken on the responsibility to provide services to our critical infrastructure customers with a sense of pride. I'm impressed by the leadership and fortitude of our team. I want to thank every member of the Nesco team for your continued resilience and professionalism through the crisis.
On that note, the health and safety of our employees continues to be our highest priority. We have implemented initiatives to ensure the continued safety and welfare of our employees with strict adherence to state and federal protocols. We are fortunate that we do not have a storefront business model. So none of our service locations across the country require in-person contact or have a staff sales team. In our service locations, we continue to service our fleet but adhere to social distancing.
Many of our office employees are working from home, which has proven to be equally as effective as being in the office. Our sales team has refined their strategy to effectively incorporate the use of virtual meetings as they have transitioned most of their interactions with existing and potential customers to a combination of video and phone calls. We appreciate that these changes were unexpected for our team and appreciate how seamlessly and effectively they have transitioned.
The collective years of industry and related operating experience of our leadership team has also been invaluable in helping guide us through the pandemic. We added 3 members to our leadership team in the second quarter. Joining Josh Boone, as key strategic additions to our leadership team are, Mike Turner and Chris Hulse.
Mike Turner joined Nesco as the new President of our Parts, Tools and Accessories segment. Mike joined us from Anixter, a Fortune 500 global distributor of utility power solutions and other products, where he had a 25-year career and held leadership positions across multiple divisions and functions, including management, finance and sales.
We also added Chris Hulse as Chief Digital Officer, a new position at Nesco. Chris is responsible for implementing digital solutions throughout our organization and leads our marketing and IT departments. He was previously a digital transformation adviser for Platinum Equity, and prior to that, was chief digital officer and marketing officer for BlueLine Rentals, where he worked with our President Rob Blackadar, before it was acquired by United Rentals for $2.1 billion in 2018.
Each of these gentlemen have exemplary credentials and are already providing valuable insights that are helping Nesco enter its next phase of growth.
Now on to our performance in the second quarter. Total revenue increased 9% from $62.9 million in the second quarter of 2019 to $68.5 million. Growth was primarily driven by our PTA segment, where revenue grew 64% year-over-year to $15.1 million, primarily due to the acquisition of Truck Utilities. Within the ERS segment, revenue decreased 0.5% to $53.4 million. Equipment sales grew 18% to $10.4 million, while Equipment Rental revenue declined 4% to $43 million. Revenue in both segments was impacted by COVID-19 as electric utilities and telecoms delayed new projects until social distancing measures are eased.
Our adjusted EBITDA declined by 14% from $30.5 million in the second quarter of 2019 to $26.2 million due to a combination of lower utilization, which resulted in reduced equipment rental gross profit and increased selling, general and administrative expenses primarily related to public company costs.
The pandemic's impact on the company has been mitigated by the fact that we serve critical infrastructure in markets. Most existing projects have continued, and there have been some new projects, but not enough to offset projects that finished up or have been put on hold. The impact of the pandemic on the company was greatest from mid-March to the end of April, while the strictest shelter-in-place orders were in effect.
As mentioned on our first quarter conference call, during this period, equipment on rent fell 8% to approximately $460 million. This decline was primarily due to off rents in the distribution and telecom end markets, where some projects were postponed or activity was put on hold. Distribution and telecom projects tend to take place in locations with higher population densities than transmission and rail, and as a result, are more sensitive to shelter-in-place orders.
Transmission and rail, which typically experience a spring pick up, remained relatively flat in this period due to COVID-19 related project delays.
Throughout May, the equipment on rent fell another 3% to just under $450 million, while muted relative to the mid-March to April period, similar factors caused the May decline. Distribution and telecom experienced slight net equipment off rents and transmission and rail held steady. In both June and July, equipment on rent remained in the same range as in May. We experienced a rebound in telecom and distribution demand as distancing measures eased, offset by the typical summer slowdown in transmission.
The electric grid is nearly entirely responsible for cooling, while heating is shared between electric, natural gas and heating oil, among others. Given that, the transmission grid is particularly strained in the summer and utilities prefer to limit summer repairs to avoid the risk of large scale, self-inflicted outages and further grid strain. Nesco's third and fourth quarters are seasonally the strongest in a typical year. In the back half of the year, we expect Nesco will benefit from this typical seasonality and pent-up demand from COVID related project delays.
We have implemented several initiatives to reduce costs and preserve capital to mitigate the impacts of the pandemic. From a cost management perspective, this includes a hiring freeze, a pull back in service costs to coincide with demand, a reduction in overtime and outsourced equipment servicing, and an elimination of nonessential spending, including all nonessential travel. In addition, we implemented headcount reductions that will provide $2.5 million in annualized cost savings.
We focused on variable and growth positions that will not disrupt our business or limit our ability to pivot quickly when demand recovers. When combined with our other cost reductions, total cost reductions to date are approximately $5 million on an annualized basis.
From a cash management perspective, we reduced net capital expenditures in the quarter to $8 million from $29 million in the second quarter 2019 and $27 million in the first quarter of 2020. We also aggressively reduced working capital, most notably a $10 million sequential reduction in accounts receivable. In the third and fourth quarter, we plan to push net capital expenditures even lower and expect working capital will provide a cash benefit, which Josh will cover in more detail.
We are laser-focused on measures to further improve free cash flow and liquidity as we weather the pandemic, but believe COVID-19's impact on our business will be temporary. We expect a relatively strong back half of the year resulting from pent-up demand from project delays in the second quarter and our typical increases in demand during the third quarter. The long-term fundamental demand drivers in each of our end markets remain unchanged.
In transmission and distribution, utilities must make significant investments to harden the grid and reduce fire hazards, extend the grid to integrate new renewable energy sources and ensure enough power can be delivered to meet future electrification needs, including electric vehicles. According to the Department of Energy, nearly 50% of the electric grid is at or near the end of its useful life, and annual power outages have increased more than 6-fold since 2000. The economic cost of power outages each year exceeds $150 billion, greatly outweighing the cost of regular inspection, repair and replacement of grid lines, poles and equipment.
Public utilities are well aware of the multiple factors driving a need for grid investment, which is why they've announced multiyear capital outlays exceeding $300 billion in aggregate, a large percentage of which is allocated to grid hardening and modernization.
Despite the economic backdrop, the need for reliable communications grid has been heightened as a result of the pandemic. More people are working remotely, and in many cases, children are attending virtual classes. In an increasingly digital world, we believe telecom companies will need to increase their focus on 5G investments, filling network gaps and maintaining existing wireline technology.
When 5G begins in earnest, these installations will be right in our sweet spot. The higher frequency millimeter waves 5G utilizes cannot travel nearly as far as 3G and 4G waves, which will force telecommunications companies to install an increased number of small cell sites, estimated at 20x the number of 3G and 4G sites. These small cells will be installed on a lower height, utility and telephone poles instead of utilizing large towers. These installations will require specialized insulated bucket trucks like Nesco's.
Finally, railroads must continue to invest to maintain, upgrade and repair their existing networks and upkeep existing operations. We believe railroads are increasingly outsourcing repairs to contractors and equipment rental providers to increase operating flexibility.
With that, I'll turn the call over to Josh, to discuss our financials. Josh?
Thanks, Lee, and good morning, everyone. I hope everyone is remaining safe and healthy. I'm excited to be part of the Nesco leadership team and look forward to partnering with other members of the team to drive overall shareholder value. On today's call, I will provide a detailed review of our quarterly financial results, discuss our balance sheet and liquidity and outline the actions we are taking to increase free cash flow while reducing leverage.
As Lee mentioned, our total revenue increased 9% relative to 2019 during the second quarter to $68.5 million. ERS revenue decreased 0.5% to $53.4 million. Equipment Rental revenue declined 4% to $43 million, primarily due to a less than 1% decline in OEC on rent to $461.1 million, and fleet utilization decline of 8.9% to 71.3%. The utilization decline was primarily a result of project delays and certain projects being put on hold, particularly in the distribution and telecom end markets.
Average rental rate per day was flat on a consolidated basis at $136.7 million in both the second quarters of 2020 and 2019. ERS equipment sales, which can vary quarter-to-quarter, grew 18% to $10.4 million and were elevated in part due to new dealer inventory investments in 2019.
Our PTA segment revenue increased 64% to $15.1 million. PTA rental revenue grew 22% to $4 million, primarily due to investments made in 2019 to establish a national footprint for PTA. PTA sales and service revenue increased 88% to $11.1 million, primarily as a result of the acquisition of Truck Utilities. Pre COVID, we expected even stronger growth in the PTA segment. Most of our PTA revenues stem from new project starts, certain new projects were delayed due to COVID-19.
Adjusted EBITDA declined 14% to $26.2 million during the second quarter. The decline in adjusted EBITDA was primarily due to a combination of a lower utilization, which resulted in lower equipment rental gross profit and an increase in selling, general and administrative expenses as a result of being a newly public company.
The decline was partially offset by higher equipment sales and truck utilities. Our core rental gross profit, excluding depreciation, only declined 7% to $32.7 million.
I am pleased to report that our free cash flow improved $41.9 million to $14.4 million in the second quarter compared to negative free cash flow of $27.6 million in the second quarter of 2019. This improvement was due to a combination of strong operating cash flows and lower CapEx, consistent with our cash preservation initiatives in response to COVID-19.
Operating cash flow increased $21.2 million year-over-year to $22.5 million, which was partially driven by our prudent working capital management in the second quarter. We plan to continue to manage our working capital in the coming quarters and anticipate working capital will be a source of cash in the back half of 2020. Cash from investing improved $20.8 million year-over-year to an $8 million net outflow.
One of the primary benefits of our business model is that we are able to significantly reduce capital expenditures in downturns and generate substantial free cash flows. We plan to spend less on cash flows from investing in the third and fourth quarters and estimate full year 2020 net CapEx to be between $35 million and $40 million.
For the first 6 months of the year, total net capital expenditures were $35 million. We expect a combination of strong earnings, disciplined cost control, reduced capital expenditures and working capital management will drive strong free cash flows in the back half of 2020, resulting in positive free cash flow for the year and further improving our liquidity.
We had ample liquidity of $83.6 million at the end of the second quarter. This includes $5.3 million of cash and $78.3 million of availability under our asset-based lending facility.
At the end of the second quarter, we had net debt outstanding of approximately $766 million and had no significant debt maturities until 2024. In the coming quarters, our focus will be on cash flow generation, debt pay down and capital preservation to enhance liquidity. We are committed to achieving a long-term leverage profile in the range of 3.0 to 3.5x. We expect to achieve our long-term leverage target through strategic growth and disciplined capital allocation.
As markets recover, we will remain thoughtful and disciplined as we look to increase our capital investments. We will make new fleet investments with a particular focus on asset level returns and positioning the company for long-term growth. As we invest in the new fleet, we will prioritize maintaining positive free cash flows and paying down debt. This will result in deleveraging through both debt pay down and adjusted EBITDA growth.
In closing, I'm excited for what the future holds for Nesco and look forward to working with the leadership team to execute our strategy, drive profitable growth and maximize shareholder value.
Now I'd like to turn the call back to Lee for closing remarks. Lee?
Thanks, Josh. The end customers in each of our core end markets have continued to reiterate spending and investment plans, and many of our public company contractor customers maintain record backlogs. In addition, we expect the decades-long shift from owning to renting equipment to continue, especially in the current environment as companies elevate their focus on capital preservation.
As we exit this period of project delays related to COVID-19, we expect to continue to be a long-term beneficiary of strong growth drivers in our end markets. We believe this will start in the back half of 2020. In the last 5 years, we have seen OEC on rent increase an average of more than 10% from the end of June to the end of September. Seasonally, the third and fourth quarters are typically our strongest. We expect these typical seasonal factors to be bolstered by pent-up demand resulting from COVID-19 project delays. After making significant investments to grow our fleet and expand the geographic presence of our parts, tools and accessories business in 2019 and the first quarter of 2020, we are prepared for growth with limited additional investment required.
In summary, we have assembled a strong team that is focused on executing and delivering on our commitments. 2020 has turned out to be a challenging year for all businesses. Our critical infrastructure end markets are somewhat insulated, but not immune to what is happening in the general economy. We are controlling the controllable and are focused on managing costs, cash flows and mitigating the downside risks. We are balancing near-term uncertainty with positioning the company for accelerated growth as the recovery begins.
The fundamental investment thesis for Nesco remains intact. We are a leading player in critical infrastructure end markets with strong multiyear growth tailwinds. We are well capitalized and have the right assets and team to manage through this challenging environment and come out stronger on the other side.
With that, I'll turn the call back to the operator and open the line for questions.
[Operator Instructions] And our first question comes from Tim Thein of Citigroup.
The first question is on, just on -- and again, recognizing you're not providing guidance, but for the second half, can you just help us maybe with a framework for how we should think about margins as activity levels pick up?
And I'm specifically, am just looking at cost of rent in ERS was up, call it $2 million and basically flat revenues. Is that -- as we think of the back half of the year, I presume some of the restructuring benefits will flow through there, but maybe just help us, again, with kind of a framework on the margins for the back half.
Sure. One of the consequences, Tim, of the level of off rents over the second quarter is we saw a significant number of units that have been on rent for a long duration. And not unexpectedly at all, you'll see a higher level of maintenance cost during that type of cycle. So as we look to a second half with increasing on rents and an increasing -- a decreasing level of off rents proportionally, we should see reduced overall cost as a percent of increasing revenue and a widening of the GP spread as we go through the quarter and see a more normal deployment of equipment with less of a wave or a rush of the off rents connected with the utilization decline and just the overall environment.
Yes, this is Josh. I'll just add to that. So as we think about our EBITDA margin in Q2, pretty significant decline compared to year-over-year, but really only down 100 basis points compared to Q1. And so we had planned for margins to be down year-over-year for 2020, with the growth of our PTA business. And also the sales of our new fleet, which have the overall lower margin profile compared to Nesco's legacy margin profile. In addition to that, the addition of Truck Utilities, which came on in Q4 of last year that also will impact our overall margin profile. And so as we think about the outlook of the remainder of the year and as we get a greater mix of rental revenue, which has a higher overall margin profile, you combine that with the SG&A cuts, overall cost reductions that we've done to date of $5 million, we would expect sequential margin improvement as we progress through the back half of the year.
And Lee, just on rates, the -- holding those flat year-over-year, in a quarter where you had such pronounced decline in fleet on rent. That I guess, stood out to me at least. And I'm just curious, as those projects were delayed and put on hold, as they restart, did that impact or does that impact the calculation at all? And do you have to -- I presume those don't get put out for bid again. But maybe just highlight or just speak to rents. Again, I think, again, in a quarter where you have that significant of a decline for them to hold flat. Again, maybe it's not as noteworthy as I'm viewing it, but maybe you just put some color on that.
Sure. We believe with great conviction, we deliver the highest level of responsiveness, highest level of service to our customer base, and we have really the best value proposition. Where your cost of equipment are a few percentage points against the whole project and a few percentage points against, let's say, 70% or 75% of project cost being labor, that responsiveness that service quality puts you in a position if you're delivering uptime, you're really avoiding for that customer, the cost of downtime for that 75% of the project cost.
So we have remained extremely focused on that. As we commented, we operated across our system throughout the entirety of the quarter with essentially no disruption. And we think that's been recognized by our ability to hold pricing consistent with prior year, consistent with the prior quarter.
Any time you've got a downturn cycle, you certainly see increasing price pressure. We've, for the most part, held, we've had instances where we've made logical concessions. We've had instances where we've logically not made a concession. And if need be passed just because of the nature of that project, short term, that application, et cetera.
It is hard to predict where literally pricing will go. We expect a continued environment of -- where our service will support sustaining solid pricing, but we do expect competition at a meaningful level over the ramp-up period we expect.
Last one for me is just on PTA. And you highlighted earlier that growing the national footprint. Where are you on the journey, in terms of growing wallet share with your customers, as you've added more of these locations? I'm just curious if you're able to quantify any increase in terms of just overall penetration rates of that -- of your customers' rental spend?
With the disruption of the pandemic in the second quarter, it's really hard to look at that measure and draw any conclusions, frankly. We ended 2019 at a 24% penetration of our rental revenue through PTA rental and PTA sales. In the second quarter -- well, first quarter as well -- first and second quarters of the year, we were up year-over-year in the rental end of PTA, and we see that growing significantly from this position in the back half like our results and equipment rental.
We also see sales bouncing back from what was a challenging quarter as it related to new project deployment and the literal sale of PTA. Again, rental held very solid. And we obviously overall reported a gain, which was a combination of the rental, the Truck Utilities impact and so on.
I wish I could quantify it for you really that share of wallet. We think we're making the kind of progress we should, in terms of recognition, as a provider of parts across the broad spectrum, rental as well as sales. That's a unique part of our value proposition; services as well as the sales and rental, again, a pretty unique element of our value proposition. And I think, we're positioned extremely well to gain the share we expect in the second half. Q2 was just, as we all know, a very unique and uncommon environment.
[Operator Instructions] Our next question comes from Richard Kus of Jefferies.
So you talked a little bit, or quite a bit actually, about some of these product -- project delays that you experienced in Q2, which makes total sense. How much revenue do you think you ended up losing in Q2 as a result of some of these delays and things that got pushed out? And what time period do you expect to catch up with all of that over? Is it something that ends up all coming through in Q3? Or is it over a few quarters? Or how do you see that playing out?
Yes. I'll take a first stab at that. This is Josh. It's difficult to quantify the actual revenue missed in the quarter. I think you can pinpoint to utilization that really impacted the offerings that Lee alluded to earlier. So we had a fairly significant decline, almost 9% utilization year-over-year. Had we been operating more normal levels at this time of year, our expectation is we would have been in that high 70s percent for utilization, which would have drove pretty significant revenues, more in line with where we saw Q1.
And so as we think about the back half of the year, which is seasonally stronger for us. And when you add the project delays and postponements that should start to pick up in the back half of the year, we should start to really see things pick up from a utilization standpoint as we progress through the year, not only from a seasonal perspective, but also from the delays of the projects that really drove down utilization in Q2.
And so I think we will see certainly a capture of some of that deferred activity in Q3 and Q4. But it's also going to spill into 2021 or the logical succession projects that will get bumped down the road. And that's going to be a function of continued challenges around dealing with the pandemic and what work can be executed in more urban areas, manpower.
There's certainly a challenge, a continuing challenge with respect to manpower, not so much with Nesco, but with respect to our customer base. So we don't expect the -- kind of an instant return to full on, and we pick all up -- picked all of that deferral up in Q3 or Q4, it will, in some fashion, direct or indirect, bump into the future and into the backlogs of our customers and basically the backlog from a rental standpoint that we have.
And do you think you can improve your utilization rates into that high 70s range by the end of the Q3?
I would say, from where we're at somewhere mid- to high 70s by the end of Q3 and continuing that into Q4. Our typical trend will be mid- to high 70s, Q3, as a reported average and a tick or so over 80 in the fourth quarter. We anticipate we'll be a little bit short of that this year. We do see nice solid growth if history repeats itself. And my reference point is 20 out of 20 years I've been in this exact industry, you're seeing Q3 and Q4 improve. We certainly expect for me, it will be 21 out of 21 years, but it's a long ways from a little bit over 70 to that what we've seen in most years. We will gain considerably, though.
And then lastly for me, you guys did pretty well on working capital. You talked about more improvements coming through in the back half of the year. How much more do you think you can get out of working capital after the performance so far? And where are you targeting those improvements to come from?
Yes, this is Josh. Yes, we focused on working capital management, consistent with our whole cash preservation and free cash flow generation in the quarter. You saw a lot come from receivables, here in Q2. As we think about PTA and our expansion, which was fairly rapidly, we have a lot of inventory in the field year-over-year. And as we kind of mature those sites, we're going to look to optimize those inventory levels. And so we would look to be bringing down inventory levels, in addition to flexing our overall working capital and receivables in particular, consistent with our revenues.
And so I would say, as we progress through the back half of the year, we may not see the magnitude that we saw in Q2 of bringing working capital down, but we're definitely going to continue to flex working capital, and we're going to continue to optimize our inventory levels at our PTA sites, which is a pretty significant source of working capital and drive that down as we progress through the back half of the year.
At this time, I'd like to turn the call back over to Mr. Jacobson for our closing remarks.
Thank you. That concludes our call today. Thanks, everyone, for your interest in Nesco. We look forward to speaking with you on our meeting -- our next meeting -- earnings call for the third quarter. In the meantime, if you have any questions, Josh can be reached at investors@nescospecialty.com. Have a great day.
That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Thank you, and have a good day.