Custom Truck One Source Inc
NYSE:CTOS
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Custom Truck One Source Inc
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Ladies and gentlemen, thank you for standing by, and welcome to Custom Truck One Source's Third Quarter 2021 Earnings Conference Call. [Operator Instructions] Please note, this conference call is being recorded.
I would now like to hand the conference call over to your host today, Brian Perman, Vice President of Investor Relations for Custom Truck.
Thank you, and good afternoon. 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 issued today. The press release we issued this afternoon, and the presentation for today's call are posted on the Investor Relations section of our website. We will be filing our 2021 third quarter 10-Q with the SEC next Monday, November 15.
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 3 months ended September 30, 2021, and prior periods. While our reported results can only include Custom Truck One Source LP for the period since the merger date, April 1, we have presented and will be discussing today pro forma combined results as if Nesco and Custom Truck had operated together for all periods. We believe such combined information is useful to compare how the combined company has performed over time.
Joining me today are Fred Ross, CEO; Ryan McMonagle, President and COO; and Brad Meader, CFO. I will now turn the call over to Fred.
Thanks, Brian. I'd like to welcome everyone to the company's Third Quarter 2021 Earnings Call. This marks the second quarter with Custom Truck and Nesco operating as a combined company. The investment thesis on bringing the 2 companies together continue to be realized with the integration progressing ahead of schedule and contributing significantly to the strong operating results we achieved this past quarter. I'd like to thank all of our employees, customers and suppliers who continue to support our business and uphold our culture of core values.
Turning to our financial results. Our strong Q3 results highlight the incredible performance of our team, demonstrating the continued strength of our strategically selected markets on a pro forma basis compared to Q3 last year. Our combined revenue was up 18%, and adjusted EBITDA was up 20%.
Our TES business continued to perform at very strong levels with backlogs growing to a record $338 million, up by 52% versus the end of Q2 this year. Our ERS business continues to perform very well with utilization increasing to 81.4% for the quarter, up from 73.4% for the Q3 last year and 80.9% in Q2 of 2021. In addition, we continue to implement a new rental pricing strategy, which Ryan will discuss in more details.
As we discussed on last quarter's call, our high utilization supports further growth in the fleet to meet the strong rental demand. We made good progress in the third quarter growing the fleet by $33 million despite well-known supply chain limitations. We continue to capitalize on the benefits of our scale and our strong supplier relations to mitigate these issues. Our strong results reflect our unique and long-established business model, which focuses our efforts on end markets that are resilient through the economic cycle. All of our end markets currently exhibit very strong tailwinds.
Our one-stop shop mile provides us the speed to market need to meet our customers' rental and sales demands, providing us with the maximum opportunity to capture customer share of wallet and achieve very strong returns on capital. Synergies from the merger have helped improve both our segment margin and our market share. In addition, our strong balance sheet and solid free cash flow provide us the resources to selectively invest additional capital and opportunities that are accretive to the business and create long-term shareholder value. I cannot be more excited about the future prospects for Custom Truck.
Before I turn it over to Ryan, I would like to take a moment to talk about the ESG and Custom Truck. As we look to 2022 and start to move beyond the integration, we will use those core values shared across our entire organization as a basis for developing our environmental, social and governance strategies. ESG will become an essential aspect to our corporate culture, and we know that it's important to our stakeholders, customers, partners across our business. My objective is for Custom Truck to become a leader in our industry as it relates to these important issues, and we look forward to updating you as our strategies take shape.
With that, I will turn it over to Ryan.
Thanks, Fred, and good afternoon, everyone. First, I want to echo Fred's comments regarding the continued tremendous efforts of our employees who delivered both significant progress towards the integration as well as strong financial results this past quarter. I'll start by spending a few minutes providing additional color on some of the key aspects of our third quarter performance.
Overall, demand remains robust in each of our strategically selected 4 primary end markets: transmission and distribution or T&D, telecom, rail and infrastructure. We continue to focus on these markets because they provide strong long-term growth opportunities and are far less cyclical than other truck related end markets. Last week's passing of the infrastructure bill by Congress is a real positive for our end markets, which should see the benefit from more than $400 billion of additional spending from the bill.
As we mentioned previously, with customer backlogs already quite substantial, our view is that this spending will take some time to materialize, resulting in an extension of our already positive multiyear outlook and further strengthening our current business fundamentals. Pricing trends across our end markets continue to be favorable, reflecting strong demand and the continued implementation of our tiered rental pricing strategy.
From a key performance metrics perspective, Fred already mentioned our improving rental fleet utilization and growth in new sales backlog. In addition, we drove margin expansion as well as an increase in our OEC on-rent and on-rent yield for the third quarter where I will cover these in greater detail. As Fred noted, the underlying fundamentals of our selected end markets continue to be incredibly strong today, with industry supply chain issues presenting the only significant limitation to our ability to meet customer demand. We believe that we are seeing the advantage of our one-stop shop approach to taking care of customers. Our position as the largest independent distributor of vocational trucks in the U.S. and our nationwide network allows us to meet our customers' rental, purchase and service needs anywhere in the country.
Our purchasing scale for both our own rental fleet and sold units allows us to produce units at a cost well below our competition. And the fact that we continue to carry inventory to both sell and rent has allowed us to continue to deliver on customer demands for equipment. Our scale and our one-stop shop business model result in superior unit economics that allow us to increase our share of customer wallet and to deliver best-in-class returns for both rental and sales. The revenue growth we have experienced in recent quarters exceeds overall market growth, offering evidence of our growing market share.
Supply chain issues and certain inflationary pressures continue to affect our business. While both issues are notable, they have not had a dramatic impact on our business to date. However, they are causing us as well as our competition to not be fully able to take advantage of current end market demand.
In the past, we have discussed how our ability to hold inventory of truck chassis and bodies affords us considerable flexibility and provides a meaningful advantage over our competition. It has also allowed us to continue to meet a significant portion of customer demand. We entered the year with $380 million of new equipment inventory. As of the end of Q3, our new equipment inventory decreased to $250 million as our suppliers have curtailed production and delayed deliveries. We are actively managing our inventory and continuing to work with suppliers to address this ongoing issue. We are optimistic that by working closely with our chassis and attachment partners, we will come through this in a very strong relative position.
Given these issues and continued strong customer demand, we have taken opportunities both to pass-through certain cost increases to our customers as well as to implement reasonable price increases. Our goal is to expand margins where possible, while being mindful of the inflationary environment that our customers are operating in and ensuring that we continue to take the long view in maintaining strong customer relationships.
From an integration perspective, the combination of the 2 companies continues to progress ahead of plan. The teams have worked tirelessly to integrate the companies and make the transition as seamless as possible for both our suppliers and customers. While most of the integration has occurred already, next year we'll see the completion of the final aspects, including systems integration.
We continue to target $40 million of annual run rate synergies by the end of 2021 and $55 million in total and currently anticipate that the cost to achieve the synergy should be less than the $50 million originally announced. These initiatives allow us to achieve the anticipated profitability gains expected from the combination as well as to counter the ongoing inflationary pressures.
Focusing on M&A briefly, we continue to selectively consider expansion into underserved areas of both the U.S. and Canada. Over the coming quarters, we will look to increase our growth in market share through a combination of both strategic acquisitions and greenfield sites. Such a measured expansion will benefit all 3 of our business segments: ERS, TES and APS.
In summary, we are very proud of the results delivered in our second quarter as an integrated company. The tailwinds we are experiencing in our end markets are positive. Customer demand for our equipment remains very strong. We are seeing the benefits of our one-stop shop business model. We are executing well even with the supply chain pressures we are experiencing. And the integration is in a good spot. We know we wouldn't be able to deliver these results were it not for the efforts of all of our employees who are working tirelessly together to take care of our customers, and I'd like to extend a sincere thank you to them.
I will now turn it over to Brad.
Thanks, Ryan. Good afternoon, everyone. Q3 was another excellent quarter. Total revenue was $357 million, up 18% first pro forma Q3 last year. Adjusted EBITDA was $84 million, which is an improvement of 20% versus pro forma Q3 last year and up 20% versus last quarter.
Reported net loss for the quarter was $20 million, a significant improvement over Q2, which in that quarter included the impact of certain charges, transaction-related costs and the impacts of purchase accounting. Pro forma gross profit, excluding rental depreciation was $123 million and adjusted gross margin for the quarter was 34.4% compared to 26.4% for Q2 this year. The sequential margin improvement was primarily driven by the change in revenue mix, with rental accounting for 31% of revenue this quarter versus 26% for Q2 this year. In addition, Q2 margins were negatively impacted by onetime reserve charges totaling $8 million, which did not occur again in Q3. SG&A was $49 million or 13.6% of revenues, which includes $5 million of share-based compensation expense.
Drilling down to the segment results, our ERS business saw a pickup in performance in the quarter, largely resulting from the growth of our rental fleet as well as improved utilization in on-rent yield. Demand for additional rental equipment remains strong, as evidenced by the fact that we added a gross $75 million to the fleet in the quarter, which was offset by the sale of $43 million in OEC. Gross adds in Q2 were $55 million. The increase in CapEx was in line with the previously discussed expectation that the pace of CapEx will increase in the second half of this year as the summer seasonal slowdown ended and utility contractors ramped up transmission work.
Fred referenced our strong utilization for the quarter, which is 81.4%, up from 73.4% for Q3 of last year and up from 80.9% for last quarter. I would highlight that utilization in September was just under 85%, and we haven't seen that pull back yet so far in Q4. Average OEC on-rent was also up more than $121 million over the same period last year, and on-rent yield was 38% for the quarter, up slightly from the 37.6% in Q2 of this year.
On-rent yield improvements continue to be driven largely by the rollout of our new tiered pricing strategy, which really started to take hold in September. The on-rent yield in September was up to 39%. As we've mentioned previously, it will take time for all of our contracts to turn over and for us to realize the full long-term opportunities from this strategy. All of these factors combined to push rental revenue, excluding asset sales, up 11% sequentially versus last quarter. The increase versus Q3 last year is 11% as combined rental revenue was $95 million, including $43 million from Nesco and $52 million from Custom Truck.
ERS gross profit, excluding depreciation, grew 34% versus Q2. Margins continue to be impacted by higher freight costs, most of which have been able to pass-through to customers as well as the deferred maintenance of the legacy Nesco fleet. We've seen our repair and maintenance costs start to decline, but this will continue to be a bit of a headwind through Q4. Overall, ERS continues to see the benefit of scale created by the merger, further bolstered by the strong underlying end market fundamentals that Ryan discussed.
TES performance was strong again in the third quarter, with revenues of $190 million, down about 12% versus Q2 as we started to see the negative impact of supply chain issues. In addition, the decline in sales were driven in part by our decision to allocate more inventory for rental fleet over sales activity as well as the fact that the third quarter is seasonally slower than the second quarter. Compared to Q3 last year, revenue was up 37% as combined revenues were $139 million, including $6 million from Nesco and $133 million from Custom Truck.
While revenue was down quarter-over-quarter, our sales activity continues to be extremely strong, with backlog growing by 52% sequentially. Growth continues to be very broad-based across our product portfolio. We believe TES growth reflects growing demand for equipment as well as strong market share gains and our strong pricing discipline.
We have been successful in countering inflationary pressures through the implementation of product efficiency initiatives put in place during Q2 in addition to passing through any net cost increases to our customers. Overall, we're very happy with the performance of the TES business last quarter and are working hard to overcome the macro pressures currently impacting the business and to take full advantage of market demand.
Our APS business posted revenue of $35 million compared to $32 million in Q2. In Q3 of last year, combined revenue was $34 million, including $15 million from Nesco and $19 million from legacy Custom Truck. Gross margin, excluding rental depreciation, was 28%, a significant improvement from 12% in Q2. This improvement reflects the benefit of our reset go-to-market strategy that we developed for the APS business as well as the fact that we are moving closer to completing the deferred maintenance on the Nesco fleet. We continue to believe that APS presents an opportunity for us to capture a larger share of our customers' wallet and strengthen our position with customers and suppliers alike. While this quarter reflects good progress to date, we are dedicated to providing the resources necessary to execute a strong profitable business plan.
In addition to strong revenue and adjusted EBITDA growth, we continue to focus on maintaining a strong liquidity position and improving leverage, while at the same time investing in the rental fleet. We increased the borrowings under the ABL by $20 million in the quarter, driven by increased CapEx spending with the outstanding balance ending at $405 million. We still have $337 million available under the ABL and the ability to upsize the facility if needed.
Leverage currently stands at 4.3x, which is a slight improvement from Q2. As we've previously discussed, approximately 3x leverage remains a goal of ours, but we will also look to make incremental investments in prudent acquisitions if we believe they create long-term shareholder value.
With respect to the outlook for full year 2021, based on the year-to-date performance, current backlog and our outlook for the rental fleet, we are reiterating previous guidance. We still expect combined FY '21 revenue to finish around $1.5 billion and adjusted EBITDA to be in the range of $320 million to $340 million. It's important to note our adjusted EBITDA outlook excludes the negative impact of the $8 million reserve charges taken in Q2.
In closing, I want to echo Fred's and Ryan's comments regarding the exceptional performance our team delivered, while managing through the integration and effectively navigating the many challenges that have impacted our suppliers and customers alike. We've built a great foundation to profitably grow the business. And with the powerful tailwinds in our end markets, we are truly excited about the clear path for shareholder value creation.
With that, I'll turn it over to the operator to open the line for questions.
[Operator Instructions] Our first question is coming from the line of Stefanos Crist with CJS Securities.
So first, you called out the sales of equipment declining sequentially due to more focus on increasing the rental fleet, but sales backlog increased substantially during the quarter. So how should we think about demand in sales and rental? Are you seeing any meaningful shift there from your customers?
We're seeing really strong demand for both. So we're seeing our rental business continue to maintain really high utilization. And as we talked about on the call, we're adding assets to that fleet. We are also seeing demand to purchase equipment. So we are, obviously, as we said on the call, where we can. We're shifting people towards rental. But at the end of the day, it's why we think the one-stop shop business model wins because we can sell and rent the equipment to them.
Great. And then can you give us a little more detail on the aftermarket parts and services? What the business reset entails and what you're doing there?
Sure. A couple of things I'd highlight. One, as we -- as Brad mentioned in the comments -- in his comments, we've been focusing on profitability. So that's been pushing 2 parts of that business. So one is the rental side of that business, which is renting blocks and then also renting our OEM manufactured parts. So it's been focusing on that business. And then we've spent a decent amount of time just getting the cost structure aligned, which has been a bit of a pricing exercise to make sure we're pricing products appropriately and then making some optimization moves from the overall footprint and how we've been managing that business. So you're starting to see some of the benefits in the numbers we showed today. And then we're feeling optimistic about that segment and that business opportunity going forward.
Perfect. And then if I could squeeze in one more. You mentioned M&A a couple of times. When we think about M&A, should we think about smaller tuck-ins or are there any bigger acquisitions that you could see out there?
Yes. I think it's mostly smaller tuck-ins. We're obviously always open to anything that makes sense or is strategic. But at this point, we're starting to think about, as we've talked about in the past, how do we continue to expand the footprint and those would generally be smaller tuck-in type acquisitions.
[Operator Instructions] Our next question is coming from the line of Scott Schneeberger with Oppenheimer & Co.
I did see in the slide deck some reference to how the infrastructure bill may affect the end markets of the business. But if you could please just highlight that and perhaps a little bit of elaboration on how you're positioning for that?
I think that most of that is futuristic, but the markets today are -- our market segments are so strong, it's not really going to have a short-term effect. But the long-term effect, we believe, will be there, especially with the 5G and everything that's going on there. So -- but currently, honestly, the markets are hot enough that it really wouldn't matter right now. So -- but I do believe that it will just continue our ability to operate at higher levels for longer periods of time as that starts to roll out.
So probably not going to see any spike. I know it would be too soon in the next quarter or 2, but you're just looking for solid, steady growth without a spike in the future if this is just more confidence in that trajectory.
Absolutely. So -- and I do think it will raise -- it will go up, but it's not going to be a hockey stick. It's going to be a nice gradual uptick.
Got it. Understood. Maybe the supply chain was referenced by you all last quarter as being a bit disruptive. And you touched upon it again in this call. Just how do you see that going forward? Should you be okay in future quarters? Might we see the potential for disruption in the future? Just your level of confidence with regard to that getting back on track for you all.
I believe that we're going to come through this just fine. We have a number of long-term relationships, and we're pivoting in multiple directions to get everything that we need. It certainly is a challenge, but it's a challenge that our team is accepting and working well with. And I feel real good that we'll be able to continue to have growth, both in rental and sales, but it certainly is a challenge.
Understood. And just a couple more from me, if I could on -- parts and accessories was a bit tricky last quarter. It looks like that's getting back on track. And cross-sell has always been discussed as an opportunity there. Too early to discuss seeing anything on that front or are you feeling like it's starting to materialize?
Yes, I think it's still early days, Scott. I think we are seeing some wins of legacy Nesco PTA customers now being able to buy equipment. So we are seeing that. We're starting to see that from a whole good sales standpoint. And then we've seen some early wins on cross-selling PTA kits, but still very early days from a cross-sell perspective.
Okay. And then lastly from me. It's good to hear the CapEx is going up, obviously a solid demand environment. Just curious how we should be thinking if that's going to have any impact on your outlook for free cash flow and just thoughts on cash generation.
Yes, Scott, I mean, I think you'll -- Q3 is typically -- and kind of our expectation for this year was going to be the easy high spend quarter there. So Q4 seasonally is always a little bit softer just as you head into December. So I think you'll see positive cash flow in Q4 and then, therefore, kind of for the year, we'd still be in the positive from that standpoint. As we head into next year, again I think we'll continue to look to invest in the fleet.
Again, we understand in trying to strike the right balance between investing in the business and free cash flow generation. You also run into kind of, what we talked about from the supply chain is somewhat of a limiting factor. We're still focusing certainly on hitting the revenue or the fleet targets, but this is the available inventory to add is somewhat of a governor there allowing us then to also generate cash. But I don't think, given the fact that we ramped up in Q3, that's in line with expectation. I don't think it changes our outlook for the investment or kind of cash flow for the balance of this year or for next year either.
And our next question coming from the line of Sean Wondrack and he is with Deutsche Bank.
Nice job this quarter. Just taking a look here, you gave the uptick in utilization here. Is there, sort of, a theoretical max we can think about in terms of utilization and do you feel that you might be coming up on that? Or if you can comment on that, I'd appreciate it.
Yes. I mean, the way that we've always thought about it is, if you're at, kind of, 85, mid-80s, you're at theoretical max, frankly, if you're kind of in -- even the low 80s you're there and starting to miss some demand. So we believe that we're there. That's why we're looking to add more equipment to the fleet to continue to meet that demand. But yes, I'd say that the mid-80s, you're kind of there, which is where, as I noted in my comments, at September is where we finished.
No, I guess that's good to hear. High cost problem I have, I guess. Just to add on the M&A front here, just whether it's tuck-ins or something broader, but is there any opportunity here maybe ways to further integrate your business, whether it's through other manufacturing abilities that you seek there or where should we be thinking in terms of, kind of, targets there?
Yes. I think we've always said we focus first on geographic footprint expansion and then continuing to add to the rental fleet. So I think that will be our focus. In the past, we have made some, what I'll call more manufacturing acquisitions when you look at the Load King trailer business that we acquired or the crane business that we acquired. So we will look at those. But I think it's definitely focused on geographic footprint expansion and rental fleet expansion at this point.
Got you. And then just lastly, ultimately, how do you think about liquidity? Is there, sort of, a level that you're comfortable with to make sure that you're able to fund working capital next year and such?
Yes. I mean, from a liquidity standpoint, we look at the business, to your point, specifically on working capital, it's not a working capital cash intensive business. Our inventory, we're able to fund with floor plan. We have sufficient capacity under those facilities to grow inventory quite substantially if we needed to, without running into any problems. So consumption of cash there is in the mid-teens. So from a liquidity standpoint, I think we're in a really good spot. We have more than sufficient in my opinion availability under the ABL, cash on the balance sheet. We can always upsize the ABL to given where the borrowing base is. So from available liquidity, I think we're in a really, really good spot to capitalize and invest both in rental as well as do M&A if we need to, without putting additional stress in the business.
There are no further questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks.
That concludes our call for today. Thanks, everyone, for your interest in Custom Truck. We look forward to speaking with you on our next quarterly earnings call. In the meantime, please don't hesitate to reach out with any questions. Thank you, again.
That does conclude the conference call for today. We thank you for your participation, and we ask that you please disconnect your lines.