Earnings Call: Q4 2019

Feb 27, 2020

Good day, and welcome to the Herc Holdings Incorporated fourth quarter 2019 earnings conference call. Today's conference is being recorded. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. I would now like to turn the conference over to Elizabeth Higashi. Please go ahead, ma'am. Thank you, Rochelle, and good morning, everyone. Welcome to our fourth quarter and full year 2019 earnings conference call. Our press release, presentation slides, and 10-K were filed earlier today and are posted on the Events page of our IR website at ir.hercrentals.com. This morning, I am joined by Larry Silber, President and Chief Executive Officer, Aaron Birnbaum, Senior Vice President and Chief Operating Officer, and Mark Irion, Senior Vice President and Chief Financial Officer. They will review the fourth quarter and the year-end results, as well as our strategic outlook. The prepared remarks will be followed by an open Q&A. Before I turn the call over to Larry, there are a few items I would like to cover. First, today's conference 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. Please refer to slide 2 of the presentation for our complete safe harbor statement, as well as the risk factor section of our annual report on Form 10-K for the year ending December 31, 2019. 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 material. Finally, a replay of this call can be accessed via dial-in or through a webcast on our website. Replay instructions were included in our earnings release this morning. We have not given permission for any other recording of this call and do not approve or sanction any transcribing of the call. I will now turn the call over to Larry. Thank you, Elizabeth, and thank you all for joining us this morning. Today, I would like to officially welcome Aaron Birnbaum, our new Chief Operating Officer, to our call. Aaron has more than 30 years in the equipment rental industry, all of it with Herc. Most recently, he was responsible for operations in the West and North Central regions of the U.S., as well as Canada, and our Herc Entertainment and Cinelease operations. Aaron was also responsible for many of the acquisitions the company made as a division of Hertz when he had responsibility for mergers, acquisitions, and strategy of the company. We have now completed three and a half years as a public company. The strategy put in place when we spun in mid-2016 provided the framework for our improvement in profitability and cash flow and continues to provide the roadmap for our future activities. Last year, we continued to focus on quality of earnings and capital efficiency through the execution of company-wide self-help initiatives to increase our operating margins and profitability. Our strategic initiatives once again drove industry-leading year-over-year price improvements that contributed to higher adjusted EBITDA margins, dollar utilization, and positive free cash flow in the fourth quarter and full year. We are excited about 2020, which we expect to be another solid year. Industry metrics continue to be positive in the key areas of our interest, and our interactions with contractors and customers reinforce our continued belief that the markets in which we participate are stable and growing. Our strategic initiatives on slide 4 serve as our roadmap to improve dollar utilization and EBITDA margins, enhance free cash flow, and reduce net leverage. We expect to continue to make annual year-over-year progress in these important financial metrics and are committed to closing the gap with our industry peers. Now, please turn to slide number 5 for a summary of our full-year financial results. Equipment rental revenue grew 2.6% to $1.7 billion. Our revenue growth in 2019 was focused on organic growth with a limited amount of fleet growth. We were consistently focused on pricing all year and led the industry with 4% fleet growth. Total revenues were nearly $2 billion, up 1.1% compared with last year. We reported net income of $47.5 million for the full year or $1.63 per diluted share. Keep in mind that net income included one-time costs of $53.6 million from debt extinguishment related to the refinancing of our notes and our ABL credit facility. Adjusted EBITDA increased 8.2% to $741 million for the full year, reflecting success in our initiative to control direct operating expenses and SG&A. We actually cut our direct operating expenses and SG&A expenses in 2019, which created exceptional flow-through and margin expansion. Adjusted EBITDA margin was 37.1% for the full year, which was a 250-basis-point improvement over the prior year. Now please turn to slide number 6. We have grown equipment rental revenue by a compound annual growth rate of 8% from 2016 to 2019, outperforming the industry growth of 5.5% over that same time period. Our revenue growth has been focused on organic growth and improved fleet utilization. Adjusted EBITDA grew 11.4% over the same time period, all with organic growth and our self-help initiatives to improve efficiency. Adjusted EBITDA margin has risen from a low of 33.4% in 2017 to 37.1% in 2019. We also reduced our net leverage from 4.1 times at the end of 2016, to 2.8 times as of December 31, 2019, below the midpoint of our targeted range of 2.5 to 3.5 times. I am going to ask Aaron to pick up from here to discuss our fourth quarter operating performance and his goals and priorities for the organization. Aaron? Thank you, Larry. I am thrilled with the opportunity to help lead this great organization and look forward to meeting many of our investors and analysts over the next several months. Let's move on to our discussion of 2019 operating results on slide 8. I would like to begin with safety, as it is one of our most important internal metrics and at the center of everything we do. In 2019, we continued to make strides in improving our safety record and reduced our total reportable incident rate to 0.84 in the United States, outperforming our target of less than 1.0 for the year. Throughout our locations, we also continue to focus on the simple concept of a perfect day, which means no OSHA-reportable incidents, no at-fault motor vehicle accidents, and no DOT violations. We celebrate those locations who report a perfect safety month. All of our branches reported at least 85% perfect days through the fourth quarter of 2019, with many of our locations reporting 100% perfect days. Our goal is for continuous safety improvements throughout our entire organization. Slide 9 illustrates the continuing improvements we made in the fourth quarter of 2019 compared with 2018. The graph on the upper left illustrates our year-over-year pricing over the last two years, with the latest quarter up 3.3% over last year and up 4% for the full year. We have now increased rates for 15 consecutive quarters. This slide also shows average fleet at OEC was up 0.7% in the fourth quarter of 2019 over last year. Our disciplined approach from the beginning of 2019 was to control our fleet spend by focusing on higher dollar utilization categories and disposing older equipment. This resulted in average fleet size running flat year over year. Our average fleet on rent during the fourth quarter of 2019 was down 1.3% compared with last year. With limited fleet growth, we have been focused on driving volume with improved utilization and efficiencies in our fleet management. We believe this was the right strategy in Q4 and are happy with the excellent rate growth and positive mix, but would have preferred better volume. We will continue to focus on volume growth in 2020 as we expect market conditions to remain favorable. As a result of the improvement of pricing and mix, you can see the steady gains we have made year over year in dollar utilization. Fourth quarter dollar utilization reached 40.5%, an increase of 80 basis points from a strong fourth quarter performance in 2018. Please turn to slide 10. Specialty includes ProSolutions and ProContractor and now accounts for approximately $837 million of OEC fleet or about 22% of our total fleet as of the end of 2019. Our core fleet of aerial, material handling, trucks and trailers, and earth-moving are also broken out on the slide. Average fleet age as of December 31, 2019, was 45 months, compared with 46 months for the same period last year. Please turn to slide 11. Our rental revenue by major customer segment for 2019 is shown in the composition chart on the left side of the slide. Contractors represented 33% of equipment revenue, followed by industrial customers with 29%. Other customers represented 20%, and infrastructure and government increased to 18% of the total. National account revenue represented about 42% of the total for the full year and was down slightly compared with 2018. Local rental revenues for the full year increased 6% compared with 2018 and now represents 58% of the total rental revenue. Growth in new customer accounts continued to be solid throughout the year at both the local and national level. We are continuing to focus on maintaining a solid pipeline for future growth opportunities in all of our targeted end markets, as well as growing a portfolio of equipment. Please turn to slide 12. We added a total of seven new greenfield locations this year in high-growth urban markets such as Boston, Raleigh, Orlando, the metropolitan New York-New Jersey market, Dallas, and in Hawaii. The map on this slide also shows the growth expectations by state and province over the next five years based on forecasts by the American Rental Association. Over the next five years, the ARA estimates equipment revenue growth in Nevada and Arizona to lead the nation, with states primarily in the West, Southwest, and Southeast regions to grow in the range of 4%-6%. Our strategy to focus on the top metropolitan markets will continue to drive our growth. We plan on opening six to 10 greenfield locations in 2020. By focusing on improving our scale in major urban markets, we will continue to improve the profitability of these urban centers. Industry growth is also expected to benefit from the continued conversion of owned assets to rental in our industry. These secular trends will contribute to steady growth in our end markets as rentals expand beyond traditional rental equipment categories. The strategic initiatives that Larry reviewed earlier were the roadmap we followed to get us to this point in our journey. My top priorities going forward are to continue to focus on fine-tuning our strategies to accelerate our volume and revenue growth and to continue to focus on operational excellence. Training and development of our people are important components to serving our customers and expanding our markets. We intend to continue to review and enhance every touch point we have with our customers and invest in any areas that need further focus and opportunity. Our purpose statement will guide our behavior as we equip our customers and communities to build a brighter future. Now let me turn the call over to Mark Irion. Thanks, Aaron, and good morning, everyone. We could turn to slide 14 for the details of our fourth quarter and full year 2019 results. Equipment rental revenue increased 2.1% from $447.7 million to $457 million in the fourth quarter of 2019. As we heard from Larry and Aaron, all of our fourth quarter growth was organic and was achieved with limited fleet growth. We focused on rate, managed our CapEx, and are pleased with the results we achieved. We reported net income of $35.1 million, or $1.20 per diluted share in this year's fourth quarter, compared with net income of $33.3 million, or $1.16 per diluted share in 2018. Adjusted net income in the fourth quarter of 2019 was $38.9 million or $1.33 per diluted share, compared with $33.4 million or $1.16 per diluted share last year. More details regarding our net income bridge and the non-GAAP reconciliations are included in our appendix. Adjusted EBITDA in the fourth quarter of 2019 increased 8.1% or $16 million to $214.4 million over the same period in 2018. Adjusted EBITDA margin improved 320 basis points year-over-year to 39.7% in the fourth quarter. The fourth quarter reflected excellent progress in terms of flow-through. We reported EBITDA flow for 263.3%, which benefited from actual reductions in SG&A and lower DOE. These are the kind of eye-popping flow-through results that we are all proud of as a team. Our focus on rate growth, CapEx, and self-help cost control initiatives has helped turn a small amount of rental revenue growth into a decent amount of EBITDA growth and a lot of free cash flow. As a result, we grew EBITDA margin by 430 basis points to 46.6% during the fourth quarter of this year. A record for Herc. Slide 15 focuses on the changes in total revenues. It includes Q4 and full year results, but as our results have been consistent all year, I will speak primarily to the fourth quarter. Equipment rental revenue grew 2.1% to $457 million in the fourth quarter. Solid improvement of pricing and mix were partially offset by lower volume. In Q4, we had a reduction in sales of rental equipment of $9.7 million, excluding currency. Q4 2018 was a big volume quarter for used equipment sales, and we have been selling less in 2019 with an overall focus on our CapEx spend. On Slide 16, we see adjusted EBITDA for the fourth quarter was $214.4 million, an increase of 8.1% or $16 million, compared to $198.4 million in the fourth quarter of 2018. The bridge starts with higher equipment rental revenue, up $9.4 million over prior year, and now the flow-through magic happens. Despite growth in rental revenues, direct operating costs were actually down $5.5 million from the fourth quarter of 2018. The team is particularly proud of these results as we kept an eye on expenses with improved operating efficiencies, primarily from delivery and freight. These reductions were partially offset in the fourth quarter by increased facility costs as well as increased personnel and personnel-related expenses. Selling, general, and administrative costs were also down year-over-year, primarily due to the reduction of bad debt and professional fees. As we've discussed, EBITDA measures the contribution of our core rental business without the impact of sales of equipment, parts, and supplies. We believe EBITDA provides a better comparison with our industry peers as it excludes the impact of varying depreciation policies. A combination of improved rental revenues and reduction in our cash operating expenses led to off-the-chart EBITDA flow through of 263.3% and drove a 430 basis point improvement in EBITDA margins to 46.6%. Overall, an excellent quarter and an excellent year for healthy revenue growth and self-help measures around cost control. Our fiscal year 2019 margin flow through is over 169%, and our EBITDA margins improved by 310 basis points. Thank you to all of our Herc team members for your contributions to these results. Turning to slide 17. On a cash basis, net fleet CapEx for the year was $414.2 million, compared with $499.1 million in the prior year. Non-fleet capital expenditures for the full year were also down by $56.9 million, from $77.6 million in 2018. For the fourth quarter of 2019, fleet expenditures at OEC were $63 million, with fleet disposals of $188 million, generating about 38% of proceeds, down from 42% of proceeds in 2018. We sold approximately 50% of our fleet through auction in Q4, and auction results were down a bit from prior year, probably more due to the condition of the fleet rather than any real weakness in the market. The average age of our disposals in the fourth quarter was 82 months. We reduced the average age of our fleet to approximately 45 months at the end of Q4 2019 from 46 months in the comparable period last year. A quarterly roll breakout of this information, along with a rolling balance of our total fleet, is also in the appendix. On slide 18, for the year ended December 31, 2019, free cash flow was $172 million, compared with negative free cash flow of $7.9 million in 2018. This represents a substantial improvement in our free cash flow generation and consolidates our strategic initiatives in 2019, focused around rate, expense control, and disciplined capital expenditures. Net leverage decreased to 2.8 times, compared with 3.1 times in the comparable period, and was solidly within our targeted range of 2.5 to 3.5 times. Total debt was $2.1 billion as of December 31, 2019, about the same as the prior year, but with no near-term maturities as a result of the refinancing of the notes in the ABL credit facility and expected refinancing of the ABL facility. We had ample liquidity of over $1.1 billion as of December 31, 2019. On slide 19, we look at the industry outlook, and we see certain economic and industry metrics have begun to report more positive signs regarding the economy. The Architecture Billings Index, which is thought to be an indicator of construction activity 9 to 12 months out, rose to 52.2 in January, the fifth straight positive month. U.S. industrial spending forecast for 2020 estimate growth of 1.7% over 2019. Our conversations with industrial customers and contractors in our markets indicate confidence for continued growth in spending in the short and medium-term horizon. U.S. non-residential construction spending estimates for 2020 suggest a bit of a slowdown, with a decline of 3.3%. The absolute dollar value of $289 billion in spending is substantially above 2016 and is certainly sufficient to sustain favorable rental demand. Longer term, the North American ARA forecast for industry equipment rental revenue growth remains solid, with the compound annual growth projected at 3.6% through 2023. We look at our end markets in 2020 as being in a slow but steady growth phase, similar to what we've been experiencing for the last five to six years. We believe that slow growth and an overhang of economic uncertainty benefits the rental industry as our customers hesitate to commit their own capital and rent equipment to satisfy their needs. On slide 20, we have our guidance for 2020. Based on our expectations for steady demand in our key markets for 2020, we are looking to build on our 2019 success with solid organic growth in our rental revenues and a continued focus to tightly manage our operating expenses and CapEx. We're initiating our guidance range for adjusted EBITDA for 2020. Our guidance range is $760 million to $790 million of EBITDA, or an increase of 3% to 7% compared to 2019. Our guidance range of net fleet capital expenditures is $410 million to $450 million and assumes moderate year-over-year fleet growth. Disciplined capital spending, along with the expectation for improved EBITDA, should contribute to strong free cash flow for the year. Our overall strategy is expected to continue to provide ample liquidity and the financial flexibility to fund our strategic growth, to improve our operating margins, to serve our customers, and to create value for our shareholders. Now, I'll pass the call back to Larry. Thank you, Mark. Before we go to Q&A, I'd like to summarize where we are today. Our strategic initiatives have continued to drive growth in rental revenues and improve dollar utilization. We improved adjusted EBITDA margin by 320 basis points to 39.7%. We increased our utilization 80 basis points to 40.5%. We improved year-to-date free cash flow from negative $7.9 million in 2018 to a positive $172 million in 2019. Our operating initiatives will continue to contribute to strong REBITDA flow-through for the full year of 2019. As we start the new year, I want to express my thanks and congratulations to the entire Herc team for their contribution in this record year for us. We're committed to the strategy we laid out four years ago and plan to achieve our stated goals through solid execution to improve value for our shareholders, customers, and employees. Now for your questions. Operator, please open the line. Thank you. If you would like to ask a question, please press star followed by the digit one. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, star one to ask a question. Our first question today will come from Jerry Revich with Goldman Sachs. Yes. Good morning, everyone. Good morning. Can you talk about your planned cadence of CapEx over the course of 2020? You had mentioned that you would have liked to have seen fleet on rent be stronger exiting the year, and I'm wondering, as you lay out the CapEx outlook, how back half-loaded is it? How much flexibility do you have to move below the low end of the range if you so decide? Yeah. Good morning, Jerry Revich. The fleet CapEx didn't have any real connection to our volume in Q4. That typically comes in early in the year, so it's heavily front-loaded into Q1 and Q2. That's very typical, and that's the way it'll happen again this year. We were conservative with our CapEx last year, which is where the comment around volume was. So we were looking for volume growth out of time utilization and rate. We certainly got the rate, but Q4 didn't really provide the opportunity for time ute that we expected. Obviously, two levers of time ute, one is the demand piece, but the other is how much capacity you folks choose to deliver into the market. Given the softer time ute in 4Q, should we think of lighter CapEx in the first quarter versus normal seasonality? Or how do you think about the pace of CapEx as it's going to be rolled out? No, as far as we're concerned, we've been very conservative with our CapEx in 2019. We'll probably be looking for a little bit more fleet growth in 2020. But the demand is solid out there. There's no real shock that we're addressing. The demand in Q1 that we've seen so far is typical of what we'd expect. So we're going into 2020 pretty much with the same cadence and the same expectations that we ramped up into 2019 with. Okay. Lastly, can you talk about what level of improvement in dollar utilization you're expecting with your 2020 outlook? It looks like at the midpoint of the range you're baking in modest improvement in dollar ute. At least that's how the math looks. Can you just comment on if that's right, and if you expect a bigger contribution from price and mix versus utilization? That'd be helpful. Our guidance has been pretty consistent in terms of dollar ute, so we're looking for 100 to 200 basis points of improvement year over year for the next couple of years. That's the goal that we set for ourselves, and we certainly went a long way to hitting that goal in 2019 and expect to do the same in 2020. We're probably not going to be able to lean on rate as hard in 2020 as we did in 2019. We're not going to consistently be able to beat the market by four times, but we will look to consistently beat the market. We've got success here, and we do look to continue to push on that lever. We will continue to look for time utilization improvement also to contribute to that. That's the bit that we maybe missed in 2019 that we're going to focus real hard and go get in 2020. Thank you. Thank you. See you next week. Operator, you can go on to the next question. Yes. We'll hear from Steven Ramsey with Thompson Research Group. Hey, good morning. This is actually Brian Biros on for Stephen. Thank you for taking my questions. I wanted to ask one about the end markets, and I guess you gave some good commentary in the prepared remarks. It seemed like slow and steady, kind of similar to the last few years. I guess, could you maybe compare how you feel now versus 12 months ago for your outlook? And if things are the same, worse, a little better? I'm just really trying to get a sense of how the end markets have evolved and feedback you're getting from the field on that. Yeah. Good morning, Brian. This is Larry Silber. Yeah, look, we're pretty optimistic about the markets. We believe that we're going to have another solid year. The markets that we participate are reporting excellent type of project activity and expectations as we flow into what is the traditional construction season coming up here. We think that personally, and as a company, we're probably a bit more positive today than we were a year ago. There was a lot of anxiety flowing around the beginning of 2019 with all the happenings in the government and some instability and some unknowns. All of that's sort of been cleared up. We're in a presidential election year. We expect that there'll be a fair amount of federal spending in large urban markets on infrastructure work, which is sort of our sweet spot, and where we expect that we'll have a good opportunity to improve our volumes. So we're as positive, if not more positive, going into 2020 than we were in 2019. That's good to hear. Just as a second follow-up. In some of our channel checks, we've heard some people mention certain markets are either oversupplied or getting to that kind of oversupplied status in fleet. I just want to see, are you guys seeing any of that in any markets anywhere? Just trying to reconcile how that goes with industry just trying to generally maintain positive rates. If it's more challenging in certain markets if they are seeing that oversupplied. Yeah. I wouldn't say that we're seeing oversupply in any markets. I think maybe by the end of 2019, supply had started to catch up, or supply growth had started to catch up to demand growth. I think we're starting to see adjustments in the CapEx sort of growth cadence from some other players in the industry, and we're happy to see that. We suspect that the industry's going to be able to adjust to the changing conditions. But there's still decent demand. There's plenty of fleet out there. As always, it's a competitive environment, but we don't see any real dramatic signs of oversupply. All right, Steve, thank you. Next I'll move to Brian Sponheimer with Gabelli Funds. Hi, good morning, everyone. Hey, Brian. Good morning. Greetings to Aaron. You guys keep doing such a great job driving margin expansion here. Given the revenue environment, is there anything on the SG&A or DOE side that kind of sticks out as an area where you can improve even further? Yeah. Hi, Brian. We're really happy with the results we've got in 2019. Obviously, they're pretty dramatic and something that we're not going to be able to sort of maintain this sort of momentum on forever. We will be back, I suspect, in 2020 to a slow growth in DOE and flattish SG&A. Delivery and freight is an area where we've got some big cost savings in Q4, and we'll continue to benefit in 2020, just as we focus on the efficiency of our logistics and just continually improving some of our results there. There are opportunities for continued efficiency. But it's not going to be as dramatic as what you see in Q4. Got it. Larry, if you're thinking about preparing your company for any sort of material correction in the market, can you walk through maybe the roadmap of first steps to make sure that you don't get caught in an area where you're exposed? Yeah. Look, first of all, we don't expect that to happen, except if there's an unforeseen issue that comes up. But if it did, look, initially, we would cut off CapEx. We are not sort of committed beyond a 60-day period out in terms of our purchase agreements with all of our vendors. We would shut the pipeline off on new materials coming in, and then we would obviously look to de-fleet, where it was appropriate, where we saw those actions happening relative to reduced demand. And we'll de-fleet appropriately in an expeditious manner that'll raise cash for us. And then we'll look to have adjustments in our DOE and SG&A that would accordingly match that. Look, the formula is pretty easy in this industry. In fact, if there were a negative environment, we'd generate a lot of cash in a negative environment. Well, the execution is certainly impressive. Best of luck for a great 2020. Thanks, Brian. Thanks, Brian. Operator? As a reminder, please press star one to ask your question. Next, we'll hear from Seth Weber with RBC Capital Markets. Hi, good morning. This is Brendan on for Seth. As we look at your fleet composition, is there any notable strength or weaknesses you are seeing by equipment type that you feel is worth calling out? Look, no, I think we are fairly strong across all of our equipment categories. We have done an excellent job over the last four and a half years of shedding the fleet that existed when we came into the company and did the spin back in mid-2016. We are pretty much beyond any of that remaining fleet. In fact, we had a great deal of that exit in the fourth quarter of 2019. That was sort of 82-month-old type fleet that had been procured prior to the current leadership team coming in place. So we feel our fleet is pretty strong across the board. We continue to look at the markets in which we have fleet. Do we have the right fleet in the right markets? Where are the hot hands? Where do we need to grow based upon the opportunities? We are pretty comfortable with the makeup and the composition of our fleet as it exists today. Okay, thanks. Earlier in the call, with the introduction of Aaron, you mentioned that some of his experience involved M&A. Does that change the strategy at Herc at all? Potential inorganic growth going forward? Look, as I've said from day one here, our primary focus is going to be on organic growth in the business. That was for a number of reasons. We had ample opportunity to grow within our existing footprint and put more volume through our existing footprint. That remains the same, particularly as we add additional footprint in these urban centers that are providing us with outstanding growth and future growth opportunities. That said, we are in an environment today where we've completed all of the, what I would call, handcuffs that might have prevented us from considering any opportunities. We are not going to be actively looking for an opportunity, but if something comes along that's opportunistic, we might consider it. Certainly, Aaron Birnbaum's experience, both on the acquisition and integration of those, will be a tremendous help to us if that opportunity arises. Okay, great. Thank you. That will conclude today's question and answer session. At this time, I would like to turn the call back over to Elizabeth Higashi for any additional or closing remarks. Thank you all for joining us on the call today. As always, if you have any further questions, please don't hesitate to call me. We look forward to seeing you all soon. Thank you. And that will conclude today's call. We thank you for your participation.