Earnings Call: Q2 2018

Aug 8, 2018

Summary

Q2 revenue and adjusted EBITDA grew strongly, with continued pricing gains and higher dollar utilization. FY2018 guidance was reaffirmed as fleet diversification and the completed IT separation supported the growth and efficiency strategy.

Good day, and welcome to the Herc Holdings Inc. second quarter 2018 conference call and webcast. All participants will be in a listen-only mode. Should you need assistance, please signal conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on a touch-tone phone. To withdraw your question, please press star, then two. Please note, this event is being recorded. I will now like to turn the conference call over to Ms. Elizabeth Higashi, Vice President of Investor Relations. Ms. Higashi, the floor is yours, ma'am. Thank you, Mike, and good morning. I'd like to welcome everyone to our second quarter earnings conference call. Our press release and presentation slides went out this morning, and both are posted on the events page of our IR website at ir.hercrentals.com. Please turn to slide 2. This morning, I'm joined by Larry Silber, our President and Chief Executive Officer, and Mark Irion, Senior Vice President and Chief Financial Officer. They will review the quarter as well as the industry outlook. The prepared remarks will be followed by an open Q&A, which will also include Bruce Dressel, Senior Vice President and Chief Operating Officer. Before I turn the call over to Larry, there are a few items I'd 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 slides 3 through 5 of the presentation for our complete safe harbor statement. The company's risk factors section of our annual report on Form 10-K for the year ended December 31, 2017, which was filed with the Securities and Exchange Commission, contains additional information about risks and uncertainties that could impact our business. You can access a copy of our 2017 Form 10-K by visiting the investor section of our website at ir.hercrentals.com or through the SEC's website at sec.gov. On a related matter, we expect to file our second quarter Form 10-Q later today, which will also be available on either website. In addition to the financial results presented on a GAAP basis, we will be discussing non-GAAP information that we believe is useful in evaluating the company's operating performance. Reconciliations for these non-GAAP measures to the closest GAAP equivalent can be found in the conference call materials, which were furnished to the SEC with our Form 8-K this morning and are also posted on the investor section of our website at ir.hercrentals.com. 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 recordings of this call and do not approve or sanction any transcribing of the call. I'll now turn the call over to Larry. Thank you, Elizabeth, and thank you all for joining us on this morning's earnings conference call. We're very pleased with the strong second quarter results we reported this morning. The year-over-year performance in this quarter continued to illustrate the positive growth trends we're realizing. Nine consecutive quarters of year-over-year pricing improvement, four straight quarters of double-digit growth in rental revenue, all of which was organic, and five straight quarters of increases in dollar utilization. Our strategy is working, and with the successful completion of the separation of our financial information technology systems from Hertz at the end of July, we've been more excited about our opportunities for growth and improvement. We have lots to talk about today, and I want to start by publicly welcoming and introducing our new Chief Financial Officer, Mark Irion. Many of you know Mark, as he was most recently the Chief Financial Officer for Neff Corporation, a publicly traded equipment rental company, until its sale in October of 2017. Mark brings comprehensive financial expertise, relevant industry experience, and seasoned executive leadership to our business with over 25 years of experience in finance and accounting. While Mark has been with us for just a short while, I'm confident that he will contribute to advancing our long-term strategies, focusing on enhancing profitable growth and operational effectiveness, as well as improving capital management. Welcome again, Mark. It's been just over two years since we separated from Hertz. With a 50-plus year legacy as one of the leading equipment rental companies in North America, we created the Herc Rentals brand in the U.S. and listed on the New York Stock Exchange as Herc Holdings Incorporated, trading under the symbol HRI. In early July, we announced that we changed our main brand name in Canada from Hertz Equipment Rental to Herc Rentals. As a result, Herc Rentals has become a true North American brand for our business. Of course, we are already operating as a unified North American team, so it's only appropriate to continue to work together to serve our customers in North America under the same powerful Herc Rentals brand. One of our highest priorities over the last 12 months has been to complete our information technology separation from Hertz. We're pleased to say at the end of July, we completed the last step of our multi-phase IT separation from Hertz as we successfully established our own Oracle ERP platform. This is an important final step in establishing our independence. Now that the separation from Hertz is behind us, our priority is improving our operating effectiveness. Please turn to slide seven. Safety is at the center of everything we do. As I said before, safety awareness dictates how we operate, how we treat our employees, and how we work with our customers. Please move to the next slide. June was National Safety Month. Our employees across the country and North America made a renewed commitment to follow and champion our safety program by signing our Think Safety banners at every location in the company. We continue to make good progress on our total reportable incident rate, or known as TRIR, compared with last year. On a 12-month rolling basis through June 30, 2018, our TRIR performance has improved with a decline of 10% year over year. We also continue to focus on the simple concept of a perfect day, which means no OSHA-recordable incidents, no at-fault motor vehicle accidents, and no DOT violations. We recorded at least 75% perfect days for the first 6 months of 2018 in each of our regions. Our New Jersey team is featured in this photo on this slide. The Herc ProSolutions and ProContractor teams at this location reported 100% perfect days in the second quarter. We congratulate and thank them for being a role model for our whole organization. We promote a culture of safety to encourage our managers and employees to make safety a second nature. Branch safety programs have been updated with easier-to-use safety guidelines and how-to photos, and we continue to focus on continuous training, excuse me, and improvement initiatives to enhance overall safety performance. We continue to aim for 100% perfect days within all of our branches. Please turn to slide number 9. These four pillars are our framework, which have been driving our strategy since our spinoff and which has been supported our improvement to date. We are pleased with the progress we have made in expanding and diversifying our revenue, improving our operating effectiveness, enhancing our customer experience, and at the same time, maintaining a disciplined capital management approach. We are committed to continuous improvement of all of the initiatives listed on this slide. Please turn to slide 10. As you can see from our strong second quarter results, our strategy is working. Our strategic initiatives drove volume, growth, and improved price and mix. Our focus on ProSolutions and ProContractor equipment continues to drive new customers and local account growth. We continue to invest in people, training, and operations to drive operational effectiveness. We are focused on improving operating efficiencies to increase our adjusted EBITDA margins. Please turn to slide 11. We are pleased to report equipment rental revenue grew 11.9% to $392.5 million compared to $350.8 million in the prior period. The growth was driven by improved pricing, mix, and increased volume. Our equipment rental revenue growth is even more impressive considering our growth in average OEC fleet was only 5.7% in the second quarter over last year. Pricing improved 2.9% year-over-year and was strong in both local and national accounts. We also continue to see gains in Canada. We improved our net results in the second quarter by $27.3 million year-over-year and reporting a net loss of $300,000 or a loss of $0.01 per diluted share, compared with a net loss of $27.6 million or a loss of $0.98 per diluted share in the second quarter of 2017. Second quarter adjusted EBITDA increased 14.4% or $19.1 million to $152.2 million, compared with $133.31 million last year. Adjusted EBITDA margin was 31.3% in the second quarter, a slight decline compared with last year, primarily due to an increase in direct operating expenses related to higher rental activity. Dollar utilization increased 140 basis points to 35.4% in the second quarter of 2018 compared with 2017, benefiting from improved fleet, customer mix, and pricing. Based on our first half results and our expectations for the rest of the year, we are affirming our guidance range for 2018 adjusted EBITDA of $630 million to $660 million. We are also affirming our guidance range of net fleet capital expenditure of $525 million to $575 million. Now please turn to slide 12. The graphics on this slide illustrate the continuing positive improvements we are making each quarter over the prior year. Strong equipment rental revenue growth in the second quarter of 11.9% marked our fourth consecutive quarter of double-digit growth. Our year-over-year pricing increased 2.9% in the quarter, which marked our ninth consecutive quarter of rate improvement. This also illustrates the growth of our average fleet at OEC on a quarterly basis for both 2017 and 2018. During the second quarter, we increased our average fleet at OEC by just 5.7% over the prior year. Our fleet on rent also continued to increase and has improved on a year-over-year basis for the last five consecutive quarters. This quarter, fleet on rent increased 4.8% compared with last year. As we continue to diversify the fleet composition, I want to emphasize the fact that we would rather improve a point in rate over a point in time in utilization. As you'll see in the next two slides, this fleet mix strategy is driving the continued improvement in dollar utilization we have been achieving. Please turn to slide 13. The cornerstone of our strategy is the diversification of our fleet, which drives higher dollar utilization and a diversification of our customer mix. Our classic line of equipment continues to revolve around aerial, earthmoving, material handling, trucks and trailers, compressors, and lighting. Our ProSolutions equipment is focused on helping our customers with customized solutions in power generation, climate control, remediation, and restoration, as well as studio and production equipment. ProContractor provides a wide variety of tools and gear that supports various types of contractors that fit our urban market strategy and square footage under roof focus. Please turn to slide 14 now. The increase in volume and improvement in pricing mix continued to contribute to the improvement of our overall dollar utilization, which increased 140 basis points to 35.4% in the second quarter of 2018 versus the prior year. This is the fifth consecutive quarter of year-over-year improvement. Fleet at OEC as of June 30, 2018, was $3.87 billion, with an average age of 46 months, compared with the 48 months for the same period last year. Together, ProSolutions and ProContractor equipment now account for approximately $771 million of OEC fleet, or about 20% of our total fleet at the end of the second quarter 2018. That's an increase of 10% in the value of the OEC fleet year-over-year. As you can see from the chart, the lower left-hand corner, the largest percentage of our fleet consists of aerial at about 27%. Earthmoving is about 15% of our fleet, and we continue to favor investments in compact equipment, which has higher dollar utilization opportunities for us. A detailed breakout of our fleet categories is in the appendix. Please turn to slide number 15. We continue to build on our North American footprint by improving scale in targeted urban markets. Our total number of branches has remained about the same, as we've closed about as many branches as we've opened over the last two years. The map is defined by projected ARA compounded annual growth rates over five years from 2017 to 2022. As you can see, the Western states, Texas, and Southeast are projected to grow at a rate over 6%. We opened a greenfield location in McKinney, Texas, as part of our Dallas urban density strategy, which is our second greenfield this year. Later this year, we plan to open a new greenfield in St. Peters, Missouri, part of the St. Louis metropolitan market, and in Covington, Georgia, supporting the Atlanta metropolitan market. Please turn to the next slide. We talked of the importance of diversification of our fleet and customers. Now let's discuss just how this neatly falls into our strategy of driving urban market density. Those of you who participated in our Newark branch tour in June saw how that diversity expands our opportunity to serve customers with a broader array of equipment and also to attract new customers. Our intent is to also make the local branch the one-stop shop where contractors can pick up whatever they need when they need it. We have also added new branches in high-growth opportunity urban markets. This allows us to improve our mix, yield, and dollar utilization in a region as we benefit from the scale of bigger fleet capable of serving more customers. Urban markets also accelerate the concept of conversion to rental from ownership, as customers are often constrained by the high cost of land or rent to store their equipment. Customers utilize rental as a way to reduce costs and eliminate storage requirements and service maintenance staff. Our strategy is driving the further diversification of our market and customer mix. on slide 17, you'll see that our customer mix has also continued to improve. Local rental revenue grew 18% year-over-year and accounted for about 57% of our total rental revenue in the second quarter of 2018. Our rental revenue by major customer segment is shown in the rental revenue composition chart in the upper right-hand corner of the slide. Contractors were about 34% of our total, followed by industrial at 29%. Other customers, which include commercial and retail service, hospitality, healthcare, recreation, and entertainment and special events, was 21%, and infrastructure and government was 16%. Please turn to slide 18. We're continuing to focus on controlling and reducing our direct operating expenses and SG&A as we support the increased rental activity we are generating. We are rolling out our XPO Logistics program to all our operating branches after conducting user testing and a soft launch to several branches. The new online portal will enable us to better manage both long distance and local external transportation costs with enhanced back office tools to better track costs related to a specific customer's equipment delivery. Early indicators of the XPO initiatives are very encouraging. Our new transportation quote tools and biweekly reporting activities are expected us to help recover transportation costs and improve ancillary sales. We continue to focus on maintenance and spare parts costs through our SmartEquip software. As we mentioned on our last call, we introduced a new bulk fuel initiative, reducing the number of vendors from 60 to two in the second quarter. This simpler process helped us to reduce our fuel prices in June, even as the U.S. national average fuel price was up slightly from May. Besides these initiatives, we continue to invest in training programs to improve our operating effectiveness, including a focus on improving our onboarding of new staff to reduce turnover. We're excited with early indications of the potential impact of these initiatives and expect to begin to see some traction in the back half of the year. In addition, we continue to evaluate other opportunities to reduce and control expenses at the branch and field support center to support our goal of improving adjusted EBITDA. Please turn to the next slide. Information technology is a crucial linchpin in operational effectiveness. As I mentioned earlier, I am pleased to say that at the end of July, we achieved a pivotal milestone in our IT area. The multi-phase IT separation from Hertz began in 2017. We achieved a key milestone in that effort when we established our front end or point-of-sale system, RentalMan, on our own platform last year. After we completed the front-end systems migration, we inaugurated Project Independence to execute the final part of our IT separation. Project Independence involved migrating not just the Oracle platform, but the additional software and processes that support our financial systems and operations. Our information technology group, alongside our finance and operations team, led this well-planned initiative. We executed multiple rounds of user testing before we conducted the final cut-over to our own platform in late July. This was an extremely complicated and well-coordinated project, and I want to thank the entire organization, and in particular, the IT, finance, and operations teams for their diligence and professionalism in completing this project successfully. We are now fully self-sufficient in managing our financial systems, which allows us to control the further development of our technology in coordination with our customer, market growth, and operational priorities for improvement. Please turn to slide 20. During the quarter, we also continued to enhance our ProControl and Herc On The Go platforms, adding features to enhance customer experience and interactions. On slide 21, you will notice that key industry metrics remain positive, as evidenced by the Architecture Billings Index, which remained over 50 through June. Industrial spending forecasts for 2018 remain solid and have continued to increase as the year has progressed. Growth is now expected to be 8.2% in 2018 over 2017. Expectations for U.S. construction spending for 2018 continue to be healthy in both residential and non-residential segments, despite shortages of construction workers. Longer term, the ARA forecast remains robust, with compound annual growth projected at 5.3% through 2022. The continuing secular shift from ownership to rental is expected to drive growth in the equipment rental industry over time. Our strategy to focus on urban market density should further accelerate the rate of growth that we can achieve in urban markets, which are more likely to be constrained by space and cost requirements that encourage rental versus ownership. We are making great progress on executing our strategy and improvements in operating performance. Key economic indicators continue to look favorable, and we are optimistic about our future growth opportunities. Now, I would like to turn the call over to Mark Irion, and he will discuss our quarterly financial results in more detail, and then I will summarize before we open up to questions. Thank you, Larry, and good morning, everyone. I am excited to join the Herc Rentals senior leadership team and look forward to seeing many of you in person in the near future. If you would please turn to slide 23, we will review the Q2 financial summary. Larry has already provided an overview of our key metrics for the second quarter. I will reiterate a couple of highlights, then I will walk you through the second quarter year-over-year changes. In the second quarter of 2018, equipment rental revenue grew 11.9% year-over-year to $392.5 million, while total revenues increased 16.8% to $485.5 million. We reported a net loss in the quarter of $0.3 million or a loss of $0.01 per diluted share, compared with a net loss of $27.6 million or $0.98 per diluted share in last year's second quarter. The improvement was due to better operating results this year and last year's pre-tax impairment charge. Adjusted EBITDA in the second quarter of 2018 improved 14.4%, or $19.1 million to $152.2 million over the same period in 2017, and increased 23.4% to $284.9 million for the year-to-date period. On slide 24, we can see that total revenues in the second quarter of 2018 grew 16.8%, or $70 million to $485.5 million, compared to $415.8 million in the second quarter of 2017. Excluding currency, rental revenue increased to $39.7 million compared to the same period last year. The higher year-over-year equipment rental revenue results we achieved in the second quarter reflect increases in volume of 4.8%, a 2.9% increase in pricing, with the remainder from improved mix and other. The improved mix is partially due to the revenue growth from ProSolutions and ProContractor lines of business, both of which increased substantially compared with the prior year. In addition, we continue to grow our local account revenues, which also improved our local revenue mix. In the second quarter of 2018, sales of revenue-earning equipment increased by $31.5 million and reflected our ongoing program to improve fleet mix and to maintain the age and quality of our rental fleet. The largest portion of our sales went through auction channels and accounted for 47% of the total sales volume in the second quarter of 2018, compared with 30% in the prior year. We continue to benefit from the strong used equipment market, with sales generating proceeds of approximately 44% of OEC this quarter as compared to 41% in the prior year. Please turn to slide 25 to review the Q2 adjusted EBITDA bridge. Adjusted EBITDA for the second quarter was $152.2 million, an increase of 14.4%, or $19 million, compared to $133.1 million in the second quarter of 2017. The bridge shows that the largest contributor was the improvement of equipment rental revenue with growth of $39.7 million. In addition, the gains on sales of revenue-earning equipment contributed an increase of $7.4 million to this year's second quarter adjusted EBITDA. The quarter benefited from higher volume of equipment sold and a higher margin contribution due to improved pricing from a strong used equipment market. Partially offsetting the positive impact of higher revenue, direct operating costs increased $23.6 million over the second quarter of 2017 as a result of the higher rental equipment activity and related costs such as maintenance, payroll and payroll-related expenses, facility costs, and insurance. Selling, general, and administrative costs increased by $4.7 million, primarily driven by an increase in the number of sales personnel and related commissions on increased revenue growth. Larry Silber mentioned a number of initiatives that have been rolled out to reduce and control expenses. With the final phase of our IT separation completed, we will now focus on managing our spend to improve our flow-through and adjusted EBITDA margin going forward. If you please turn to slide 26. The net loss in the second quarter was $0.3 million compared to a net loss of $27.6 million in 2017. The benefit from income taxes declined $23 million over the same period in 2017, primarily driven by the significant reduction in our pretax loss. We estimate our effective tax rate for the full year 2018 to be approximately 28%, driven by certain permanent differences. However, we continue to assess the impact of the Tax Cuts and Jobs Act of 2017. Interest expense for the second quarter increased slightly, primarily due to an increase in average outstanding borrowings and a higher average interest rate on the revolving credit facility during the quarter compared to the prior year. The increase was partially offset by a decrease in interest related to lower average outstanding borrowings on our notes during the second quarter of 2018 compared to the prior year, due to partial redemptions made in October of 2017. Spend costs in the second quarter declined $5.2 million to $3.9 million from $9.1 million in the prior year. Year-over-year change in net results this quarter was also affected by last year's $29.3 million impairment charge, which was primarily due to the write-off of intangible assets related to the development of information technology systems. The currency translation and all other category shows improvement of $16.7 million related to the positive impact of higher revenues, partially offset by higher operating expenses that we have previously discussed. Details of the components are included in our appendix. If we turn to slide 27, we have broken out fleet expenditures and disposals on an OEC cost basis and have provided a rolling balance of the OEC value of our total fleet. A quarterly breakout of this information for 2018 and 2017 is also in the appendix. Total fleet at OEC was $3.87 billion as of June 30, 2018. The average OEC of our rental fleet during the quarter increased 5.7% over the prior year quarter. For the second quarter of 2018, fleet expenditures were $321 million, and fleet disposals at OEC were $179 million. The average age of our disposals in the second quarter was 80 months, and we improved the average age of our fleet to approximately 46 months at the end of the second quarter of 2018 from 48 months in the comparable period last year. We turn the page, slide 28. The fourth pillar of our strategy is focused on disciplined capital management. Our total debt was $2.15 billion as of June 30, 2018, down $27.1 million from year-end 2017. Net cash flow from operations for the three months ended June 30 improved from $126.3 million in 2017 to $232.9 million in 2018, or a $106.6 million increase. Net fleet capital expenditures increased in the second quarter from $72.2 million in 2017 to $170.4 million in 2018. Free cash flow for the six months of 2018 was $31.7 million, compared to $29.8 million in the same period of 2017. A reconciliation of free cash flow is also in the appendix of the deck. We had ample liquidity of $666.1 million as of June 30, 2018. Our strong financial position enabled us to proceed in July with the redemption of $61 million in aggregate principal amount of the 7.5% notes due in 2022, and $63 million of the 7.75% notes due 2024. To fund the redemption, we borrowed on a revolving credit facility, which is a rate of approximately one month LIBOR plus 1.75%, and will result in annualized interest savings of $5 million. We are continuing to focus on a disciplined financial strategy to reduce leverage and fund organic growth opportunities with our operating cash flow. Please turn to slide 29. As Larry mentioned earlier, we are reaffirming our guidance range for 2018 of adjusted EBITDA of $630 million to $660 million, or an increase of 8%-13% compared with our 2017 adjusted EBITDA of $585 million. With projected net fleet CapEx of $525 million to $575 million this year, we expect that the net leverage ratio will stay in our targeted range of 2.5x-3.5x in the calendar 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 create value for our shareholders. Now, I will turn it back to Larry. Thanks, Mark. We have been very pleased with the strength of our top-line growth. Pricing has continued to improve for nine straight quarters over the prior year periods, and our new account growth is exceeding our expectations. Our focus on urban market density continues to gain momentum, and local rental revenue growth has been outstanding. We continue to make good progress in the diversification of our fleet, and ProSolutions and ProContractor fleet growth is on track to reach the 25%-30% target we set in the five-year plan. Now we look forward to taking your questions. Thank you, sir. We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If any time your question has been addressed and you would like to withdraw your question, please press star then two. Again, that is star then one to ask a question. At this time, we will just pause momentarily to assemble our roster. The first question we have will come from Adam Seiden of Barclays. Please go ahead. Great. Thanks, guys, for taking the question. Just some quick ones, I guess, from me. First on the pricing. Nice job, I guess, on the ninth consecutive quarter of improvement there. Could you give us a sense of the rate progression that you saw through the quarter, for you guys? And then also perhaps how rate has been looking so far in July. On top of that, has there been any difference in rate progression based on customer mix or regional areas across the U.S. or Canada? Look, I think we can answer most of that except for maybe the forward-looking pieces. Bruce, you want to comment on rate during the quarter and what we saw? Yeah, sure. We don't give sequential, but once again, extremely happy to report nine consecutive quarter of price improvement. As a company, we continue to stay focused and use our Optimus tool to drive disciplined pricing performance. We're operating in a strong market, and our expectations would be to continue to see positive pricing improvement throughout the year. All right. I saw your accounts payable increase. Just wondering where you stand in terms of fleet purchases, the amount that's already been committed for 2018. Also, I know we're a bit early on the 2019 purchase cycle, but when you think about your CapEx today, you guys brought down fleet age to about 46 months. How aggressive do you need to be on CapEx when you think about your fleet over the next year, particularly in an inflationary environment? Yeah. Hi, Adam. I'll take the first piece of that. The payables portion is really just due to the timing of the CapEx spend coming through the year. It's heavily weighted into Q1, gets paid for in Q2 and Q3, and then drops off into Q4. That's really just a timing during the course of the year. Bruce? Yeah. I'll take the second part. We're really not giving any guidance yet on CapEx for 2019. You mentioned kind of an inflationary environment. We started our initial discussions with all of our partner suppliers, and our expectation going into 2019 would be that if we received any price increases, they would be in line or below whatever your expectations are or ours for inflation for 2019. Got it. That makes sense. Then also, I guess just lastly, you guys have actually seen a lot of progress in the areas of technology. You spoke to, I guess, that you'll be separating off the old legacy Hertz systems as well. Is there anything that you could quantify around the benefits from, whether it's from the various technology tools or just merely from the separation of the old HERC systems or XPO or whatever, the different areas along these lines in the second half or over the next year or two? Well, look, just to clarify, we have completed the separation. As of July 30, there are, pardon the pun, no strings attached between us and the car rentals company. We are responsible for our own IT platform instances, which includes, as everybody knows, the industry standard and leading RentalMan platform, as well as our back end and related systems, Oracle. I think the big improvement for us is that we don't have to go to a third party to make changes for improving operating efficiencies or adding capability into any of the software technology we had. Over the last three years, as you know, we've been a bit hamstrung because we'd have to go back through a third party and get in line in a queue to get upgrades and implementations done. We don't have that facing us any longer. I think as it relates to some of the programs like you mentioned on XPO and others, I think those operated more with our front end system independently, and we are able to integrate that during the back half of the second quarter and have rolled it out in July. And we are pretty favorable in terms of our expectations and opportunity for improvements. And there will be other customer and supplier initiatives that we will be able to address as a result of having complete control of our IT capability. Thanks, fellas. I will pass it on. Okay. Next we have Seth Weber of RBC Capital Markets. Hey, good morning. Good morning, Seth. I wanted to maybe just follow up on that a little bit. My question is really on flow-through margin. You talked about a lot of the initiatives that you have in place here, so it is really a two-part question. Maybe can you talk about what you think is the right way to think about normalized flow-through margin for the company going forward? Then, is there anything you would call out here in the second quarter, whether it was freight cost or fuel or whatnot, that caused the flow-through margin on the rental business to be a little bit lower than what we were looking for anyway? Thanks. Right. Hi, Seth. Yeah, flow-through was a little bit soft in this quarter. We did see some increases in freight, fuel, and maintenance expenses. Going forward, the target is north of 60%. We would expect to try and flat line our costs here based on the investments we have made historically and just try and push the rental revenue growth down into the bottom line. So Q2 is a little bit of an anomaly, I think. We should see improvements going forward and we are certainly focused on flow-through as a company and we will be generating better results here going forward. Yeah, this is Bruce, Seth. I would just say also, as we have said in the past, we kind of lagged in our ability for revenue from delivery and pickup as a percentage of rental revenue. As you can see in the 10-Q under the topic 606, we are still probably 150-200 basis points behind where we need to be in that metric, and we are focused heavily on achieving that. Sure. Okay. Just to be clear, Mark, the 60% target you talked about, is that a 2019 event or do you think it's further into the future? You did sort of low 50s in the second half of last year. Do you think you could repeat that again in the second half of this year, or is it still going to be in the sort of 30%-40% range for the second half? If you look at Q1 versus Q2 and average those two, you sort of come to a better number than 30% for year to date. These costs, if you go back historically, did sort of take a big jump into Q3 and Q4 of next year. Mathematically, the number gets easier from a comp basis going into Q3 and Q4. There is a variable cost component to these costs, which do increase as revenues come up. We are focused on just flat lining these costs to the extent that we can and just generating maximum flow-through from our revenue growth. Okay. If I could just pivot then to my follow-up question on dollar utilization. Rates were particularly strong, which were great. I'm just trying to understand what's going on on the time side. Larry, you talked about you'd trade rate for time any day, which I get. Was there something going on with time utilization that caused just sort of overall dollar utilization growth to be lower than where it's been tracking over the last couple of quarters? Thanks. Yeah, Seth, this is Bruce. You can see, we kind of purposely accelerated the timing of fleet adds in the quarter to continue to drive our mix strategy. We're happy to see that that is beginning to get absorbed in without taking any negative impact on price. I don't think there's an issue there other than because of timing, we brought a lot of fleet in. I think you'll start to see that improve out in the back half. Okay, so dollar utilization, you think, is better on a year-over-year basis than what we saw in the second quarter for the back half of the year? I don't want to give any guidance on that, but I would say that as you can see, the amount of fleet that we brought in the quarter if you compare to years past. So you'll probably see less CapEx coming in in the third and fourth quarter than you've seen historically, which should then trend that dollar utilization up if we continue to get the strong revenue growth that we're seeing. Right. Okay. Thanks very much, guys. Appreciate it. Thank you. Next we have Neil Frohnapple of Buckingham Research. Hi, good morning. Good morning. Mix was, call it a 4-point tailwind to rental revenue in the quarter. Should we continue to expect a similar magnitude benefit to the growth rate for the remainder of 2018, just given the shift in fleet mix to more ProContractor and ProSolutions and then continued faster growth from local accounts? Or is there something that would sort of change the contribution there? It's really hard to sort of forecast that mix impact. I don't think there's going to be a significant change in fleet composition in the back half of the year compared to what we've got in the front half of the year. So from there you could maybe impute that the mix stays relatively constant. Part of it is also the timing of the fleet coming in and that sort of averaging in terms of the volume contribution. But the metric that we can focus on is rate. We will stay focused on rate. Volume is mostly in for Q2, so that's going to sort of flat line. So the sort of main driver that we'll be pushing on is rate, especially through the summer months where we've got peak demand. Got it. Then switching gears, you cited continued strong industry outlook that's supportive of further growth. But could you talk more about what you're hearing from some of your larger customers on the national account side that have good visibility into 2019? Yeah. Hey, this is Bruce. So there's no question that we're in a good, strong, robust market across all the regions we're in, and all the intel we're getting back from our customer base is the same. So we see no reason not to expect this to continue for the near future. Okay, great. Thanks. I'll pass it on. The next question we have will come from Rob Wertheimer of Melius Research. Hey, good morning. Just a quick question. It seems like your mix is trending positive on what you've been trying to do on bringing in more of the contractor shorter-term customers and on the specialty. Is that margin accretive right now? Or just given the extra cost to service some of those, has that been part of the drag on margin growth? This is Bruce again. I would tell you it is accretive, so we're driving a higher dollar utilization for the investment we're making in both ProContractor and ProSolutions. I would also tell you, we haven't achieved the type of margin that we will because we've been fleeting up so heavily there. We have had some drag from that. Ultimately, as we go through this journey, the five-year plan, we're two and a quarter or so into it, that we should continue to see that improve because the portion of fleet we're bringing in won't be so large compared to the base we have. Okay. No, makes sense. I'm sorry, is there a crest in the curve of how you fleet versus how you get the fleet to pay off? Or is it just a steady journey over the next two, three years? I think it's a steady churn based on the absorption. As long as I can buy it and it gets absorbed, I'll continue. As the absorption slows, then that investment will have to slow. But right now, we're feeding it everything we can get to it, and it seems to be absorbing it well. Great. Okay. Thanks, Bruce. The next question we have will come from Kathryn Thompson of Thompson Research Group. Good morning, guys. This is Steven Ramsey on for Kathryn. Thinking about branch closings and openings, did that have any impact on elevated costs in Q2? Is there a targeted branch count you want to get to? Okay, so first part of the question, no. No immaterial impact on any closures within the quarter or the first half. We have no targeted branch count out there that we're trying to achieve. The strategy is to be in these large urban markets and build out footprint to get efficiency and gains in customer service out of that. As we open certain branches in large urban markets, we always rack and stack and cut the tail on other branches that aren't performing that may be actually a drag on the overall performance. Any branch closings we do have, we should see in the future an improvement in the performance overall. Great. Then thinking about the equipment sales market continuing to be strong, does this make you want to more aggressively try to sell fleet and invest in fleet that results in better dollar utilization? Or does that not really shift your long-term plan much? No, I think it absolutely is helping in the plan, as you see that in the quarter. We just brought in much more than we historically have and disposed of much more than we historically have. We achieved 44 cents on the dollar of the disposed OEC, which was above our expectations, while not really hitting the correct channel mix, as you can see where our auction channel was much higher than we would have anticipated, but the market was so strong that we took advantage of that. Great. That does it for me. Okay. The next question will come from Jerry Revich of Goldman Sachs. Yes, hi. Good morning, everyone. Hi, Jerry. Good morning. I am wondering if you can say more about the transition to XPO Logistics in the test operations. What kind of efficiency gains have you folks seen? What is the scope in terms of the total spend that you are handling internally versus what you are going to be outsourcing going forward? Can you just help us understand that from a high-level standpoint? Yeah. Let me just start with the use of XPO's capability is around certain types of software that they have that will integrate with our software, that will allow us to select vendors to move equipment primarily in non-local circumstances, out of regions or across the country to other regions. Primarily where we do not have a large fleet of our own to do that, nor do we want to encourage that cost because the peak shave opportunities there, the peaks and valleys are too long to justify investment. So where we are using XPO is to help identify those best carriers at the least expensive rate to do the pick and move. I would tell you, I do not have enough here to give you empirical data. We should have some good empirical data of what that might have produced by the end of Q3 in the early phases, and certainly by the end of Q4. But the handful of transactions that I have personally reviewed, along with Brad Jacobs personally reviewed, have been very encouraging for us. As you know, he is the CEO of XPO, and he has helped us implement this program. Okay. From a pricing standpoint, you folks have had better pricing gains year-to-date than the rest of the industry. I am wondering, as you look at the benchmarking analysis across your footprint, where do you folks stand now in terms of your rates versus your primary competitors on a region-specific basis? Is there more room for you folks to outperform the industry in terms of pricing gains as we think about the back half? Yeah. Hi, Jerry. This is Bruce. I would tell you that I think we are absolutely on par with the others. This kind of myth of that we were underperforming the market and that is why we are over-executing the market is probably behind us. We feel we are in a strong environment that we will be able to continue to see the pricing performance that we have seen in the past. Yeah, I would just add, remember that when you look at our dollar utilization, that is a function of your rental revenue divided by your OEC cost. Remember, we are only three years into changing our fleet or adjusting our fleet and buying it at a better pricing level than we did when we got here three years ago. So we still got a long way to go to trade out the denominator in terms of the cost of our fleet as you calculate the dollar utilization. Not to pile on, Jerry, but as we kind of change out this mix of customer, you got to kind of look at our percentage of what was what we considered large national accounts to kind of local. We have always said in this new customer business that we are growing, we get much better pricing performance than we do from the large nationals. As we kind of trade that out and get a better balance, once again, not going away from national, protecting, defending, and continuing to grow that part of our business, but just outgrow the local market, that pricing performance will continue to improve. Thank you for that context. Bruce, the better pricing performance year to date, you would attribute to slide 17, which is that mix of greater concentration on local? Am I understanding your comments right? You could say that there is some that fuels that, but also we are seeing pricing performance from our large national customers also through a mixture of straight just price gains and then mix of fleet, different types of product that we rent into them and gaining more wallet share from that customer. Ultimately allowing us to deliver a much higher level of service to that customer, making that customer more sticky. Okay. Thank you. Next, we have Bill Mastoris of Baird & Company. Thank you very much. I apologize if this question has been previously asked. I had to step off the call for just a second. But, Larry, as your leverage has come down into your target range, particularly with the subsequent redemption of the second lien notes, does that change your capital allocation priority or is there an ambition to actually take that leverage a little bit lower, maybe into the low twos and maybe gain a competitive edge with the cost of capital? This is Mark. I think the leverage is just sort of getting into within our target range, and that we will continue to focus on deleveraging the business over the medium term. It does not change our immediate sort of views on the capital structure and we will continue to maintain a conservative capital structure and focus on deleveraging over the medium term. Yeah. If you remember what we said early on is our desired range is to be between 2.5 and 3.5 times. That obviously as long as the cycle remains robust, we'll operate towards the upper end of that range. If there was a cycle shift to happen, we would obviously sell off gear and pay down debt, which would move us down to the lower end of the range in a down cycle. Okay. So we can expect leverage to remain relatively constant from where we are right now. If you do generate free cash flow on a consistent basis, if you could review maybe the capital allocation priority. Would it go towards first investing in the business, second to debt repayment and then to shareholders? Or has that changed? You are spot on. First will be to reinvest in the business and I think that'll be our priority. Paying down debt this last time was a bit opportunistic because we had those provisions incorporated and we saw significant savings. But outside of that, we have no more opportunities to pay down our bonds as we have the last three tranches. Look, we still have plenty of room to invest in this business as long as the cycle is strong. Okay. Thank you very much. Our next question will come from Michael Cohen of Opportunistic Research. Please go ahead. Hi. Thanks for taking my question. If you could talk about the denominator of OEC, what percent of it do you think is still kind of the inefficiently earning OEC? And what percent do you feel like has turned over to OEC that is more on par with the industry? Yeah, I think the way to look at that is we've stated that if you look at mix first in that, we've stated that we would like to be in the 25%-30% range of our OEC being in ProSolutions or the ProContractor range. The other way to think about it is, we dispose of our fleet on average in about 7 years. So we're 3 years into this, so we've got another 3-4 years to go before we would be able to say that the fleet is the exact kind of mix and style that we want. So lots of opportunity in future to continue to get some benefit from that. I think I would highlight that it's the denominator, so it's expensive fleet in the denominator. It's not inefficient earning fleet in the numerator. So it's not a revenue drag, it's a cost drag on the fleet side. Sure. No, of course. I know some folks have sort of picked at this. Maybe I'll pick at it a little harder. Can you sort of talk about potential cost saves and maybe trying to quantify and put a little more robust set of estimates around what we might be able to expect over a medium or longer term horizon? It's a little bit tricky, especially in an inflationary environment on some of these other lines. So it's more, I think, a highlight of the focus of the company in terms of managing cost, as opposed to really being able to put a handle on specific initiatives that are going to have a material impact on the cost cube going forward. I think the primary focus is really just to flatten that out and to fix our cost base at or around where it is. The investments in sales reps and the growth in the fleet and some of the other investments that have been made to improve the business recently have been made and don't need to be repeated going forward. We're going to focus on just sort of fixing that curve, flattening it out and continuing to sort of drive this excellent revenue growth that we do have, and sort of benefiting from that on the bottom line over the medium term. What would you expect? As we look at specific line items within your P&L, are you essentially saying that over the course of a multi-year horizon, you would expect the direct operating to kind of continue at this sort of run rate that, the quarterly run rate that you're at? The 194 or what have you, is that sort of the way to think about that? Or is it more on the SG&A side at $75 million, $80 million? Are those line items going to remain relatively close to fixed and there's a fairly high pull-through rate from here on out? Yeah. I think in broad strokes. The DOE, there's a variable component in there, so that moves quarterly as your revenue moves. So we would look to sort of flatten that out over the next couple of quarters and push the flow-through from there. The SG&A we can hopefully see a decrease continuing, similar to what you're seeing Q2 over Q1 and Q2 year-over-year, as we take out some of the conversion costs, if you like, that we've been incurring over the last year or so with the systems adjustments and the separation from Rent A Car. Great. That's helpful. Last question, as you present the adjusted EBITDA, there's about $3.9 million related to the spin. What would you think that number would trend to? Are those actual hard costs that are totally spin related that will go away over the next 6 months? Well, look, I would say the spin costs go away, but there will most likely need to be some additional costs that we incur that we're now operating the system on our own that we didn't have in place before, and we're just quantifying that. But the spin costs certainly go away, but there will be other costs that will come in to make up for that. Okay. Then why, I guess, were they included in adjusted EBITDA? The spin costs are going away. Larry's comment is that some of that cost moves up into SG&A going forward as they become our own. The spin costs are duplicate costs to a certain extent, where we are incurring our own costs in getting the new systems up, as well as paying the old service agreement with Hertz Rent A Car, as well as just direct costs involved in getting these systems separated that are not recurring. The spin costs go away. A portion of that goes up into the SG&A line going forward as we take control of the systems and manage from ourselves. Okay. Thank you. Showing no further questions at this time, we will go ahead and conclude our question and answer session. I would now like to turn the conference call back over to Ms. Elizabeth Higashi for any closing remarks. Ma'am? Thank you, Mike, and thank you all for joining us on the call today. If you have any further questions, please do not hesitate to contact me. We look forward to talking to you or seeing you all soon. Thanks a lot. We thank you also, madam, for your time today and to the rest of the management team. The conference call is now concluded. At this time, you may disconnect your lines. Everyone, thank you. Take care, and have a wonderful day.