Send me real-time posts from this site at my email
Motley Fool

H&E; Equipment Services (HEES) Q3 2020 Earnings Call Transcript

Image source: The Motley Fool.

H&E Equipment Services (NASDAQ: HEES)
Q3 2020 Earnings Call
Oct 28, 2020, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good morning, and welcome to the H&E Equipment Services third-quarter 2020 earnings conference call. Today's call is being recorded. At this time, I would like to turn the call over to Mr. Kevin Inda, vice president of investor relations.

Please go ahead.

Kevin Inda -- Vice President of Investor Relations

Thank you, Sarah, and welcome to H&E Equipment Services conference call to review the company's results for the third quarter ended September 30, 2020, which were released earlier this morning. The format for today's call includes a slide presentation, which is posted on our website, www.he-equipment.com. Please proceed to Slide 2. Conducting the call today will be John Engquist, executive chairman of the board of directors; Brad Barber, chief executive officer and president; and Leslie Magee, chief financial officer and secretary.

Please proceed to Slide 3. During today's call, we will refer to certain non-GAAP financial measures, and we've reconciled these measures to GAAP figures in our earnings release and in the appendix to this presentation, each of which is available on our website. Before we start, let me offer the cautionary note that this call contains forward-looking statements within the meanings of federal securities laws, statements about our beliefs and expectations, and statements containing words such as may, could, believe, expect, anticipate and similar expressions constitute forward-looking statements. Forward-looking statements involve known and unknown risks and uncertainties which could cause actual results to differ materially from those contained in any forward-looking statement.

10 stocks we like better than H&E Equipment Services
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and H&E Equipment Services wasn't one of them! That's right -- they think these 10 stocks are even better buys.

See the 10 stocks

*Stock Advisor returns as of October 20, 2020

A summary of these uncertainties is included in the safe harbor statement contained in the company's slide presentation for today's call and also includes the risks described in the risk factors in the company's most recent annual report on Form 10-K and other periodic reports. Investors, potential investors and other listeners are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The company does not undertake to publicly update or revise any forward-looking statements after the date of this conference call. With that stated, I'll now turn the call over to Brad Barber.

Brad Barber -- Chief Executive Officer and President

Thank you, Kevin, and good morning, everyone. Welcome to H&E Equipment Services third-quarter 2020 earnings call. On the call with me today are John Enqquist, executive chairman; Leslie Magee, our chief financial officer; and Kevin Inda, our vice president of investor relations. Slide 4, please.

I will briefly discuss our third-quarter performance and current market trends, and then Leslie will review our financial results for the quarter in more detail. After, we will take your questions. Slide 6, please. I'm pleased to begin today's call by saying the operational environment has progressed from what I would characterize as stable to expansion.

I will provide some additional color on the positive trends we're experiencing in our end-user rental markets and physical utilization in a moment, but let me first quickly review our top-line financial highlights. While we continue to see meaningful improvement in the rental business, our financial results remain below year-ago levels. Total revenues were down 18.1% or $63.7 million compared to a year ago. This was largely the result of an $18.8 million or $38.3 million decline in total rental revenues and $42.7 million or $27.8 million decline in new equipment sales from a year ago.

Adjusted EBITDA declined 22.5% or $28.7 million from a year ago, and margins decreased 200 basis points to 34.1%. Let me now address the improvements in our rental business. I stated during our second-quarter call that I expect that utilization could be flattish through the balance of this year. Instead, during the third quarter, we experienced a solid increase in equipment on rent, while we continue to adjust our fleet by selling our older assets.

Even though oilfield and industrial rental opportunities remain far below historical levels, demand has improved within our nonresidential construction markets. Physical utilization for the quarter was 63.8%, a 430-basis-point improvement from the second quarter. As of September 30, 2020, physical utilization was running just over 67%. Keep in mind, demand historically begins to decrease around the holidays and seasonality becomes a greater headwind, but we are very pleased with the positive cadence in our physical utilization.

Rates are still negative. However, our sequential rate trend improved. As Leslie will detail, we remain focused on managing our balance sheet and maintaining the appropriate size rental fleet and inventories. Our ongoing activities to reduce capital expenditures and operating costs resulted in significant free cash flow for the quarter.

We have also continued to improve our leverage and liquidity. In conclusion, the momentum in our rental business is encouraging. We believe the current environment could further increase the secular shift toward renting versus owning equipment, creating greater opportunities for H&E. Based on our improving visibility, we plan to accelerate our growth strategy.

This includes significantly increasing the number of warm starts next year. We also remain focused on pursuing acquisition opportunities in both the general rental and the specialty rental businesses. I will now turn the call over to Leslie to discuss our third-quarter financial results in more detail. Leslie?

Leslie Magee -- Chief Financial Officer and Secretary

Good morning, everyone. Thank you, Brad. Let's proceed to Slide 11 for more details of our financial results. Total revenues decreased 18.1% or $63.7 million to $289.3 million compared to the same period a year ago.

Our rental revenues decreased 19.1% or $35.4 million to $149.4 million from $184.8 million a year ago. The size of our fleet decreased by 7.8% or $154.5 million compared with the prior-year comparable period. Rental rates this quarter declined 4% year over year, and rates also decreased 0.4% sequentially, but this was a significant improvement from the 2.8% sequential decline in the second quarter. Given lower physical utilization and rates, our dollar returns declined 510 basis points to 32.4% compared to last year but also reflects meaningful expansion from the second quarter.

New equipment sales decreased 42.7% or $27.8 million to $37.2 million, compared to $65 million last year. The decline was primarily the result of a 69.5% or $21.6 million decline in new crane sales, as well as declines in all other categories with the exception of new other equipment sales. Used equipment sales increased 28.3% or $8.8 million to $40 million, an increase in all product lines. Sales from our rental fleet comprised 92.6% of total used equipment sales this quarter, compared to 88% a year ago.

Our parts and service segments generated $43.5 million in revenue on a combined basis, which is down 12.3% from a year ago. Moving on to a discussion of our gross profit and margins. Our gross profit decreased 25% to $99.1 million from a year ago, and our consolidated margins were 34.2%, compared to 37.4% a year ago, primarily because of lower rental gross margins. Margins were also lower in all other segments.

For gross margin detail by segment, rental gross margins were 44% during the quarter, compared to 50.8% a year ago and were impacted by continued pressure on rates and time utilization. Margins on new equipment sales decreased to 11.1% during the third quarter, compared to 11.6% a year ago, largely due to lower new crane margins. Used equipment sales gross margins decreased to 30.3% from 31.3% last year, primarily due to lower margins in all categories, except cranes and earthmoving. Margins on pure rental fleet-only sales remained solid and were 32.1%, compared to 34.8% a year ago.

And parts and service gross margins on a combined basis decreased to 39.9%, compared to 41.4% a year ago. Slide 12, please. Income from operations for the third quarter of 2020 decreased 44.2% to $31 million, or 10.7% of revenue, compared to $55.5 million or 15.7% of revenues in the prior-year period. These declines in income from operations and margins were primarily a result of an 18.1% decline in revenues, lower rental gross margins and higher SG&A as a percentage of revenues despite SG&A costs declining by 9.4%.

Partially offsetting these decreases to income from operations were higher gains on sales of property and equipment and a positive shift in revenue mix. Proceed to Slide 13. Net income was $10.1 million or $0.28 per diluted share in the third quarter of 2020, compared to net income of $28.4 million or $0.79 per diluted share in the third quarter of 2019. The effective income tax rate was 40.9% in the third quarter of 2020, compared to 26.7% a year ago.

The increase in the effective income tax rate was primarily due to unfavorable permanent differences in relation to pre-tax income. Excluding the impact of our 2020 first-quarter goodwill impairment charge, our effective tax rate for the nine-month period ending September 30, 2020, would have been 23.5%, resulting in a third-quarter effective tax rate of 26.2%. Based on a third-quarter effective tax rate of 26.2%, net income and earnings per share for the third quarter would have been $12.6 million and $0.35 per share, respectively. Please move to Slide 14.

Adjusted EBITDA was $98.8 million in the third quarter, compared to $127.5 million a year ago, a decrease of 22.5%. Adjusted EBITDA margins declined 200 basis points to 34.1% this quarter compared to a year ago, also primarily due to lower margins in the rental business and higher SG&A costs as a percentage of revenues. Partially offsetting these results were higher gain on sales of property, equipment and revenue mix. Next, Slide 15.

SG&A expenses for the third quarter of 2020 decreased by $7.3 million or 9.4% to $70 million. SG&A expenses in the third quarter of 2020 as a percentage of total revenues were 24.2%, compared to 21.9% a year ago. Employee salaries, wages, payroll taxes, employee benefit costs and other employee-related expenses decreased $5.6 million, primarily as a result of lower commission and incentive pay, combined with headcount reductions. Also, expenses related to greenfield branch expansion increased $1.3 million compared to a year ago.

Next on Slide 16, please. On this slide, you'll find our capex and cash flow for the nine-month period ending September 30, 2020. Our gross fleet capex in the third quarter was $27.8 million, including noncash transfers from inventory. Gross capex was down 72% compared to the third quarter a year ago.

And our net rental fleet capex for the third quarter was a negative $9.2 million. Gross PP&E capex for the third quarter was $3.8 million, and net was $1.5 million. Our average fleet age as of September 30, 2020, was 40 months. Free cash flow for the third quarter of 2020 was $66.2 million, compared to a use of $6.4 million a year ago.

The increase in free cash flow was largely due to lower net fleet investment this year. Next, on Slide 17, at the end of the third quarter, the size of our rental fleet was 7.8% or $154.5 billion decrease from a year ago. Average dollar utilization was 32.4%, compared to 37.5% a year ago, reflecting lower time utilization and rates yet has improved from the second-quarter dollar utilization of 29.6%. Proceed to Slide 19, please.

Lastly, our balance sheet remains very strong with ample liquidity and no near-term maturities. At the end of the third quarter, the outstanding balance under the amended ABL facility was $18 million and is down $198.9 million since December 31 of last year. We had $724.3 million of cash borrowing availability at quarter end, net of $7.7 million of outstanding letters of credit. Our excess availability was in excess of $1 billion.

Our excess availability is the measurement used to determine if our springing fixed-charge coverage is applicable. Our senior security credit facility requires $75 million of excess availability before this covenant would even spring. So therefore, with excess availability at September 30, just over $1 billion, we are in a very strong liquidity position, and we have no covenant concerns. The company paid its 25th consecutive quarterly cash dividend.

And while dividends are always subject to approval by the board of directors, it is our intent to continue the dividend policy. With that, we'll move into our Q&A session. Operator, please provide the instructions.

Questions & Answers:


Operator

Thank you. [Operator instructions] Our first question comes from Steven Fisher with UBS. Please go ahead.

Steven Fisher -- UBS -- Analyst

Great. Thanks. Good morning, guys. Brad, I wonder if you could just talk a little bit more about the improved visibility that you cited that's driving you to accelerate some of your growth plans.

Just what is that visibility you have? What's driving that? It seems like in other places, we've heard there's sort of -- I know that your utilization has improved sequentially, but we're hearing broader about the construction markets, there's still not much visibility. So I'm curious what you're seeing that's improving?

Brad Barber -- Chief Executive Officer and President

Sure. Well, the -- good morning. Thank you for the question. The primary driver for that comment is the feedback we're getting from our customers in project activity.

In some cases, projects that were postponed for an indefinite period of time have started. In other cases, we're seeing fewer postponements and much fewer cancellations of projects than we were just three to six months ago. Going forward, looking at some of our information, we've got a couple of our product lines that are significantly above prior year's utilization. Right now, our earthmoving products, for example, both our larger construction products and what we categorize as utility earthmoving, these are mini excavators, skid steers, are both well above prior-year utilization levels.

And we always view earthmoving as kind of a leading indicator of the health and vitality of the construction markets. So it's -- we've got kind of anecdotal and quantitative information. We also continue to look at some of the reports in our selected markets. As we sit here today, oil and industry, the Gulf Coast more broadly, for the first time in a long time has really been a headwind for H&E.

These markets are expected to start recovering at some level, even if it's just the pent-up demand associated with maintenance that's been postponed. I believe most of these facilities have postponed every bit of maintenance they could during 2020, and it's anticipated and reported that we'll start to see that activity level sharply increase. So those are -- that's the commentary I can offer you around our improving visibility and our enthusiasm.

Steven Fisher -- UBS -- Analyst

OK. That's helpful. And then maybe just a question on cranes and how you're thinking about kind of where we are in the cycle. Are we still sort of coming off-peak in some of the markets? I know some of those are weaker.

What do you think it will take to get the broader crane market going again a little bit better?

Brad Barber -- Chief Executive Officer and President

Yes. I think it's going to take energy recovering at a meaningful level for it to get going. Crane business is very difficult right now, as evidenced in Leslie's prepared comments, where we talked about the declines being almost 70% year over year in new crane sales. Our physical utilization, although the crane fleet is only 4% or 5% of our total investment in our crane, in our rental assets, that utilization is well down year over year.

So when we see energy start to come back, I think there could be a tremendous upside within the crane business. But for the foreseeable future, it's going to be difficult.

Steven Fisher -- UBS -- Analyst

And just to clarify, energy, meaning more sort of the big process industry plants or are you thinking more of the upstream kind of side of the business?

Brad Barber -- Chief Executive Officer and President

It's all of the above. It's all of the above. I mean, obviously, oil is the anchor of energy when I speak of it, but it's really all the above, Steve.

Steven Fisher -- UBS -- Analyst

OK. And just last quick clarification, I'm not sure if I missed this, but did you guys comment on how much storm-related work there may have been in the quarter?

Brad Barber -- Chief Executive Officer and President

We did not. It's interesting. We certainly do benefit when there's destruction. I mean, we have more product on rent in Lake Charles right now from the first hurricane, not just the second hurricane that has struck there.

But in the short run, it causes us some pressure. Weather has -- it can be a blessing and a curse. And so flooding, not so great for our business. Real destruction where structures are knocked down, you bet it helps us.

As we sit here today, every location south of Baton Rouge for our business is shut down because there's a hurricane about to make landfall in New Orleans. So it will be a net positive. But sometimes in the short run, like today, it can be a headwind for us.

Steven Fisher -- UBS -- Analyst

Got it. Thanks a lot.

Brad Barber -- Chief Executive Officer and President

Thank you.

Operator

Our next question comes from Steven Ramsey with Thompson Research Group. Please go ahead.

Steven Ramsey -- Thompson Research Group -- Analyst

Good morning, everyone.

Brad Barber -- Chief Executive Officer and President

Good morning.

Steven Ramsey -- Thompson Research Group -- Analyst

I guess to think more on warm starts, can you talk about some of the decision process on where to place these, kind of the cadence of opening? And maybe are they building on existing strong geographies, adding new ones and then, along with that, the capex per fleet required to load those new branches?

Brad Barber -- Chief Executive Officer and President

Sure. Yeah. So we kind of have a prioritization process, and we certainly like adding density and expanding existing geographies, first and foremost. We are not opposed to entering a new geography.

But in general, we would prefer to enter new geographies through an acquisition. As far as the cadence going, we expect to open somewhere between eight and 10 locations in 2021 going into next year. And over time, we've always spoke about warm starts as typical rule of thumb, year one about $10 million in OEC. For rental fleet, probably about $1 million PPE for the operation, and then they mature at various levels over periods of time.

No reason to think they will be loaded in any particular quarter. We would spread these out across our footprint over a period of time, primarily in the geographies we serve that we're either building density or slightly expanding our geography. But we're not opposed to entering brand-new geographies on a greenfield basis, but it's not a top priority.

Steven Ramsey -- Thompson Research Group -- Analyst

Great. And then kind of a follow-on with that on the acquisition pipeline pursuit, maybe can you talk to, to the level that you can, how that has changed, if it's a bigger pipeline or a pipeline that's maturing and closer to closing transactions and if the acquisitions fit that strategy of adding new geography or if they're densifying existing.

Brad Barber -- Chief Executive Officer and President

Sure. Well, look, there's a variety. We are always out working. John helps leading on that.

John and I as well as other team members are consistently working relationships and potential acquisition opportunities. These are both in and out of our existing geographies. They are both in the products that we deal in today, and we are specifically considering new products or specialty rentals. So what I can comment is that we're continuing to be active, and we're looking for the right opportunities.

Steven Ramsey -- Thompson Research Group -- Analyst

Great. And then can you talk to the fleet size coming down? Was that in line with expectations? Or did Q3 did you -- were you able to offload more fleet maybe at favorable prices? So where does fleet size stand now relative to 2021 better expectations? And maybe how it diverges at all, if at all, from Q2 thoughts on fleet size?

Brad Barber -- Chief Executive Officer and President

Sure. The fleet size is right in line with our expectations. I think I last call referenced that we would be in the mid- to upper single-digit fleet decrease by the end of the year. We still plan on that being our plan for this year.

I would comment that we started the year with a 37-month old rental fleet. We've only aged the fleet three months as we sit here reporting Q3 and so really proud of the job our team has done. Our pricing on used equipment has been solid, but there's been no upward or downward pressure with pricing that's caused us to act differently. We're just working our plan.

So we're going to take the fleet down a little bit further than it is today, as is our plan. As we get into 2021, clearly, we are focused on this growth opportunity with warm start greenfield opportunities. That will be new capital. We've seen our rental rates stabilize, that 0.4% we were off sequentially is a good indicator that we believe rates have stabilized and should continue to be so moving forward.

And we're in the middle of our forecasting process for our existing 97, 98 locations we have today. And I can tell you that the early feedback is some amount of fleet growth. We're going to balance that fleet growth, of course, against continued improvement in physical utilization and us achieving rate improvement as well.

Steven Ramsey -- Thompson Research Group -- Analyst

Great. Thank you.

Brad Barber -- Chief Executive Officer and President

Thank you.

Operator

Our next question comes from Stanley Elliott with Stifel. Please go ahead.

Stanley Elliott -- Stifel Financial Corp. -- Analyst

Good morning, everybody. Thank you for taking the question. Just a point of clarification, Brad. You mentioned projects were being postponed and definitely started back.

Are those larger-scale projects? Are they a bunch of smaller-scale projects? Just trying to get a sense of the magnitude.

Brad Barber -- Chief Executive Officer and President

It's a variety. I want to stay away from talking about specific project names. I will say that we've seen projects that we were told were postponed that they have decided to go forward and do limited scope work, right? Maybe it's foundation work. Maybe it's the infrastructure around the facility with an anticipation that they will restart the full scope of the project, so it's really been a variety.

But when I say that, I'm talking about, generally speaking, larger projects, not small projects.

Stanley Elliott -- Stifel Financial Corp. -- Analyst

That's great. And then can you talk a little bit more about the decision or the discussion around specialty? Is this something your customers are requesting? Is this just kind of the way you see the market migrating longer term? Would love to get a little more color there, if you wouldn't mind.

Brad Barber -- Chief Executive Officer and President

Sure. Happy to provide color. It's both. We've got a significant amount of earthmoving.

We have continued to grow our earthmoving fleet a little faster than the other product types within our equipment profile. That, in and of itself, kind of lends itself to certain products that we may want to enter to better serve existing customers. And we see customers continuing to look for sources that can provide a wider array of products for their needs. And so the punchline is we're on these projects.

We know these customers. We have good working relationships, and we're looking to facilitate more of what their requests are. So I think there are a couple two or three specialty types of products that are well aligned for our existing business, our existing footprint and our existing customer base, and we're well focused on achieving that becoming part of our rental offering.

Stanley Elliott -- Stifel Financial Corp. -- Analyst

Perfect. And then lastly for me, 10% sort of kind of new store growth is nice to see. Are you seeing anything with some of your smaller competitors out there that the pandemic has really impaired their business, and so this is more of a share gain opportunity? Or is this more that what you're seeing in the tea leaves is that encouraging to push forth on the expansion side?

Brad Barber -- Chief Executive Officer and President

I think it's three things. Number one, I think the smaller operators are really struggling right now, and I don't think it's going to get a lot easier for them. So I think that is some level of an advantage for H&E. I believe that we see opportunity within the markets themselves just as they are, right, for us to continue to expand.

And the third thing that I will add, that we've been doing these warm starts now for about 10 years. And we've been, I think, the last few years punching out. Really, I think, 2018, we did only one location. But other than 2018, we do about four of these a year.

I think we've done as many as five in a year. We've got four that we've announced in 2020 we've done, and I think that will complete 2020 this year. But as we look and do analysis of these locations, looking at return on capital, just the performance and we compare them to other locations or acquisitions or acquisition opportunities, I got to tell you, we have performed really well with these organically grown warm starts. And so there's just a lot of reasons it adds up.

We've got the balance sheet. We're not going to hurt our leverage. We're going to stick with this -- our capital structure is good for it. We're going to stick with our dividend.

And we can just do eight or 10 of these a year, and we feel like they are very safe growth opportunity for H&E. And history tells us that they're going to provide us good returns, and so we've also gotten better at doing warm starts along the way.

Stanley Elliott -- Stifel Financial Corp. -- Analyst

Perfect. Thanks so much. Appreciate it.

Brad Barber -- Chief Executive Officer and President

Thank you.

Operator

[Operator instructions] Our next question comes from Seth Weber with RBC Capital Markets. Please go ahead.

Brendan Shea -- RBC Capital Markets -- Analyst

Hi. Good morning. This is Brendan on for Seth. Thank you for the color on what drove the increase in SG&A as a percent of revenue in the quarter.

I'm curious as to how you're thinking about that going forward, particularly given your increased greenfield growth focus. And I guess what's the typical time line when you do put in a new location to kind of get that up to operating at company averages?

Brad Barber -- Chief Executive Officer and President

Yes. So the time line associated with getting these at company averages can be as short as six to 12 months and probably more like 18 months on average. So I mean, there's a range within that as far as them looking more like a mature location and having typical metrics throughout the P&L. As far as the impact to SG&A, obviously, they have a negative impact to SG&A early on.

You front load. You hire the staff you need to run a business that's not yet ramped up. And I think, generally, there have been times before we've called out the costs associated with those, and we will likely do the same thing going forward since we're going to start to do these in multiple numbers. So it's a negative impact in the short run, certainly, not in our longer view.

And we will be giving some helpful information as we ramp these warm starts up in 2021.

Brendan Shea -- RBC Capital Markets -- Analyst

OK. And then your pots and service was roughly flat sequentially. Any more color you can give on sort of what you're seeing there? And then thoughts on sort of maybe when we might see an uptick in rebuild activity?

Brad Barber -- Chief Executive Officer and President

Yeah. When cranes take off, we're going to see an uptick in that service activity. Until they do, I think we're probably going to be fixed at very similar levels for the foreseeable future.

Brendan Shea -- RBC Capital Markets -- Analyst

OK. Great. That's it for me. Thanks.

Brad Barber -- Chief Executive Officer and President

Thank you.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Barber for any closing remarks.

Brad Barber -- Chief Executive Officer and President

Sure. We thank everyone for taking the time to join our call today and look forward to updating everyone on our year-end results as we move forward. Thank you.

Operator

[Operator signoff]

Duration: 32 minutes

Call participants:

Kevin Inda -- Vice President of Investor Relations

Brad Barber -- Chief Executive Officer and President

Leslie Magee -- Chief Financial Officer and Secretary

Steven Fisher -- UBS -- Analyst

Steven Ramsey -- Thompson Research Group -- Analyst

Stanley Elliott -- Stifel Financial Corp. -- Analyst

Brendan Shea -- RBC Capital Markets -- Analyst

More HEES analysis

All earnings call transcripts

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

Motley Fool Transcribing has no position in any of the stocks mentioned. The Motley Fool recommends H&E Equipment Services. The Motley Fool has a disclosure policy.


Source

Popular posts

Welcome! Is it your First time here?

What are you looking for? Select your points of interest to improve your first-time experience:

Apply & Continue