U.S. Markets closed

Edited Transcript of NSCO.N earnings conference call or presentation 9-Aug-19 8:30pm GMT

Q2 2019 Nesco Holdings Inc Earnings Call

Aug 14, 2019 (Thomson StreetEvents) -- Edited Transcript of Nesco Holdings Inc earnings conference call or presentation Friday, August 9, 2019 at 8:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Noel Ryan

Nesco Holdings, Inc. - IR, Vallum Advisors

* Lee Jacobson

Nesco Holdings, Inc. - CEO

* Bruce Heinemann

Nesco Holdings, Inc. - CFO

================================================================================

Conference Call Participants

================================================================================

* Chad Dillard

Deutsche Bank - Analyst

* Abe Landa

Stifel Financial Corp - Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good afternoon. My name is Mike and I will be your conference operator today. At this time I would like to welcome everyone to the Nesco Holdings second-quarter 2019 results conference call. (Operator Instructions)

I will now turn the call over to Noel Ryan with Nesco Holdings. You may begin your conference.

--------------------------------------------------------------------------------

Noel Ryan, Nesco Holdings, Inc. - IR, Vallum Advisors [2]

--------------------------------------------------------------------------------

Thank you, Mike. Good afternoon and welcome to Nesco Holdings' second-quarter 2019 results conference call. Leading the call today are CEO Lee Jacobson and CFO Bruce Heinemann. Also joining us is Dyson Dryden, former President and CFO of Capitol Investment Corp IV and now a member of Nesco's Board. I am Noel Ryan of Vallum Advisors, the Company's investor relations council.

We issued a press release this afternoon detailing our second-quarter results. Please note that we recently updated the investor relations portion of our corporate website to provide increased accessibility to key resources while allowing users to sign up for real-time email alerts. We encourage you to sign up for these real-time alerts if you have not done so already.

I would also like to remind you that management's commentary and responses to questions on today's conference call may include forward-looking statements, which, by their nature, are uncertain and outside of the Company's control. Although these forward-looking statements are based on management's current expectations and beliefs, actual results may differ materially.

For a discussion of some of the risk factors that could cause actual results to differ, please refer to the risk factors section of our filings with the SEC. Additionally, please note that you can find reconciliations of the historical non-GAAP financial measures discussed during our call in the press release issued today.

Today's call will begin with remarks from Lee Jacobson, who will provide an update of our second-quarter results and general business conditions, followed by a financial review from Bruce Heinemann. At the conclusion of these prepared remarks, we will open the line for questions.

With that, I will turn the call over to Lee.

--------------------------------------------------------------------------------

Lee Jacobson, Nesco Holdings, Inc. - CEO [3]

--------------------------------------------------------------------------------

Thank you, Noel. For those of you on the phone, thanks for joining us today. Since this is our first quarterly conference call as a public company, we will begin with a high-level overview of our business followed by a summary of our second-quarter results and outlook as we look ahead to the remainder of the year.

On July 31, Nesco completed its merger with Capitol Investment Corp IV, creating a newly publicly traded entity: Nesco Holdings. Nesco is now listed on the New York Stock Exchange under the symbol NSCO. The team at Capitol IV and Energy Capital Partners, our private equity sponsor, have been valued strategic partners during our transition from the private to public markets.

Ahead of our public listing, Nesco assembled a world-class Board, one that includes the former CFO of United Rentals, Bill Plummer, who is our Chairman; and the current CEO of SBA Communications, Jeff Stoops, who together with the senior members of Capitol and ECP teams form our Board. We appreciate the ongoing support and guidance of our Board, together with the many contributions of our leadership and team members leading up to the consummation of the merger and our public listing.

During the past decade, Nesco has grown to become one of the largest specialty rental companies in North America, supporting the critical maintenance, repair, upgrade, and installation services for electric transmission and distribution, communications, and rail infrastructure in North America. Collectively, these infrastructure end markets represent more than $100 billion of annualized investment spend, growing at a compounded annual growth rate of approximately 8% over the past two decades.

In recent years, electric utilities, telecom, and rail companies have shifted increasing volumes of maintenance, construction, and upgrade work from in-house teams to third-party contractors, a trend that has and will continue to benefit us. Approximately 85% of our revenues are from the contractors serving these end markets. Last year, more than 80% of our revenue was generated by electrical transmission and distribution customers, a market that has effectively doubled in size since 2010, as major utilities have worked to replace, expand, and harden the aging electrical grid.

The highly anticipated nationwide 5G wireless network rollout is a very exciting opportunity for Nesco. We have not participated meaningfully in the 3G and 4G wireless network deployments or maintenance, given that the towers are approximately 85 feet of height and the cranes that are used to move that material in place are not in a part of our specialty fleet. 5G necessitates small cell nodes placed at approximately 40 feet of height, which is perfectly aligned with our fleet strategy.

Currently, most of our telecom work is on existing wireline and small cell wireless infrastructure; however, we view 5G infrastructure spending cycle as a significant growth opportunity over the next decade. Finally, within the rail markets, Class I North American railroads have increased capital spending budgets in recent years to support a combination of increased commercial rail traffic coupled with accelerated growth in commuter rail usage.

Given sustained growth in capital investment throughout each of our three core end markets, the demands on our fleet have increased. Customers prefer our young fleet, which includes equipment that on the average is 3.8 years old in comparison to useful life typically ranging from 15 to 25 years as engineered by our equipment OEMs. The long useful life of our equipment is a key driver of attractive asset economics with unlevered returns on invested capital approaching 3 times and internal rates of return of approximately 30%.

We also provide our customers a total job site solution, offering a range of parts, tools, and accessories for rent or sale to fully equip their equipment and crews for activity in the field. Customers also like the fact that we are nationwide, providing access to equipment and support at more than 50 locations coast to coast.

With more than 90% of total revenue coming from reoccurring customers, we believe we have developed a loyal brand following. Our top 10 customers have on average been customers of Nesco for more than 16 years. This one-stop value proposition positions us to have a first-call strategic relationship with our customers.

In recent years, despite considerable growth in our fleet unit count, we have been forced to turn away substantial business due to fleet availability. Our fleet has regularly operated at around 80%, the optimal utilization for a fleet due to maintenance and transportation intervals. With the recent completion of our merger with Capitol, we are well positioned to expand our fleet to address pent-up customer demand.

With that high-level introduction, let's transition into a review of our second-quarter results. Total revenue increased 12.6% on a year-over-year basis in the second quarter to $62.9 million, driven by broad-based growth in our two operating segments: equipment rental and sales, also referred to ERS; and parts, tools, and accessories, also referred to as PTA.

Total adjusted EBITDA increased 7.4% to $30.5 million, up from $28.4 million in the same period in 2018, mainly due to higher equipment on rent within the ERS segment and an increase in the number of service locations and product lines within the PTA segment.

Our ERS segment revenue increased by 6.7% to $53 million in the second quarter versus $49.6 million in the same period of 2018. Notably, in the second quarter of 2018, ERS segment revenue included a net benefit of $1.4 million related to non-reoccurring hurricane-related power restoration work in Puerto Rico. Equipment on rent increased 3.7% to $468 million in the second quarter from $451.4 million in the same period of 2018.

Fleet utilization was 78.7% in the second quarter versus 80.9% in the same period of 2018. However, fleet utilization was impacted by a higher volume of net fleet additions in the second quarter of 2019 as compared to the prior-year period. These fleet additions were not immediately available for rent, but are included in the utilization calculation from the date of their delivery to the Company. Including the impact of fleet additions not immediately available for rent, our utilization was 79.7% in the second quarter of 2019.

Utilization in the second quarter of 2018 was benefited from that non-reoccurring Puerto Rico-related work. Excluding the impact of Puerto Rico, utilization was 78.3% in the second quarter of 2018. Adjusting for these one-time factors, fleet utilization was 1.4% higher in the second quarter of 2019 as compared to the prior-year period and close to our optimum utilization level.

Average rental rate per day was $137 in the second quarter versus $139 in the same period of 2018. This is due to a continued shift in fleet mix during the period towards lower cost equipment, primarily used in the growing telecom and rail end markets.

During the last 12 months, we have grown our fleet by 7% or 275 units to address an acceleration in activity within many of our end markets. Given our plans to continue to increase the fleet count, our utilization metric may continue to be skewed by purchased units not yet in service during a given quarter. With this in mind, we believe an important productivity metric will continue to be our average equipment cost on rent, which increased 4.7% on a trailing 12-month basis through June 30, 2019.

Turning to a discussion of our PTA segment, revenue grew 59.4% to $9.9 million in the second quarter versus $6.2 million for the same period in 2018. Segment growth was driven by the opening of two new locations in April 2019 and from the addition of several product lines, including a variety of insulated products related to the N&L acquisition, which occurred in the third quarter of 2018. Our planned PTA footprint expansion from two to six locations continues to progress on schedule.

Excluding capital invested to grow our fleet, trailing 12-month free cash flow was $82.2 million at the end of the second quarter. As we deploy capital resources toward the purchase of new equipment units, we believe an effective measure of free cash generation is adjusted EBITDA less maintenance capital expenditures plus cash from the sale of equipment rentals.

Looking ahead, we anticipate continued stable growth in capital spending by customers within our core end markets. Within our electric utility transmission distribution markets, our customers are seeing significant growth in T&D backlogs with a combination of existing demands on the grid, load growth in regional markets, and a shift towards new generation sources occurring across the country.

Importantly, our customers are guiding that T&D activity will be busier in 2020 than in 2019, given an increased number of small- and medium-sized transmission projects on the horizon as well as sustained distribution demand.

Within our telecom markets, the 5G transition is underway. For every regional cell tower required to support 3G and 4G, we expect up to 20 times as many small cell 5G nodes will require installation and subsequent maintenance.

By 2022, Cisco estimates that North America will be using upwards of 5 billion network devices, up from 2.9 billion devices in 2019, creating a 36% increase in data traffic during the same period. And it is not just wireless infrastructure that requires investment. Legacy wireline systems remain critical to supporting wireline backhaul for 5G.

Within Class I rail, North American railroads are regularly spending 20% of their annual revenue to maintain and expand their lines. Within the next 20 years, commercial freight tonnage by rail is expected to increase by 37%, while commuter rail ridership has increased by 300 million rides annually since 2010.

Given current levels of customer activity, together with the heightened levels of activity we expect over the next several years, the demands on our fleet are increasing. In the last 12 months alone, Nesco has passed on 2,300 customer rental opportunities due to a lack of fleet availability. We estimate the quantifiable missed revenue opportunity is approximately $140 million annually. Assuming a 50% normalized EBITDA margin, this implies approximately $70 million of lost EBITDA due to unmet customer demand.

The message from this is clear: demand for our specialty rentals is strong and is expected to remain so into 2020. Infrastructure investment is expected to grow considerably in the coming years, supported by increased consumer and commercial demand for safe and reliable systems and services.

Unlike general rental companies, the infrastructure markets we serve reflect a low correlation to the construction cycle. Every day, major utilities, telecom providers, and railroad companies must ensure the safety and reliability of their networks, requiring a base level of continuous investment that supports a stable outlook for infrastructure spending in our markets for years to come.

Our ability to provide customers access to a newer fleet, best-in-class responsiveness, service, and support, together with vertically integrated parts, tools, and accessories offerings place Nesco in a position to win in the markets we serve.

While our current full-year 2019 EBITDA forecast does not include any potential contributions from acquisitions, we remain an optimistic -- opportunistic acquirer of complementary specialty rental franchises. Our industry remains highly fragmented, providing us with ample opportunity to pursue accretive acquisitions.

In the last seven years, we have completed six acquisitions at an average multiple of 4x, including synergies. Typically, we will realize 1x to 2x of estimated acquisition synergies within 12 months of acquiring an operation.

As a large national player, we are able to realize economies of scale that smaller operators are not able to achieve. To that end, we have realized 100% or more of expected synergies from every acquisition that we have completed since 2012.

In conclusion, our business remains well positioned to capitalize on strong underlying fundamentals within the core infrastructure markets we serve. Customer backlogs continue to grow, supporting a stable multiyear outlook for our business. As we scale our fleet and complementary PTA business to address the growing demand from our customers, we anticipate corresponding growth in EBITDA and free cash flow. We are excited by the opportunities for growth that lay ahead and look forward to executing on the plans we have shared today.

With that, I will turn the call over to Bruce for an update on our capital structure and liquidity, together with a summary of our financial guidance.

--------------------------------------------------------------------------------

Bruce Heinemann, Nesco Holdings, Inc. - CFO [4]

--------------------------------------------------------------------------------

Very good. Thank you, Lee, and welcome to everyone. Today I'd like to begin with a summary of our recent refinancing activities and balance sheet, followed by a reiteration of the 2019 financial guideline.

In connection with the Capitol merger, Nesco reduced its net debt of $821 million as of July 31, 2019, to approximately $679 million. We established a new five-year senior secured asset-based revolving credit facility of up to $350 million. Our availability under the revolving credit facility is based on percentages of the value of our accounts receivable and fleet inventory, in each case subject to certain eligibility criteria. As of July 31, 2019, the Company's balance on the facility was $175 million.

Also on July 31, we completed a $475 million offering of 10% senior secured notes due 2024. These notes are callable beginning in August of 2021. Collectively, these financings, which were consummated in connection with the Capitol IV merger, position us to execute our growth plan, outlined by Lee, as outlined during the merger process over the past few months.

Quickly turning back to the quarter, our average fleet count increased to 4,205 units from 3,930 units in the same period of 2018. During the three months ended June 30, 2019, we continued our fleet expansion program that began in the first quarter this year, shifting capital expenditure planned for the second half of 2019 into the first half of this year. The acceleration in planned capital expenditures resulted in the addition of 130 units to the fleet during the second quarter of 2019 versus 51 units in the same period of 2018.

Total net capital expenditures in the second quarter were $29.5 million, including $5.7 million of net maintenance expenditures and $23.8 million of growth expenditures in the quarter. The Company received $10.5 million from used equipment sales in the second quarter.

From a capital prioritization standpoint, we firmly believe investment in expanding our fleet is the best use of our free cash flow generation at this given time, given the strong demand we continue to see in our end markets and the compelling economic returns generated by our specialty units.

As additions to the fleet translate into incremental growth in adjusted EBITDA and unlevered free cash flow, we will be positioned to reduce net leverage consistent with our long-term net leverage target of about 3 times trailing 12-month adjusted EBITDA. Lastly, as indicated in our press issued today, we have reaffirmed our full-year 2019 outlook for revenue and adjusted EBITDA of $278 million and $137 million, respectfully (sic).

With that, we will return the call back to our operator, Mike, and open up the line for questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Chad Dillard, Deutsche Bank.

--------------------------------------------------------------------------------

Chad Dillard, Deutsche Bank - Analyst [2]

--------------------------------------------------------------------------------

Hi, good afternoon, everyone. So within your guidance for the back half of the year, can you just talk about how you are thinking about each of the end markets: utilities, telecoms, and rail? Just what is baked in there?

--------------------------------------------------------------------------------

Lee Jacobson, Nesco Holdings, Inc. - CEO [3]

--------------------------------------------------------------------------------

Sure. Within the transmission and distribution market, there is a seasonal tendency towards great strength in the third and fourth quarters. It is historically a period of significant activity. We are seeing that right now from a project start and restart activity. And so we are anticipating a really solid environment, as I mentioned earlier, dominated by small- and medium-sized transmission projects as well as solid distribution activity.

In telecom, and in particularly in commuter rail, we're seeing awards of larger projects. And we will see those kick in over the balance of the third and fourth quarters and expect sustained opportunity in each of those markets and sustained strength.

There is a tendency towards a little bit of a softening, particularly in the transmission and distribution market around the Christmas holiday. There is just kind of a legacy curtailment of overall activity. But that is normal and that will come off the peaks for the year in August/November of deployed fleet.

--------------------------------------------------------------------------------

Chad Dillard, Deutsche Bank - Analyst [4]

--------------------------------------------------------------------------------

That's helpful. And just a bigger picture question. So fire hardening has recently become a greater focus for utility contractors. To what extent are you seeing that incremental demand flowing through into your business? By how much do you think you actually need to raise capacity to support that trend? And if you can talk about like the type of equipment that is most frequently used for that sort of work?

--------------------------------------------------------------------------------

Lee Jacobson, Nesco Holdings, Inc. - CEO [5]

--------------------------------------------------------------------------------

You know, there certainly is a growing trend towards timely execution of that work. This is one of those areas that has been kicked down the road for years by the utilities. And the magnitude of the disaster in California certainly heightened the awareness and it is something that will be approached by essentially all the investor-owneds more aggressively with more of a committed schedule.

It does have significant upside to us as we look out over the next several years. PG&E, as an example, commented that they thought it would take them five-plus years to accomplish rebuild and hardening. I have dealt with the investor-owned utilities for about 20 years now and if you were to round up or down off that five years, you would certainly round up, which is advantageous for us.

It does impact both distribution and transmission really depending upon the location of the fire and what type of lines are really servicing that area. In the current heightened case of California, it is some of each.

--------------------------------------------------------------------------------

Chad Dillard, Deutsche Bank - Analyst [6]

--------------------------------------------------------------------------------

Great, thanks. I will hop back in queue.

--------------------------------------------------------------------------------

Operator [7]

--------------------------------------------------------------------------------

(Operator Instructions) Abe Landa, Stifel.

--------------------------------------------------------------------------------

Abe Landa, Stifel Financial Corp - Analyst [8]

--------------------------------------------------------------------------------

Thank you for taking my question this afternoon. I just have a question regarding how you think about kind of free cash flow that you are going to be burning this year versus the big capital investments that you are making ahead of like industry demand. How do you kind of weigh those two this year and moving forward?

--------------------------------------------------------------------------------

Lee Jacobson, Nesco Holdings, Inc. - CEO [9]

--------------------------------------------------------------------------------

You know, from an industry investment in advance of that, we really don't look at it that way at all. In the last 12 months, we have lost 2,300 opportunities due to lack of equipment availability. So demand at the current level it's at is what we are really targeting with this spend. It is not in the hope or prayer of increased demand, just simply addressing the passes we have had to take because of lack of availability.

We think we are generally our customers first call or perhaps second call. And if we had had those 2,300 units over the past year, we would have captured a substantial majority of those. That is what we look at from an investment standpoint over this next year and a half particularly.

--------------------------------------------------------------------------------

Abe Landa, Stifel Financial Corp - Analyst [10]

--------------------------------------------------------------------------------

Moving topics to rates. What are the current rental rates that you are seeing out there versus your current average rental rate? Are we seeing any increases there? And maybe what will cause rental rates to kind of go back to those averages we were seeing about five years ago, kind of in that high $140s, $150s area? Or is that just a part of mix has changed and you will never get to those levels?

--------------------------------------------------------------------------------

Lee Jacobson, Nesco Holdings, Inc. - CEO [11]

--------------------------------------------------------------------------------

Our mix has decidedly changed and I don't think under our current forecast it will get back to those levels. But it's really not -- the absolute rental rate isn't the critical measure; it is rental rate as a function of OEC. And the reason our rates have come down, stabilized a little bit at a lower level in the past 2 1/2 years is really our investment in our diversified markets.

As we have invested in telecom- and rail-oriented equipment, that equipment typically has an average OEC hovering right around $100,000 per piece. On the other hand, transmission and distribution has an OEC per piece of equipment north of $150,000 per piece of equipment.

So our increasing investment in telecom- and rail-oriented equipment has really brought the nominal average down. We are seeing modest gains year over year like product line by product line across essentially all of our portfolio.

--------------------------------------------------------------------------------

Abe Landa, Stifel Financial Corp - Analyst [12]

--------------------------------------------------------------------------------

Okay, that's very good color. Kind of moving on to M&A, are you primarily focused on more tuck-ins or even focused on becoming more vertically integrated, like two of your larger competitors? I mean, owning your own supply base. Kind of what are you thinking on the M&A front?

--------------------------------------------------------------------------------

Lee Jacobson, Nesco Holdings, Inc. - CEO [13]

--------------------------------------------------------------------------------

I would say first off, we are really committed to a rent-to-rent business model. And so that would take us out of vertical integration into heavy manufacturing of significant equipment product lines. If you look at our gross profits, you look at our EBITDA contribution, it sure makes sense to us to be in the rental business versus the heavy plant intensity, the manpower requirement of being both a manufacturer and, oh, by the way, a rental business secondarily.

Most of our acquisition opportunities will come in the form of fleet tuck-ins. And there is a significant pipeline of the small- and medium-size types transactions we have seen. And that is where our expectation would lie over the next several years in similar deals, tucking those businesses in. And they are tremendously accretive typically; not extraordinarily high multiples and awesome synergy opportunities.

--------------------------------------------------------------------------------

Abe Landa, Stifel Financial Corp - Analyst [14]

--------------------------------------------------------------------------------

Just a follow-up to that. Is that focus more on the T&D side or telecom/rail or all of the above?

--------------------------------------------------------------------------------

Lee Jacobson, Nesco Holdings, Inc. - CEO [15]

--------------------------------------------------------------------------------

Really all of the above. It will be really focused on where can we find appropriate pricing and outstanding synergies. Because we really do look at our fleet as producing awesome asset-level returns, we ought to have strategic gain as well as good pricing and good synergies in any M&A opportunity to really take a look at it, given the option of organic investment in fleet.

--------------------------------------------------------------------------------

Abe Landa, Stifel Financial Corp - Analyst [16]

--------------------------------------------------------------------------------

And my last question is just around the 5G opportunity. Are you currently in contract with any kind of -- some of that early work that I think is coming on later this year or late this year? I know it tends to be more of like a 2020, 2021 event. Have you had any discussions with contractors about any efforts around 5G? Have you signed anything, etc?

--------------------------------------------------------------------------------

Lee Jacobson, Nesco Holdings, Inc. - CEO [17]

--------------------------------------------------------------------------------

It really is a discussion point at this time. I will give you -- I believe, as you do, it's going to be a 2021 event. But just the other day we secured a 65-, 75-unit commitment on small cell. Fundamentally, small cell is 5G and so it's the same sort of activity as the telcos take advantage of existing servicing capability. And we all wait for 5G to actually become economic activity in our market.

--------------------------------------------------------------------------------

Abe Landa, Stifel Financial Corp - Analyst [18]

--------------------------------------------------------------------------------

Great. Thank you very much for taking my questions this afternoon.

--------------------------------------------------------------------------------

Operator [19]

--------------------------------------------------------------------------------

There are no further questions at this time. I will turn the call back over to the presenters.

--------------------------------------------------------------------------------

Lee Jacobson, Nesco Holdings, Inc. - CEO [20]

--------------------------------------------------------------------------------

Okay, thanks very much, everyone, for participating today. We look forward to your continued engagement with the Company and investment. This concludes our call today. In the interim, should you have any questions, Noel Ryan is our investment -- investor relations; can be reached at investors@nescospecialty.com. Thanks again for joining us today.

--------------------------------------------------------------------------------

Operator [21]

--------------------------------------------------------------------------------

This concludes today's conference call. You may now disconnect.