Ladies and gentlemen, thank you for standing by and welcome to Custom Truck One Source Second Quarter 2023 Earnings Conference Call. Please note that this conference call is being recorded. I would like to hand the conference over to your host today, Brian Perman, Vice President of Investor Relations for Custom Truck. Please go ahead.

Thank you and good afternoon. Before we begin, we would like to remind you that management's commentary and responses to questions on today's call may include forward-looking statements, which by their nature are uncertain and outside of the Company's control. Although these forward-looking statements are based on management's current expectations and beliefs, actual results may differ materially. For a discussion of some of the factors that could cause actual results to differ, please refer to the Risk Factors section of the Company's filings with the SEC. Additionally, please note that you can find reconciliations of the historical non-GAAP financial measures discussed during the call in the press release we issued today. The press release we issued this afternoon and our quarterly investor presentation are posted on the Investor Relations section of our website. We filed our second quarter 2023 10-Q with the SEC this afternoon. Today's discussion of our results of operations for Custom Truck One Source Inc. or Custom Truck is presented on a historical basis as of or for the three months ended June 30, 2023 and prior periods. Joining me today are Ryan McMonagle, CEO; and Chris Eperjesy, CFO. I will now turn the call over to Ryan.

Thanks, Brian. And welcome, everyone, to today's call. I'd like to begin by thanking all of our employees, customers and suppliers who continue to support our business and helped us deliver another strong quarter. The entire Custom Truck team continues to deliver record levels of production, which enables us to continue to grow our rental fleet to meet continued strong demand for new equipment and to fulfill our goal of providing unrivaled service to our customers. For the second quarter of the year, we delivered strong year-over-year revenue, adjusted gross profit and adjusted EBITDA growth. We generated $457 million of revenue, $154 million of adjusted gross profit and $103 million of adjusted EBITDA in Q2, up 26%, 22% and 21%, respectively, versus Q2 2022. Our second quarter results align with our expectations that our business this year would reflect the benefits of moderating inflation, improved supply chain performance and continued operational excellence. Demand remains strong in each of our strategically selected end markets: utility or T&D, telecom, rail and infrastructure. These markets continue to offer compelling long-term growth opportunities well in excess of GDP, which we believe should continue for the foreseeable future. The reported backlogs of the utility and telecom contractors, our largest customer base, continue to be good proxies for this sustained growth and remain at or near record levels. We see continued strong demand in our own new sales backlog and in the performance of the rental fleet. Additionally, in the second quarter, we continued to experience strong demand from our customers to purchase assets in the rental fleet. We see all of these as positive leading indicators for sustained future demand. The rental segment experienced 16% revenue growth year-over-year. We continue to see strong demand for rental equipment and we remain focused on rental pricing and…

Thanks, Ryan. Q2 was another very strong quarter. End market demand remained strong resulting in total revenue of $457 million, up 26% compared to Q2 2022. Adjusted gross profit was $154 million, up 22% compared to Q2 2022 resulting in an adjusted gross margin for the quarter of 34%. Adjusted EBITDA was $103 million, a 21% improvement compared to Q2 2022. Adjusted gross profit and adjusted EBITDA growth lagged revenue growth largely as a result of segment revenue mix. While all of our segments experienced year-over-year growth, rental asset sales and TES revenue, which have a lower average gross margin associated with them than our equipment rental business, comprised 66% of total revenue in Q2 2023 versus 60% in Q2 2022. SG&A was $58 million for Q2 or 12.7% of revenues, an improvement versus 13.5% in Q2 2022. Net income for the quarter was $11.6 million, the third consecutive quarter of positive net income. Ryan referenced our continued strong performance within our ERS segment for the quarter, utilization was just under 82% and average OEC on rent increased by more than $53 million compared to Q2 2022. On rent yield was over 40% for the quarter compared to just over 39% for Q2 2022. We continue to see the benefits from previously announced pricing actions implemented since the beginning of last year. Our OEC in the rental fleet ended the quarter at $1.47 billion, up by $68 million versus Q2 2022. Consistent with our expectation, we had continued strong investment in our rental fleet this quarter with net CapEx of $50 million. We expect to continue to invest in the fleet during the second half of the year. For Q2, ERS rental revenue was $118 million, a 9% increase versus Q2 2022. ERS used equipment sales for Q2 remained strong…

[Operator Instructions] The first question comes from Michael Shlisky with D.A. Davidson.

Can you go back and explain again the utilization being down quarter-over-quarter? I wasn't sure I caught the flotation, could you just give more detail? Did you imply that the customers that didn't have the supply chain for the things that they put on to their equipment? Or I guess I would normally expect it to be a little bit warmer outside so just higher utilization. Just give a little more of a narrative as to why it went down quarter-over-quarter?

Sure. Mike, it's Ryan. You're right, utilization did decline a touch from Q1 to Q2. It's still kind of at very strong levels of 81.7% for the second quarter. Normally there is just a touch of seasonality in the second quarter too so that's a pretty normal decline that we see. And then what we did see this year is that some of the distribution equipment, we saw utilization fall a bit in distribution equipment. We're seeing it return now later into August so we're seeing it pick back up. And the explanation we're hearing from customers is really around availability of their supply chain so things like transformers in particular. So I think it's a onetime issue and it will continue to come back and again it's at 81.7%, which is if we hadn't been running in the mid 80%s, we would say it's as good as it gets really from a utilization standpoint. So still feel really good about it. And then we expect transmission equipment will pick up kind of to your hot comment. Transmission will pick up here as the heat breaks and as some of the new transmission work begins, which typically happens right after the end of the summer.

Got it. I wanted to turn to truck chassis supply. The broader Class 8 outlook for 2024 truck production is still down and that includes both vocational and cargo. I can understand cargo being down, but it sounds like you've got such great tailwinds in your end markets that we'll see vocational trucks to be up, at least that's what you'd like it to be. I guess could you give us some thoughts as to how you feel about chassis supply for next year if the trajectory of the way things are going now continue also in the next couple of quarters?

It's a great question. We're still seeing constrained supply chain, right? So it's not wide open that we're able to receive as many chassis as we'd like, but we are seeing our chassis flow increase. So that's why you see TES revenue in particular is up as much as it is in the first half of the year. You're also seeing that we've deployed more capital into the rental fleet in the first half of the year too because truck supply chain is up. I guess where we look forward a little bit is when we're able to deliver the growth that we have in TES and see backlog continue to grow from the beginning of the year and even quarter-on-quarter. We think demand will obviously remain very strong into next year. And right now in our conversations with our chassis partners, we're anticipating that we should see more chassis next year. How many more chassis is somewhat to be determined and we do think it will still be a constrained supply chain, but we do think that we'll see a larger allocation heading into next year as well.

The next question comes from Tami Zakaria with JPMorgan.

So my first question is your ending OEC came in somewhat below what we were modeling and you're expecting mid to high single-digit growth for the year. So can you help us understand are you expecting to scale back equipment sales versus the first half or accelerate asset purchases to get to that mid to high single-digit percent number?

Tami, this is Chris. As we said, it would be mid to high single digits. That still is our plan. We still expect to get there. We're somewhat flexible in terms of gross CapEx versus some of the sales and so there could be some movement. I think previously we've given guidance that we expect to spend over $400 million on gross rental CapEx. That's still our plan and it's still our plan to grow in the mid high single digits.

Got it. That's helpful. And then the other question I have on rent yield, you saw a sequential tick up. Is that mostly pricing benefits flowing through? Should we expect this to continue to tick up until you lap some of these price increases?

I think that's fair. Yes, that would be fair to say, Tami.

Okay. So we should be modeling like sequential growth in 3Q and 4Q as well?

Tami, it's Ryan. It takes about a year, right, for the whole fleet to turn in terms of new pricing and obviously depends on utilization and some specifics. But yes, I think right now we're still seeing kind of the benefits of price flow through in terms of that on rent yield metric. So we think it will continue to pick up a bit in the second half of the year.

The next question comes from Justin Hauke with Robert W Baird.

I wanted to ask about the ERS segment guidance for the second half, which is implying even at the high end kind of flat revenue growth for the second half and that segment is always hard to kind of model because it's got the rental component and then the sales component and I know you had some kind of unusual sales activity last year that makes some difficult comps in there. But maybe just thinking about the seasonality between 3Q and 4Q and I guess how we should think about maybe the sales component of that business in particular.

I think you summarized it pretty well. It is going to be a tough comp versus last year. We talked a little bit about the utilization, the decrease in utilization we saw at the end of the quarter leading into Q3. And so there are some components there that clearly are a little more difficult to predict, in particular the rental asset sales. But I think you summarized it pretty well in terms of our thinking.

Okay. Any comment on just the sequencing of 3Q versus 4Q in terms of the difficulty in the comps?

I don't think we expect. We talked earlier in the year in terms of how the year typically plays out. So our expectation coming into the year, both revenue and EBITDA was 45/55 split. We think that's narrowed somewhat first half versus second half. Q4 tends to be the strongest, we continue to expect that to be the case. So I don't think any updated guidance there in terms of what our expectations are.

Okay. And then I guess my second question is just on the free cash flow. One of the biggest drags that you've had year-to-date has been the inventory investment on the working capital side, which makes sense, that's steadily increased really every quarter sequentially and it makes sense because you're growing. But is that a release of free cash flow in the back half as maybe some of the really high sales activity kind of moderates? I'm just trying to understand what the moving pieces are for free cash flow in the second half.

Yes, we certainly would expect in Q4 that you would see that. We're in a position where with all the growth, we're happy to have the chassis, we're happy to have the attachments. So it's a situation where just 18 months ago we were in a much different position. So we feel very good about the level of inventory we have certainly as we look out to 2024. But to your comment, we should definitely see improved cash flow in the second half of the year and certainly in Q4.

The next question comes from Scott Schneeberger with Oppenheimer.

If we could, could we talk about the guidance increase, Chris? What was the outperformance in second quarter that you factored and then what were your considerations in the back half? I think a lot of the prior questions have gotten at this point, but can you tie it all together about how you factored in the second half guidance particularly with regard to EBITDA?

Yes. I'll maybe just start on revenue. We've seen a significant improvement in terms of our inventory flow which has allowed us, as Ryan talked about, certainly to have record quarters on new equipment sales and deliveries and so we expect that to continue in the second half of the year. So that's part of it. You saw a pretty significant increase on the revenue there. We've continued to see strong utilization, strong demand for rental asset sales so we took that into account. The reason you're not seeing it all flow through on the EBITDA is because we're also seeing with the increased inventory with higher rates, increased costs with respect to floor plan. So there's a little bit of not the flow through you might have expected and that's why you're seeing the $5 million on the lower and top end on EBITDA and a little bit higher on the revenue -- on the higher revenue and higher EBITDA range with the higher commissions and higher bonuses paid. And so we took all that into account as we updated the guidance.

Okay. And could you talk a little bit about rental versus sales decisions as you are seeing the supply chain open up a good bit? Just how you're feeling? It sounds like you're feeling good about getting what you want -- most of what you want maybe not all of what you want, in the back half of this year. Maybe a comment on that. And then on how you're allocating sales versus rental, the decision process there.

Scott, it's Ryan. You're right. We are seeing improvement, right, and so we're able to able to increase rental OEC what we're putting into the fleet, which is what you see relative to last year. I think it's about a $50 million increase versus last year on a year-to-date basis and that's why we aren't able to sell because we're selling into so much backlog too. So look, we obviously allocated $1 to a rental asset kind of on the margin where we can, but right now it's just about taking care of the customer. And even with kind of the pace of new sales that we've realized really in the last two months -- sorry, the last two quarters, we're still seeing backlog grow, right? So there is still more demand out there that we're trying the best we can to take care of both and obviously do that prudently and we'll continue to do that in the back half of the year as well.

All right. One more from me if I could. Could you just address your primary end markets, what you're seeing good and bad? And as a kind of a 1b part of the question. Are you seeing anything associated with the infrastructure bill yet? It doesn't seem like the funds are flowing or there's a lot of project allocation. What are you seeing on that front?

Great question. We're still seeing really good demand on transmission and distribution. We're hearing more about transmission jobs that are being awarded. We are -- so still a really good kind of macro landscape that we're playing into and we're seeing a lot of distribution work that needs to be done. The only constraint that we're hearing about now is their supply chain. So as they're waiting for transformers or conductor that it's just taking time, right, to get that equipment to be able to work. So that's the only constraint that we're hearing. We think that's temporary, but that's the constraint that we're hearing. When we look at positive indicators and we mentioned that we're still seeing strong RPO buyouts, real asset buyouts in both of those categories. So we take that as a really positive indicator and we're continuing to see that into the beginning of Q3. And so we're seeing a good dynamic there, which we certainly feel like there's a bullish run that will continue on both sides on transmission and distribution, which is the largest end market. And then related to the IRA question, I would agree with what you said that we are hearing about dollars being allocated. We are having some discussions now and seeing in our backlog maybe a little bit on the vocational side of things so some of the specialty dump trucks and that type of equipment. We're starting to see some of that that we think is IRA related. But I would say that it's very little revenue still at this point, but we're starting to see a little bit of it show up in backlog. So we think that's again just more tailwind for why backlog will continue to perform well and why we'll be able to deploy capital into the rental fleet as well.

The next question comes from Nicole DeBlase with Deutsche Bank.

Maybe just starting with a follow-up on the utilization discussion. So with the I guess delays that you're seeing with distribution, do you think that that's a quick factor where you kind of see utilization kind of snap back in the second half or do you think it will take time for that to kind of work its way through?

Yes, I think it will gradually improve. We think you have two dynamics playing there. You'll have distribution kind of gradually improve, which is what we're already seeing so far in the third quarter and then on the transmission side, you'll see the pickup that normally happens that we are still anticipating for later this summer, early fall. So you'll see both of those continue to pick up like we normally see in the third quarter.

Okay. Got it. And then with respect to the TES backlog, can you just speak to where lead times stand now and if those have come down at all?

So total backlog where it is almost four quarters even looking at kind of where the Q2 sales number was. So it is still higher than we would have expected more than it would be historically, maybe I'll say that, and we are seeing lead times continue to push. So we are largely on order for a good portion of next year when it comes to our key attachment suppliers and the same is true on chassis as we're talking about full year allocations and just waiting on final numbers to begin to put those units on order too. So again it depends by product category and in the aggregate we saw backlog build and the majority of product categories build in the second quarter. There were a few that we saw some modest declines, but those were already in product categories where backlog is elevated. So we are still seeing really good overall demand across all the product categories.

[Operator Instructions] The next question comes from Tim Thein with Citigroup.

Maybe just one quick one on your telecom customers. I'm just curious if they -- certainly there's been a lot in the press around these potential [lead] cable issue and I'm just curious if that -- and who knows what the potential costs could be to remove or remediate these cables. I mean do you think that impacts at all their capital decisions as they kind of ponder what could be a bigger outlay? Does that impact Nesco in any way do you think or just TBD?

Tim, I'd say TBD. Telecom is less than 5% of revenue and backlog is still there and we've still been delivering. So it's not anything that's come up in any significant way in any of our conversations with our customers, but obviously it's in the news so we're watching it closely. But it's nothing that's come up to this point.

Okay. I appreciate that the significance or lack of you guys, I'm just curious if that bleeds into other areas of the business, but I don't care as much. And just on the TES backlog and given the growth there and given how long it extends, is it too early in terms of your discussions with suppliers as you look into '24, presumably the uncertainty around inflationary cost pressures I would imagine have abated. But how are you approaching that in terms of how you price these new orders relative to a backlog that continues to extend and just making sure you're keeping the -- the question relates to basically the gross profit and the backlog and how you're approaching those pricing decisions in what I would imagine is still kind of an uncertain cost backdrop?

Yes, you're right. We're still working closely with suppliers in terms of understanding costs so that we can price appropriately. But I think we mentioned it a few calls ago that we have the ability to reprice the backlog as we need to and so when we see significant -- so we're using our best estimates and we're communicating that to the customers. But when we see a significant price increase come through, we're obviously going back to our customers and talking through that with them. So it's something we're very aware of and we'll continue to manage closely.

This concludes the question-and-answer session. I would like to turn the conference back over to Ryan McMonagle for any closing remarks. Please go ahead.

Thank you. Thanks, everyone, for your time today and your interest in Custom Truck. We look forward to speaking with you on our next quarterly earnings call. And in the meantime, please don't hesitate to reach out with any questions. Thank you again.

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.