Custom Truck One Source, Inc. (CTOS) Earnings Call Transcript

Awesome. So shifting to the new equipment side. There's a regulation coming, NOx regulation, a lot of back and forth around whether there's going to be prebuy, whether NOx goes through, doesn't go through. So is any of that baked into your guidance, any prebuy? Do you expect NOx to go through in its original form? What does your guidance assume?

Yes. We're in listen closely mode is how I would describe kind of our view on NOx, right? It feels like there's a lot of discussion of will it be in effect for 2027. And it feels likely that it will be, but it could be a little bit later, right? So I think timing is probably more of a question than the regulation itself. And so it feels like right now, our chassis OEM providers are asking for orders. So it's not kind of indicative of a prebuy yet would be how I would answer the question. And so we're watching that regulation. And we're also watching the ACT regulation, too, which is more around electrification, but also has some implications for chassis that we can sell into certain states as well. So we're in listen closely mode and react because we have such a good relationship with our chassis OEM partners to be able to pivot quickly. But I would say in our guidance, we are not expecting much, if any, kind of prebuy. It feels like it could be at the very end of this year and potentially into next year. And until I think the EPA makes a final ruling there, I think there's a lot of people who are in a wait-and-see mode on what will happen with both the low NOx regulation and the ACT regulation related to electric trucks.

And going back to the tariff comment, we've seen some third-party studies reports that came out and said, if tariffs go through, it could potentially raise the price of a truck by somewhere between 5%, 10%, 15%. That's a decently large sticker shock. So from your perspective, you're more vocational. So yours could be even higher. So are you having those discussions with customers that, look, if these tariffs go through, we may have to raise pricing. This is what the cost burden would be?

Not yet would be my answer, right? So we were -- I was talking to our heads of commercial today about that, and that's not a discussion, right, that we're engaging in. Again, I think having 9 months of inventory or $1 billion of trucks on the ground gives us some time to figure out how this really will play through. It's a similar story to the -- excuse me, the low NOx regulation, right? They're talking about a $25,000 to $30,000 increase in the cost of the Class 8 chassis related to the low NOx requirements. And so I think our customers are aware. I think our customers haven't quite processed all the way through what's going to happen and when is it going to happen. More importantly, I think Custom Truck is well positioned because of the rental fleet also. And so I think those are all things that might make people more interested in renting. If the cost of the truck is x more for tariff and then y more for low NOx requirements. I think that's where we think the one-stop shop of being able to pivot between the two, becomes really compelling from a company perspective.

Understood. Before I move on to my next question, if anyone in the audience has a question, raise your hand and we'll get the mic. I think we have a question here.

Going into the trough, shall we say, in the last 18 months, one of the factors cited on a number of occasions was the inability for utility customers to get financing, to secure financing and/or they're waiting for better financing rates. So now that, that business is kind of on an upswing, have they effectively resolved that problem? And how did they do that because it appears that financing rates haven't necessarily dropped?

Yes. I think what we're watching closely there are rate case approvals, right? And so how are their rate cases being approved, and we're seeing that more of those have been approved, which means that they're then deploying their contracts to their customers -- their providers, which are our customers, to the contractors. So it feels like that is kind of where that unlock has happened. The other big unlock that we've seen that we've talked about there is some of the regulatory unlock of getting some of these transmission jobs, in particular, moving, and it feels like that piece is also moving. And then I'd also highlight their supply chains, right? So there was a lot of discussion a year ago talking about how their supply chains weren't ready or their product wasn't on the ground. It feels like that process of what we called mobilization and then demobilization has also been corrected where they have the product they need to begin construction. So less specific to the financing question, but all those 3 were the other 3 things we talk about kind of in that context.

All right. Very helpful. Second one is, just in terms of the L.A. rebuild, how do you think about that? Or how do you -- what are they talking about in terms of what that could mean for your business and related kind of infrastructure?

I would say for our customers, it's still early days, right? There's a lot of cleanup, obviously, that's happening out there. We are seeing some dump truck in some of our roll-off truck activity happen. The feedback we're hearing from the ground is that it is space constrained. And so it's not even a lot of roll-off work. It's a lot of dump truck work that's happening out there to clear some of the areas that were most impacted. So I'd say it's still early days from our customers, they all expect that it will be work and that they are well positioned to do that work, but it's still early days in terms of planning it.

Any other questions? So I'll keep going. If anyone has, just raise your hand. U.S. mega projects, that has been a theme -- investment theme for about 2, 3 years now. And with the change in administration, we've heard some headlines that some funds could be diverted away from, let's say, the CHIPS Act. And so 2-part question. Where do you see this mega project, where we are in that cycle of mega project spend? And secondly, how is your product portfolio positioned to take advantage of mega project spend over the next few years?

Sure. Yes. We always think about the CHIPS Act and the IRA and the IIJA kind of all in that same construct. And I would say that our business is most aligned to the dollars that were being approved and are being allocated in the IIJA, which I think is the least at risk, maybe is the right way to say it of those 3 federal stimulus bills. So we think about half of the IIJA has been allocated. And of that, that's been allocated about 2/3 or so is in process. And so we see that as kind of good tailwind for some of our end markets when you think about roads and bridges and certainly some on the transmission and distribution side related to that there. And so I think that's where Custom Truck product portfolio is most aligned and where our customers are most focused. And I think that's where we're benefiting the most, less so from the CHIPS Act, like there's not a -- of course, there's some secondary or tertiary kind of connections there, but it's less of a direct spend based on the types of trucks that we have.

And in terms of your product portfolio, do you see the bulk of the demand, let's say, during groundbreaking or during the middle of the project or toward the tail end, when does the demand for you come in?

Sure. So I think it depends on the type of project that we're talking about. And so if we're talking about a major transmission line, I think there is some of our equipment that's required at the beginning. The bulk of it is, I'd call it, in the middle to end portions of that project. So some of -- as they're setting up laydown yards and they're doing some of the ground clearing or pad formation work, I think there are some of our dump trucks and roll-offs and heavy haul tractors that are being used. And then as they're going vertical with transmission structures and then obviously, lines, that's where our equipment is much more necessary. And so it is kind of middle to late stages on projects like that.

That's very helpful. And we always talk about specialty rental versus general rental. General rental has a higher penetration in the U.S. than specialty. Is there a structural reason why specialty penetration for rental should be lower than general and people would rather own than rent? Or do you think over time, specialty can also get to that higher penetration as general rental?

Yes. I think it's a great question, and it is kind of -- it's structural to our end market. I think if you think about utility and transmission and distribution, today, the majority of the equipment is still owned by IOUs or power-producing entities. And so they are less likely to rent. We do rent some equipment to IOUs, but obviously, they're factoring that into their capital plans and into their rate cases. Who is renting are primarily contractors. So we talk about utility contractors own about half of their fleet. They rent about half of their fleet. That's a broad generalization, and there's people all around kind of that number. But I think as contractors perform more of the work for IOUs or as more of the work is outsourced to contractors, I think you'll see kind of the universal rental fleet or kind of universal penetration continue to increase. I think it will -- could easily be less than where GenRent rent is today, but I think there's still plenty of room to increase penetration, right there over time.

So I get this question from investors quite often, especially investors who are relatively new to the Custom Truck One Source story. And the question is, if you look at general versus specialty rental growth of some of your -- the peers that are public, specialty has grown double digit versus general rent flat and down for some companies. And so when I think about CTOS, you're in the specialty market, but your growth -- your rental income has actually gone down last year. So how would you bridge that disconnect of your performance versus some of the others out there?

Yes. A couple of thoughts. I think it's a great question. I think last year is the exception. And if you look at how the rental fleet has grown over the last 5 years or the last 10 years, right, that I've been here, it's been a double-digit growth number over that time period. So I think last year is the exception. I think when we're looking at GenRent's talking about their specialty fleet, too, I think a lot of that has been acquisition, right, as you're thinking about the last couple of years in those cases. So I think that's a big difference. And then I don't think anybody else has a utility-focused specialty rental fleet. And so to me, you really have to begin to isolate to T&D and what's going on with T&D. And while there are great macro tailwinds, there was this air pocket or lull that we talked about for the first 2 quarters of last year that I think really is the reason. But I think getting back to, as Chris said, kind of growing the fleet at kind of mid-single digits from a growing the size of the fleet standpoint, thinking about improvements in utilization and improvements in rate, I think you get right back to those numbers fairly quickly.

Got it. Let's talk about used equipment. We've heard other rental companies talk about pressure in used equipment sales gains after very strong gains they've seen in 2022, 2023. And from your perspective, what is your view of the used equipment market? Are we done with the correction? Could there be finally a stabilization or even inflection given if tariffs are put on, usually used equipment prices tend to go up. So what is your view of the used equipment market?

Yes. I think it's probably a good comparison just to GenRent rental, too. We don't see as much volatility as GenRent does either in terms of utilization or in some of the residual values or sales price on used equipment as they do. And so I think it's one of the things is that we have seen some decline, right? We give kind of a broad range of -- generally speaking, a 5-year-old asset is generally worth between 60% and 70% of our cost kind of after 5 years. And I would say the 70% is the high end of that bound and 60% seems to be the lower end of that bound. And so we have seen that pricing come back. We did see some of that last year in 2024. And I think we're feeling like there are a couple of pockets where that's starting to improve, and we expect that it will improve. And certainly, it's a beneficiary of inflationary tariff or of low NOx or of any of these kind of regulations that we see coming. Those should all be positive for residual values and for the used truck side of the business for sure.

Awesome. We are down to the last 5 minutes. Any questions from the audience?

Can you talk about the data center industry and the build-out as expected there? Is there a way to think about the impact that may have on your business?

Yes. I think -- I put data centers in one of those great tailwind categories. So there's -- and I kind of call it more of a secondary tailwind than a primary tailwind. So more demand, obviously, is good for our business, it's good for our customers. I mean, technically, our customers, there is some distance, right, that our customers will be adding line or bringing power right to the data center. But I think of it more of just a really good kind of long-term demand driver for the amount of power that needs to be produced.

Any other questions? Over there, we have one over there.

Yes. Just curious to get your sense on how much of the IIJA dollars and those tailwinds have actually kind of flown through versus what you expect over the next several years?

Yes. Yes. I mean it's -- I wish there was an easy tracker on that. I think the best tracker that we've tracked is about half of the IIJA dollars have been allocated and then about 2/3 of that has been spent or is in process. So we're still kind of -- we -- I think on the call, we said middle innings, and so that's kind of what we meant by that is we seem to be somewhere along those lines.

Any other questions? So I wanted to ask about M&A and leverage. So any thoughts on M&A and also thoughts on your leverage profile where you wanted to get to over the next 12, 18, 24 months?

Yes. I think the way I would characterize it is certainly, there's a lot of attractive opportunities out there. We're not currently pursuing any of them. Deleveraging is definitely a priority for us. As we said, our goal is to get below 4x leverage this year and then 3x next year. Having said that, we do have liquidity. We have over $350 million available on our ABL and then another $160 million of suppressed availability. So if a very strategic acquisition were to come along, certainly, it would be something we would consider. And historically, we have had no issue and felt comfortable managing the business at this leverage level.

We didn't talk about the parts segment. So what's the strategy there? What do you think is the growth algo of the parts business for you? And where do you -- is there any new initiatives strategies that you're taking on to accelerate the growth of that business?

Yes. I'll start. Look, parts, the aftermarket parts and service business has been something that since we merged with Nesco, we realized we needed to use the service locations in particular, to primarily take care of now rental fleet. They've doubled when we did the merger with Nesco back in 2021. So I think our guide is less revenue growth in the APS segment. I would say there are 2 things, though, Tami, that we're starting to get some momentum on. The first is proprietary parts. So as we've started to manufacture more of our product, there's a lot more proprietary parts where distribution is becoming more important that I think will be a growth lever for us this year and really heading into the future, and then we're also starting to now stock the trucks that we sell with parts, tools and accessories more, and I think we did something like 700 trucks last year that we sent out, which was up meaningfully. And so we see that as another easy adjacency to selling trucks is that our customers need their trucks tooled up to be able to go to work on the job site. And so those to me are the 2 areas initially that we're focused on. We'll come back around and think about how do we improve our service offering for our sales customers. We know that's on kind of our couple of year road map, but it's nothing that we'll make any strategic moves on in the near term.

Awesome. Any other questions from the audience?

Maybe one quick one on cash flow, working capital. I think in terms of increasing free cash flow, working capital reduction has been part of the strategy. I think that's expectations going forward. How could that be impacted in any way given the tariff and holding higher inventories that you talked about?

Yes, I didn't hear the last part. But in terms of the tariffs and holding inventory, you thought that was a mitigation. How does that impact the working capital reduction expectations this year? It could impact it, but it would be within the range that we've given kind of for our target. And just because we're running out of time, in terms of net working capital reduction, I think we gave a target of $50 million to $100 million of levered free cash flow, and the working capital reduction by coincidence would be roughly the same. So we're expecting to get about $50 million to $100 million out, which would be further inventory reduction largely.

Awesome. Any final thoughts before we call it?

No, thank you for having us, Tami. We appreciate it, and thank you for all the questions.

Of course. Thank you so much, everyone, for joining.