Herc Holdings Inc (HRI) 2022 Q3 法說會逐字稿

(technical difficulty) page of our IR website at irhercrentals.com. Today, we're reviewing our third quarter results with comments on operations and our financials, including our view of the industry and our strategic outlook. The prepared remarks will be followed by an open Q&A.

Now let's move on to our safe harbor and GAAP reconciliation on Slide 3. Today's call will include forward-looking statements. These statements are based on the environment as we see it today and therefore, involve risks and uncertainties. I would caution you that our actual results could differ materially from our forward-looking statements made on this call. You should also refer to the Risk Factors section of our annual report on Form 10-K for the year ended December 31, 2021.

In addition to the final results presented on a GAAP basis, we will be discussing non-GAAP information that we believe is useful in evaluating the company's operating performance. Reconciliations to these non-GAAP measures to the closest GAAP equivalent can be found in the conference call materials.

Finally, a replay of this call can be accessed via dial-in or through the webcast on our website. Replay instructions were included in our earnings release this morning. We have not given permission for any other recording of this call and do not approve or sanction any transcribing of the call.

This morning, I'm joined by Larry Silber, President and Chief Executive Officer; Aaron Birnbaum, Senior Vice President and Chief Operating Officer; and Mark Irion, Senior Vice President and Chief Financial Officer.

I'll now turn the call over to Larry.

Thank you, Leslie, and good morning, everyone. Before we get started today, I want to take a minute to recognize Elizabeth who, as was mentioned, after nearly 7 years with Herc, has elected to retire next year. Until then, Elizabeth will continue shepherding our ESG strategy and further developing and executing our corporate sustainability initiatives.

On behalf of everyone at Herc, I want to thank Elizabeth for her commitment to building our IR function and for her many contributions to our success over the years, including managing our relationship with all of you. Elizabeth will be listening in to today's call but will not be directly participating.

As Elizabeth narrows our focus, I'd like to welcome Leslie to our team. I've had the pleasure of working with Leslie in the past, and I know she will be a great partner to the investor and analyst community.

Now let's go ahead and get started on Slide #4. We I'm pleased to report another strong growth quarter that reflects strong organic growth across all of our regions as well as contributions from our expanding branch network. I'm incredibly proud of our financial and operating performance. Third quarter total revenue, rental revenue and adjusted EBITDA were at all-time quarterly highs for the company.

In addition to an unwavering focus on managing rapid same-store growth from our existing locations, we completed the acquisition of 7 companies in the third quarter, adding 12 more locations, which brings the year-to-date total to 16 companies and 24 new locations. You'll recall, our acquisition strategy helps drive revenue, scale and operating leverage by increasing fleet and locations in and around targeted urban markets.

Through the end of the third quarter, we have spent $441 million in support of our acquisition strategy and have a solid pipeline to fill in the balance of our $500 million annual target. Additionally, we opened 7 greenfield locations in the third quarter, which brings the year-to-date total to 17.

The winning combination of targeted M&A and greenfields in high-growth markets will continue to drive our strategy to sustain growth and to expand market share as we solidify our position as one of the leading rental equipment companies in North America.

As you saw in our press release, based on third quarter results trend and our outlook for the rest of the year, we updated our 2022 guidance for adjusted EBITDA to $1.22 billion to $1.25 billion, which implies a 36% to 40% increase over our 2021 results. We also tightened our guidance range for net fleet capital spending. Mark will share more on our outlook in a few minutes.

When it comes to capital allocation in the third quarter, we repurchased in excess of 0.5 million shares of our common stock at an average price of about $109 per share. Given our operating performance and long-term growth prospects, we believe our stock price implies a discounted valuation to our real work.

We intend to continue to take advantage of this price [imbalance] to enhance our return to shareholders longer term while maintaining debt levels within a targeted range of 2x to 3x net leverage. Now let's move on to our financial highlights.

Slide #5 shows the third quarter results over the last 5 years. Our third quarter results demonstrate the continued momentum and sustained growth as we focus on executing our shift into high gear strategy. Equipment rental revenue increased 36% over the prior year, driven by robust performance in our core business, growing market share from higher-margin specialty businesses and the contribution from acquisitions.

Total revenues grew 35%, impacted somewhat by lower sales of used equipment, a decision that we made to continue to meet customer rental demand as we continue to experience tight supply of new equipment related to supply chain issues from original equipment manufacturers.

Adjusted EBITDA grew 40% over the prior year, with an adjusted EBITDA margin up 160 basis points to 46.3% in the third quarter of 2022, driven by the growth of our rental business and focus on operating leverage.

We are committed to providing excellent customer service and expanding our rental solutions to a broad array of customers and industries to achieve even greater success. This is an exciting time for team Herc, and we are especially pleased with the performance and the tenacity of our people.

That was never more evident than in the wake of Hurricane Ian over the past several weeks. We have teams on the ground and across the country, including new team members from our acquired branches, stepping up to support their Florida-based colleagues, the impacted communities and our customers.

Our people have worked tirelessly and under difficult circumstances to get equipment where it needed to be and to provide essential services. The planning, collaboration, responsiveness and execution, it's a true reflection of operational excellence. Our people are getting it done, and I couldn't be prouder.

But it's not surprising. With 57 years of history in the equipment rental industry, our 6,400 team members work hard to ensure our customers achieve optimal performance safely, efficiently and effectively every day.

Now please turn to Slide 6. Everything we do is built on our promise and our commitment to help our customers and communities build a brighter future. As of the end of the third quarter, we operated 351 locations across the United States and Canada in 42 states and 5 Canadian provinces.

As we add locations and employees to Herc Rentals, we are committed to ensuring that we focus on safety training and other programs to assist the new team members in their integration to our Herc culture. I'd like to personally welcome all of our new members who joined us in the third quarter through our acquired businesses. It's great to have you on board.

The addressable North American market size is estimated to be $61 billion and growing by about 13% in 2022, according to the American Rental Association. Every day, new mega infrastructure and other industrial and commercial projects are announced throughout North America. We intend to get our fair share of this new activity.

We expect to continue our momentum by addressing the opportunities in the market and outperforming the overall industry as we grow organically, supplemented by select acquisitions and greenfield operations.

And now Aaron Birnbaum will update you on our operational progress.

Thanks, Larry, and good morning, everyone. Our strong performance in the third quarter reflects the benefit of our strategic branch network expansion, the improved scale and diversity of our equipment fleet and our successful penetration into a variety of industry verticals.

These initiatives driven by the dedication and commitment of the entire Herc team are making a clear difference in Herc's growth trajectory. Moreover, secular growth trends further position us for sustainable long-term growth.

Now please turn to Slide #8. Our third quarter results reflect the opportunity we seized by accelerating investment in fleet, with average OEC fleet up 35% over last year's comparable period. Equipment rental revenue in the quarter increased 36% compared with the prior-year quarter.

Our regional leaders are doing an excellent job leveraging our expanded offering and entry into new markets to incrementally drive the top line, while capitalizing on the broad economic recovery across commercial and end markets.

Rate growth of more than 6% in the quarter helped to offset inflationary pressures, and our team successfully managed rising fuel costs through increased revenue recovery and equipment delivery and equipment refueling charges in the quarter. Our core business benefited from the continued strong demand for equipment across all our regional operations. And our ProSolutions business delivered double-digit growth year-over-year again in the third quarter.

As you know, ProSolutions offers targeted solutions that support mobile power and distribution, climate control, remediation and pump equipment. This is a fast-growing, high-margin business for Herc. We are capturing share here by capitalizing on cross-selling opportunities with new and existing core business customers and leveraging the increasing density of our branch network for faster response.

Our acquisition and integration activities are our core competency of Herc Rentals, and we are successfully building on new businesses towards growing the core and urban market strategies. I'm incredibly proud of this team's performance and the growth they are delivering for the company.

As Larry mentioned, they did an incredible job quickly mobilizing fleet and supplies in Tampa Bay ahead of Hurricane Ian and then responding immediately to meet the needs of our communities and customers in Southwest Florida in the aftermath of the storm.

On Slide 9, you can see our fleet composition at OEC on the left side of the page. Total fleet is now a record $5.4 billion as of September 30, 2022, 33% higher than OEC fleet at the end of Q3 2021. As you can see, specialty represents about 24% of the fleet and there's room to grow. Our total fleet expenditures at OEC totaled $311 million in the recent third quarter.

We continue to see strong project starts, and our sales teams are absorbing the fleet we purchased in the third quarter and quickly putting it on rent. We disposed the $54 million of fleet at OEC in the recent quarter, only about $10 million more than last year's third quarter, as we continue to be prudent in managing our fleet to meet strong customer demand and address supply chain constraints.

Proceeds from disposals were 43% of OEC, benefiting from stronger pricing of used equipment and an improvement in our sales channel mix, utilizing more of the retail and wholesale markets. The average age of our disposals was 94 months in the third quarter, and fleet age is now about 49 months.

Please turn to Slide #10. In addition to a best-in-class fleet, we have a diverse, well-balanced customer mix, made up of large national accounts and local contractors across all business sectors in North America with a wide variety of equipment needs.

Incremental rental growth is coming from initiatives to expand our local customer base to 60% of our revenues. In the third quarter, we achieved that goal. Specifically, investments in M&A and [core] fleet are driving this growth.

We are also focused on continuing to generate absolute growth in our national account business, while maintaining it at 40% of revenues. There are significant cross-selling opportunities between specialty and core accounts, and our greater branch network density allows us to service customers faster and with access to a broader equipment offering.

You can see that we have a lot of strategic initiatives driving growth. but we are also continuing to see macro opportunities from the solid demand in our end markets and the increasing number of new multiyear infrastructure projects being announced.

The secular trends on Slide 11, surrounding electric vehicle development, power grid modernization, renewables transportation and the reshoring of manufacturing fall closely aligned with our business offerings. Individual projects are gradually ramping up as both public and private funding are being put in place.

Moreover, many of the industrial projects being announced are in the geographies where we have focused our acquisitions in greenfield additions, such as Texas, Arizona, Toronto, Detroit and Chicago. The Southeast also has strong prospects.

We are closely monitoring these new project announcements in the field. The project provides solid visibility for upcoming [construction] starts and support our view of the substantial long-term growth opportunities in our markets. Our regional operations are primed and prepared to continue our growth strategy.

Please turn to Slide #12. Before I turn the call over to Mark, I want to emphasize that safety is always at the core of everything we do and we continue to focus on striving for 100% Perfect Days throughout the organization.

Our major internal safety program focuses on Perfect Days, that is paid with no OSHA-reportable incidents, no at-fault motor vehicle accidents and no DOT violations. In the third quarter, on a branch by branch measurement, all of our branch operations achieved at least 98% of days as perfect.

I'd like to thank our team Herc for their commitment to operational excellence and safety. Their professionalism shows up in the execution of our services to our customers every day. Now I'll pass the call on to Mark.

Thanks, Aaron, and good morning, everyone. The Herc team continues to execute our strategy, and we continue to operate in high gear as we maintain record performance in our key metrics in the third quarter of 2022.

The strength and momentum we are achieving bodes well for the rest of the year and into 2023 as we focus on fast profitable growth and continue to deliver improvement in the key metrics that create long-term value for our stakeholders. Strong demand in our end markets and the ongoing supply chain challenges of equipment manufacturers continued to provide a strong operating environment for our rental business.

As Aaron mentioned, we ordered early, so our new fleet is arriving at a steady pace throughout the year, and we have been putting the additional fleet to work, driving revenue growth.

Our operations team has done an excellent job maintaining strong time and dollar utilization in a fast-paced, high-growth environment while integrating new team members, customers and fleet into the Herc model. This consistent execution has led to sustained performance and strong momentum that will continue for the rest of '22 and beyond.

Slide 14 shows the summary of our third quarter results compared with 2021. Equipment rental revenue increased by a very impressive 36% to $706.2 million from $519.6 million in 2021, primarily due to continued volume and pricing momentum.

We are pushing hard on both our organic growth and acquisition strategies and enjoying a lot of success. Taking a look at the 36% rental revenue growth for the third quarter, about 2/3 of the growth was organic and 1/3 from acquisitions. This validates our ability to grow our core business.

Our organic growth is outpacing the market growth, and we believe we continue to expand our market share. Our successful acquisition strategy provides a nice supplement to our organic growth story and allows us to quickly bring on key rental talent and to penetrate key markets.

Our revenue growth is not only fast and impressive but profitable. We are delivering excellent results for our investors and creating long-term value. Adjusted net income in the third quarter of 2022 increased 42% to $103.4 million or $3.42 per diluted share compared with adjusted net income of $72.7 million or $2.38 per diluted share in the third quarter of 2021.

Adjusted EBITDA increased 40% in comparison to Q3 of 2021. Adjusted EBITDA margins were also a record for the third quarter, improving 160 basis points to 46.3% in 2022 from 44.7% in 2021. All in all, an excellent quarter. We achieved most of what we set out to achieve, and we are very happy with our margin expansion and flow-through.

We are lucky to have a solid inflation-resistant model and have grown fast and expanded margins in a challenging inflationary environment. All of this is manageable for Herc within the context of 36% growth in rental revenues. And as it's clear with our performance, we can invest in our business and in our people and continue to improve our adjusted EBITDA margin and investor returns.

On Slide 15, we highlight the momentum in our pricing and utilization trends by quarter. The graph on the upper left illustrates our success in managing price over the last couple of years and our ability to consistently drive rate growth. This is always an important metric to manage and is especially important when faced with cost pressures in an ablationary environment.

We have maintained momentum in pricing with year-over-year rates up by 6.2% in the current quarter. The current market environment of tight equipment supply and steady demand continues to support our focus on rate. We also benefit from our excellent pricing tools and the discipline and professionalism of our sales team.

The industry seems to be enjoying price momentum, and we are achieving success in the spot market with our pricing tool as well as with our larger national contract negotiations. Our track record of executing on price and all sorts of operating environments is clear. The momentum in our rates is clear, and we expect to deliver improved rates in Q4, which will result in strong momentum running into 2023.

Our OEC fleet size closed the quarter at about $5.4 [billion] , a combination of early ordering and savvy purchasing has contributed to the steady delivery of fleet in 2022, which is also supplemented by fleet integrated in conjunction with acquisition activity.

Our average fleet on rent at OEC in Q3 was up by 35% in comparison to average fleet growth of 35%. We have been receiving record amounts of fleet all year and have been efficiently putting it on rent. Dollar utilization dipped slightly in Q3, down 70 basis points to 45.3%. Dollar utilization in our core business continued to improve.

However, we had some tough comps in other parts of the business, which impacted dollar utilization a bit. The entertainment business has lost some momentum in the latter half of 2022, with a lot of studios recalibrating their spending from the boom in 2021 as well as dealing with COVID protocols.

In addition, we had some hurricane activity in Q3 of last year, which tends to drive utilization in the specialty business. The storm activity from Hurricane Ian will benefit Q4 utilization this year as Ian made landfall at the end of Q3.

We are targeting annual dollar utilization in the mid-40s and are on track for another year for improved dollar utilization in 2022 that moves us towards that goal.

Slide 16 summarizes the acquisitions we've made so far in 2022. We focused our acquisitions on high-growth markets that complement our current location network. So far, through the end of the third quarter of 2022, we've acquired 16 companies and 24 locations. We spent $441 million in net cash, with an average multiple of approximately 5.5x.

We see significant revenue synergies in most of the companies we acquire and over time, we can run the fleet and operations more efficiently, generating synergized multiples of approximately 4x to 4.5x.

On Slide 17, you can see we have no near-term maturities. As we announced at our Q2 Investor Call, we amended our revolving credit facility in July and have doubled the capacity to $3.5 billion and extended the maturity to 2027.

We've got ample liquidity to fund our growth goals for the remainder of 2022 and into the future as we commit capital to invest in our business and drive fleet growth into the new cycle.

Net capital expenditures exceeded cash flows from operations in the third quarter, and we reported negative cash flow of $252 million before acquisitions.

The timing of fleet deliveries and the terms with our suppliers usually puts a drag on working capital in Q3 as we pay for fleet delivered during the year. We are continuing to take deliveries and are taking as much fleet as we can get our hands on.

Our volume growth of 35% shows that we are putting it out on rent as soon as it hits the yard. Our leverage remains conservative, and our current leverage of 2.4x is in the middle of our target range of 2x to 3x. We also continue to pay our quarterly dividend at $0.575, a rate which implies an annual payout of $2.30 per share.

The ARA forecast of 2022 North American rental industry revenue is steady at $61 billion, with 13% growth now forecast for 2022 and 5% for 2023. Clearly, there is some strength to the current cycle, despite all the negative sentiment around recession risks. Our 36% rental revenue growth is clearly eclipsing the broader industry growth rate, with [year] focus on the top line of our organic -- or our organic growth rate that is over 20%.

We look to have much more momentum than the industry in general and are taking market share. Two of our key end markets are industrial spending and nonresidential construction, and both have solid growth forecasts in 2022 as well as for 2023. Combined, these end markets reflect about 2/3 of our customer base, and both are likely to outperform other more consumer-driven markets in 2023.

Looking at industrial spending on the top right chart, growth for 2022 is forecast at 6.3%, and further growth of 6.5% is forecast for 2023. This reflects strength in the downstream oil and gas and chemical industries as well as the secular shift towards the onshoring of the manufacturing supply chain.

Industrial activity is clearly still trying to rebound from the [2022] -- it's not particularly sensitive to movement in short-term interest rates and looks to have a cyclical tailwind. We're focusing on nonresidential construction charts, on the chart to the bottom right. This is new construction activity that is broken ground this year and looks to be up 19% in 2022, with additional growth of 2% in 2023.

As a lot of analysts have noted, there is a change in the current size and scope of construction activity, with many more mega projects filling out the construction plan in 2022 than has historically been the case. These mega projects last for a couple of years, so there is activity on those projects into 2023 and 2024.

Nonresidential construction put in place in 2022 is forecasted $595 billion, which is almost 2x the level of new starts. So increasing amounts of construction activity started this year as a benefit into 2023, which gives us a good read-through into the relative strength of nonresidential construction activity for 2023.

On top of nonresidential buildings, there is another $313 billion of nonres, nonbuildings or infrastructure projects slated for 2023, which is supported by federal funds approved in the recent infrastructure package, the chips and the Inflation Reduction Act.

The current strength in mega projects and infrastructure work benefits bigger rental companies with bigger rental fleets. As one of the leading North American rental companies, Herc stands to benefit from this trend.

There is continued strength in our end markets and strong demand for our rental services, and it's our current focus to continue to take advantage of the current strong environment to create long-term value for our stakeholders.

We remain cognizant of all the recession talk and have a lot of experience in running the recession playbook. However, right now, we are in a robust operating environment, and we are executing on the strong demand for our services in delivering robust operating results.

With that, we have raised our guidance range as we grow more confident with the strength of our business. Our guidance for adjusted EBITDA is now $1.22 billion to $1.25 billion, which translates to an increase in adjusted EBITDA of 36% to 40% over our 2021 results. We're also narrowing our net fleet capital expenditures guidance to $1 billion to $1.1 billion.

We're experiencing all of the trends consistent with an industry in an up cycle and intended to continue to deliver excellent performance as we look to execute on our high-growth strategy.

With that, I'll turn the call back to Larry.

Thanks, Mark. This summary demonstrates the acceleration in growth we are achieving with our investments in fleet and M&A. As you can see, we have truly shifted into high gear. We've come a long way in the 6 years since we went public, and I'm proud of the tremendous strides we've made.

We are demonstrating that we can accelerate top line growth and show an improvement in adjusted EBITDA margin. I think we provide a unique opportunity for all of our stakeholders. But most important of all, I'd like to thank our team Herc members for their diligence, professionalism and commitment to customer service. We are proud of our team Herc.

Please turn to Slide 21. Many companies are now focusing more on purpose. We began our vision, mission and values and are committed to a purpose statement to equip our customers and communities for a brighter future. We do what's right. We're in this together. We take responsibility, we achieve results, and we prove ourselves every day.

Now I'd like to turn the call back to Leslie Hunziker, before we open the lines.

Thanks, Larry. I understand that my opening remarks, where I introduce myself, were cut off. So let me take 1 more minute to do that. Again, my name is Leslie Hunziker. I've recently joined Herc to support the company's Investor Relations and Corporate Communications program. I'll be transitioning the IR responsibilities with Elizabeth Higashi as she recently announced her plans to retire next year.

Elizabeth would have been here today to share this news with you herself, but for an emergency appendectomy that has her solidly in recovery mode. Once she's back and we've transitioned the IR responsibilities, Elizabeth will continue to focus on driving Herc's expanding sustainability initiatives.

For me, I come from HERC most recently from WESCO, a Fortune 250 industrial distributor, where I also led Investor Relations and communications. And prior to that, I handled IR for Hertz and Tenneco. I'm looking forward to working with all of you.

So let's go ahead and get started with Q&A. Operator?

(Operator Instructions) Your first question is from the line of Jerry Revich with Goldman Sachs.

Please send our best to Elizabeth for a quick recovery. I'm wondering if we could just talk about the implied fourth quarter EBITDA guidance at the midpoint of the full-year range that implies EBITDA is up 7% sequentially, which is much better than normal seasonality.

I'm wondering if we can talk about how much of that is just the impact of the benefit from the storm versus other parts of the business. Can we just expand on the drivers of the 4Q outlook?

Yes. Jerry. I mean, the storms typically generate $5 million to $6 million worth of EBITDA. So that's not a massive driver of Q4. I mean, the timing is a little bit different this year against the comps we had won in Q3 last year. We've got it in Q4 this year.

So most of it is coming from fleet growth that's been received still throughout the quarter and continues to come in Q4 as well as sort of acquisition activity that was consummated during the year that builds into Q4. So it's growth in the business that's already baked in by Q3 that continues to roll into Q4.

Got it. Sorry, Larry, please go ahead.

I was just going to say, Elizabeth can hear you. She's in listen mode. So she heard your comment.

And can I ask about pricing in the quarter, based on the year-over-year acceleration? It looks like you folks got better-than-normal seasonal increase in pricing. It looks like it was up 2.5 points in the quarter. Is that about right, Mark? And is that momentum continuing into October and year-end?

Yes. No. I mean, I'm not too sure about momentum. I mean, we've talked about pricing in terms of looking to sort of maintain that, I think, mid-single digits for the medium term rather than sort of looking for sharp spikes this year. So we will maintain high pricing. It's probably going to level off as we roll through into Q4, and we'll look to maintain that around this time into 2023.

So it's more of managing the pricing. We've had strong growth in spot that's limited in terms of how far we really want to push that, but we've got a sort of tailwind coming in from the ongoing contract negotiations. So as we sort of move those contracts up closer to the spot increase, then we get continued sort of pricing strength rolling into Q4 and 2023.

Super. And lastly, can you talk about your initial views on CapEx outlook for '23? And when do you need to have firm purchase orders? And then you mentioned flexibility in the business model. Can you just talk about how you -- what's the date around which you'd have flexibility to make changes to your commitments to vendors?

Jerry, it's Aaron. We -- our view for '23 is still very robust. So we've got planned CapEx of $1.5 billion for new fleet. We've ordered already -- we have POs on about $1 billion of that and agreed on pricing for about 70% of that number, so call it $700 million.

And so the markets are robust. So we think next year is going to be a terrific year as well. But if things ever change, we do have a lot of flexibility to pull back if we need to.

Your next question is from the line of Rob Wertheimer with Melius Research.

I had two questions kind of following up on that fleet dynamic. And just -- I know people talk a lot about aerials, that you have a pretty diverse supply base. Can you just generally characterize whether the expected loosening up and freeing up supply constraints does mean there's a lot more availability for you in the industry next year or if that's not yet evident?

And then I don't suppose we've seen a rising rate environment like this in a long, long time. So just -- I'm curious about any opinions you may have about how it affects the ability or desire of smaller rental companies to purchase with higher funding costs?

This is Aaron again. I'll take that first one. The -- as far as the aerial specifically, the supply chain or the availability of equipment is still how it's been all year long. I don't think they're going to be able to produce everything that the market, the industry wants in '23.

Now if the small -- to your second question, it's a -- smaller rental operators have difficulty accessing capital to buy that equipment. It might loosen some of that fleet up. But as of right now, we have -- none of that's been kind of evidenced.

And outside of aerials, do you think you have any listening up or not?

No. No, we haven't seen it yet, but that could happen next year sometime if the things I mentioned occur.

We expect the supply chain -- Rob, the supply chain looks to be constrained as far as we can see into next year. So there's no loosening up. Maybe by the end of next year, there's some progress, but we are expecting a similar environment to what we've been dealing with this year.

Your next question is from the line of Neil Tyler with Redburn.

A couple of questions, please. Firstly, on the customer mix that you pointed, the -- can you remind us of the strategic sort of rationale and benefits of targeting the mix as you do? And whether you are able to or how you benchmark the sort of cross-selling penetration rates in the different customer groups? That's the first question.

And then secondly, any thoughts on the sort of potential scale? I think, Aaron, you mentioned the industrial orders and the link to things like to the Inflation Reduction Act and the semis act. But have you done -- you guys done any work in terms of scaling that perhaps relative to the Infrastructure Bill?

I remember, Larry, about 18 months ago, you poured some cold water on my enthusiasm around the size of that Infra Bill. But I'm just wondering whether you want to do the same thing at this point or not?

Well, are you talking about the mix between local business and national account business or you are talking about...

Yes. Yes.

Well, look, we have said from the time we got here, the numbers were exactly opposite. It was 60% national account and 40% local customers, and we said our desire was to flip back and go 40% national account, but keep that growing, not reduce that, and go to more of a local mix because that tended to be a higher-margin business, faster and more rapid turnover, where we could accelerate and penetrate the local markets and not totally be reliant on our national account base.

So both of them continue to grow, and we've gotten to the point where the mix we feel is appropriate for how we want to do business and how we're focused on large metropolitan geographic areas, where there's density of people and work and where that seems to be more continuous on a regular basis.

So that's where we're at there. As far as throwing cold water, I'll give you some warming water as we're beginning to see the letting of that -- of those funds for infrastructure project. There's been some shovels going into the ground. We'll see more of that as we progress into '23. And we certainly think that will -- to add and perhaps replace some of the concerns that folks have about slowing consumer spending on the consumer side.

So we think a combination of the Infrastructure Act and then the other acts and federal spending that Mark mentioned, not to mention the mega projects in the EV world and the data centers and the other things, we think, will certainly give us the momentum to push through any concerns about slowing demand on the consumer side.

Your next question is from the line of Sherif El-Sabbahy with Bank of America.

So just looking at the secular shift from ownership to rental over the last few years, how much growth do you expect is coming from customers who might prefer to typically own their own equipment, but they cannot do the supplier costs? And then, once supplies do improve, do you expect to see any impact from some of these customers reverting back to owning their equipment?

Sherif. See, I mean you do tend to see -- you see a pickup in the secular shift in the down cycle like you saw in 2020, with people sort of unloading fleet and then not necessarily getting back into it. And then in this environment, you're going to see that extend and probably take another step up just due to the difficulties in getting the hands on the new fleet, even if they wanted to.

So it's kind of incremental on the margin. You might have someone who owns 4 pieces of equipment and rents 4 pieces of equipment and sells off 2 and then doesn't replace them and moves into a few more pieces of retail equipment.

But without a doubt, the current environment, where we're struggling to get our $1 billion worth of -- plus worth of fleet, if you're going to a retail store and trying to buy retail, it's, 1, very expensive, and 2, you're probably waiting a year or 2 for that.

So without a doubt, I suspect the current environment is driving an increase in that secular shift. And once that step change happens, it doesn't revert, right? So you look at that over history, it continues just to go up and go up. It might slow down as the dealers return to a more normal sort of inventory cycle, but it's not likely to reverse.

Your next question is from the line of Brian Sponheimer with Gabelli Funds.

Larry, Leslie. And obviously, hello to Elizabeth. I hope you're doing well, and I'll speak to you soon. If I could just start with just a question on leverage and the confidence there, we've seen others in the -- in this industry see a 2x to 3x levels being a little too heavy. You're at [2x to 4x] now and buying back stock into what is still going to be a fairly heavy CapEx cycle here.

Any thoughts there, Larry, as far as wanting to stay towards the lower end or even going below that, once you start generating considerable cash in the fourth quarter here?

Yes. Look, I think we've said, 2x to 3x is our desirable level. And certainly in a strong economic environment, we don't mind going up a bit towards the top end of the range. And in an environment where we feel that there might be any headwinds, we would try to keep that towards the lower end of the range. But I'll let Mark comment a bit on how he's viewing that and how we're going to utilize our capital allocation.

Yes. No. I mean, we're comfortable in that 2x to 3x zone. The balance sheet is pretty much bulletproof. There's not a lot of risk to that, as you've seen in the recent sort of 2022 fire drill -- 2020 fire drill.

We're at peak leverage in the quarter, just given the working capital drain in terms of funding the CapEx. So that does decrease slightly, going into Q4. So we will manage it at the lower end of the range, but unlikely to be dropping it below 2 in the current environment, just given our growth sort of trajectory and the amount of money we're investing in the business.

Sure. Mark, while I have you, given the level of profitability, the absolute level of profitability, are you all subject to any minimum tax thresholds from a cash perspective?

This at [stake]. Yes, not at this stage. So I mean there's still -- we still benefit from accelerated depreciation on the fleet coming in. So that protects us on taxes for the short term. So if it continues for another 2 to 3 years, then we start moving into a cash tax position, but not this year and not next year.

Your next question is from the line of Seth Weber with Wells Fargo.

This is actually Larry [Savitsky] on for Seth. I just wanted to ask about the acquisitions. I think you mentioned third quarter acquisitions contributed about $250 million to total revenues. How should we think about that in the fourth quarter? And was that one of the main sources of the EBITDA raise?

Yes, I don't know that you've got that number right. I think we mentioned that 1/3 of our growth was from acquisition activity, and that's from all the acquisitions completed for '21 and 2022. So you might have misconstrued that comment a little bit.

And I think that's the ratio that we're looking at. So it's about 2/3 of organic growth and about 1/3 of acquisition growth, and that's likely to be the contribution in Q4. Part of the raise was from additional acquisitions, and part of it is sort of continued strength in the 2/3 of the business that's driving organic growth.

Got it. Got it. That makes sense. And then I just wanted to touch on used equipment pricing. If you guys can kind of give your take on it and what you guys are seeing out there regarding used equipment pricing?

It's still a vibrant used equipment market. There's still a lot of demand because there's limited supply. Most categories, when you look at -- if it's retail, wholesale, still very, very strong. If you look at the auction prices, depending on the category, most of them probably peaked already, and they're starting to gradually roll over, but still higher than a normal baseline. So it's still a good -- really good overall used equipment market.

Yes. I was just wondering how that contrast to the Ritchie Bros. release earlier this week and if there's any disparity between what came out from them and what you guys are seeing? But okay. I understand.

No, I believe I read that maybe the same one that you're referring to. And they said the volume was ticking up of auction assets being sold. And I believe that's accurate. I mean that's what they stated. We're seeing that, too.

Your next question is from the line of Steven Ramsey with Thompson Research Group.

Maybe to circle back on the topic of fleet, the fleet spend of $1.5 billion next year, is that net or is that on a total basis? And then, do you expect used sales will be lower again next year if fleet supply conditions are similar to this year?

That's -- that 1.5, that was a gross number, Steve. And as far as disposals for next year, we believe that towards -- since back half of next year, we'll start to pick up and sell more of our aged fleet. We've really sweated out to a degree, and we need -- next year, we'll be selling more of it than we did this year, based on its useful rental life.

Okay. Helpful. And then thinking about acquisitions, is the macro picture or end markets changing your appetite to do deals in the next 2 to 4 quarters, are changing conditions, changing sellers' willingness to do deals? And is it changing the multiples that you or others are willing to transact at?

No, not really. I mean the pipeline is pretty robust. There's, I would say, a steady stream of opportunities that we're looking at. We're pretty confident, going into 2023, that we'll be able to sort of maintain at this level. And multiples remain unchanged.

So it's a similar sort of environment that we've seen all year. We don't really see it changing. And I'd say, it's a pretty sort of robust line of opportunities for us to look at there, and we sort of approach that with our strategic lens and go after the ones that makes sense for us.

Our next question is from the line of John Healy with Northcoast Research.

A quick question for Mark. I wanted to ask about the M&A strategy just a little bit. When you guys are buying these properties? I think you have in one of the slides kind of the spend to date and the amount of EBITDA you've gotten and then what your kind of pro forma target EBITDA and a creation multiple would be -- how do you think about kind of the timing to get to that?

And are there -- is there anything that we should be expecting that maybe not be in our -- there's nothing talked about as it relates to getting those synergies or anything like that as we look to next year?

Yes. So I mean, clearly -- and we're doing smaller type tuck-in deals. So they are typically focused on one key market and single branches or a couple of branches. So not big deals. They benefit straightaway by being part of our network, right? They're moving into a district that's got additional fleet. It's got more (inaudible) classes available to rent that's got other sales guys in the market already and other customers that are [rented].

So the cross-sell and the fleet efficiencies start straightaway. Most of the synergies, we look to have -- we start realizing by the end of year 1. And if it's a big lift, then some of them might roll into year 2. But we've got, I would say, 80% of the synergies starting to roll within 18 months.

Great. And then just one question. When you're buying these properties, I'm just kind of curious to kind of get your thoughts on how these operators are pricing versus your pricing. Is there anything kind of lessons learned there in terms of the pricing strategies or the opportunities to kind of harmonize pricing between acquired properties and how you guys are running the business and how you have been running the business?

Yes. So I mean, there's -- we've got tools as a big national platform that's operating in 350 stores and across a lot of geographic markets that a lot of the smaller players just don't have. They tend -- they're competing against big national players in their market. So they have to sort of focus in on a niche customer base or have a niche pricing strategy.

So as part of their not operating fleet as efficiently as we can and operating margins as we can, they're typically not pricing as well as we do. We don't look to change that straight away as part of a cultural change in terms of moving them into our network and just assimilating their customer base.

So we're not looking to shock the system, if you like. But over time, we plug them into our tools and the rest of the sort of operating model that we operate with, and we get pricing lift into the sort of second year of the [hold], if you like.

Your next question is from the line of Mig Dobre with Baird.

Yes. And all the best to Elizabeth. I want to go back to the fleet as well. And maybe clarify for us, as you're thinking about net CapEx. So I mean you talked about gross CapEx next year, but presumably, net CapEx would be up relative to '22 as well?

Yes. Yes. No, it will be up. We're probably still going to be somewhat constrained on our sale of used equipment, certainly through the first half. And we'll have to determine what a fleet availability looks like into the back half of the year to see if we can relieve some of the older fleet.

But look, if we have it on rent, we're not going to take it off rent just to sell it. So it will all depend upon availability of the new gear that comes in from our OEM suppliers.

Yes. Understood. And I'm also trying to think about sort of the framework that you laid out at your Analyst Day a little while back as we're thinking through 2024. The way you're kind of talking about CapEx and the fleet into '23, it seems like we're doing the 2024 plan a year earlier, maybe into '23.

So related to that, I'm kind of curious, what have been kind of the moving pieces that you're seeing to your business, again, relative to that plan that you laid out? It seems like the overall demand environment is maybe a little more robust than what you anticipated initially. But I'm wondering if there's anything else that differs relative to that plan that you might want to kind of highlight for us as well.

Right. Yes. Mig, so that plan was organic that we laid out. So there's almost there's $1 billion of M&A since then and -- well, probably $700 million more since then. So those branches need fleet replacement and need fleet growth. So we're working off a bigger base in that plan.

Now that plan was obviously front-loaded -- or growth was front-loaded into the front end of that plan, which we've seen. But as you mentioned, we weren't anticipating 35% growth in '22. So the demand has been stronger. We've responded to that with more fleet and more M&A, and that creates a bigger base for us, going into 2023.

So net CapEx is likely to be higher than it was in 2022, but the growth rate slows down, which was kind of the anticipated model in that September Investor Day. So it's a bigger fleet base to work with. We've deferred replacement for a year, just sort of working into this very tight demand environment. So that will start loosening up and -- towards the end of the year, potentially.

But I think we've got more growth into 2022. That sort of creates more CapEx into 2023, and we'll -- that's kind of our first look at this stage. We'll adjust accordingly as we deal with the facts on the ground next year.

That makes sense. One final one for me. As you're looking at your fleet age and based on your comments for 2023, kind of curious what your expectations are exiting 2023, if you actually convert on that CapEx plan. Should we be thinking that fleet age sort of remains kind of around the current levels? Or do you see that reverting back closer to pre-COVID levels?

It'd be sub-50 months and in a range of like 45 to kind of where we are that we reported this quarter of 49 months.

[That will] drop. But I mean we're not selling that old fleet at the same rate that we normally do. So that's -- we're not getting the same benefit as we normally would from the amount of new fleet that we're putting in. But...

That's sort of what I was wondering, if you're stepping up your sales towards the back half of '23, do we start to see this average age coming down? And the implication here is really replacement demand, right? Are you really kind of [satisfying] that replacement demand that you naturally have, given a more aged fleet at this point?

Yes. No, that's correct. And we are not replacing at the same pace that we normally do. So there will be -- once this market loosens up in terms of supply, then we'll be reverting back to our more normal replacement pace.

Your next question is from the line of Ken Newman with KeyBanc Capital Markets.

This is Katie Fleischer on for Ken Newman. I wanted to ask about the SG&A this quarter. So I know it's a little bit elevated, I think. Most of that was driven by the acquisitions. How should we think about that, going forward? And do you see it normalizing to a more normal level?

Yes. We didn't get as much leverage, I would say, out of SG&A as we typically do. I mean that is expanding, and most of it is volume driven. So it's sort of coming into selling expenses and variable comp and a little bit of receivables sort of provision.

It -- some of the step-ups we made in terms of selling expenses were done in the back half of last year. So we'll be anniversarying over those. So that rate of increase won't be to the same extent as it was in Q3. So we should revert to sort of more normal leverage on that SG&A line, going forward.

Okay. Great. And then just one more quick question. Can you talk about some of the conversations that you've been having with your customers as you finalize pricing for 2023? I know you had talked about in the last call, being able to pass through cost to those customers. Are there any concerns about that for next year? Or have you been getting pretty good feedback from them so far?

So we stepped up a lot of the ancillary charges. I mean that was really just a sort of 1 month delay in February that sort of caught us off guard, just that big leap in fuel. So we've been increasing our fuel ancillary charges. They -- we're increasing our recovery of the increased fuel costs. Fuel costs have flattened out to a certain extent.

There's still an increase in volume, but that increase in unit cost is not as dramatic and into Q3, might have even dropped a little bit. So yes, we continue to focus on our ancillaries. We've had great success in delivery fuel charges. And we're recovering a big portion of the increased fuel costs on a year-over-year basis.

Your next question is from the line of Steven Fisher with UBS.

Wondering what impact, if any, are you seeing from a softer housing market and if it's too soon to see anything now, kind of what might you be doing to prepare for that? Or is it just not a market that really kind of swings your business too much?

The housing market, residential market really doesn't swing our business very much at all.

So the potential -- go ahead.

Yes. I mean the only place that might is big multifamily. But purely, like tract homes and that kind of construction, not at all. So I did -- I have -- we've been watching some statistics on multifamily, and that has slowed down, but it's really a smaller piece of our business. We're very balanced with industrial, government, commercial contractors, larger projects.

And is there any sort of impact you're seeing on sort of the lighter commercial side at this point from housing or not really?

Actually, nothing at all. I get out into the field half the month every single month. So I see a lot of the activity in the field. And now there's no slowdown to mention at this point.

Your next question is from the line of David Raso with Evercore ISI.

The gross CapEx for next year, I apologize if I missed this. But of that roughly 30% to 33% growth, how much of that is pricing and also the cadence of your suppliers to ship?

Are you hearing anything unique about it having to be later than normal or maybe some slots have opened up for whatever supply chain reason that you can get it on a normal cadence?

Yes. So I think what -- we're probably looking at high single digits, mid- to high single digits for most of the suppliers in terms of pricing. And the cadence is probably not going to change significantly from the cadence that we've seen this year. We, several years ago, due to the efforts of our fleet team, began to take fleet on a year-round basis rather than sort of drive it all into Q1 or Q2.

And so we have been able to input fleet on a fairly normalized and even level into our business. And Consequently, we've been able to work with our suppliers on their supply side and our demand side to get acceptable levels, although we still see delays of 30 to 60 to 90 days, but that won't change much throughout next year.

And we don't hear anything different from our suppliers other than that they're hopeful, and I use the word hopeful in parentheses, they're hopeful that their second- and third-tier suppliers improve, which will allow them to improve their supply line to us in the back half of the year.

But going into the first half of the year -- the balance of this quarter -- of this year and going into the first half of next year, we're not anticipating nor planning for any type of a different supply chain.

That's helpful. And real quickly on your national account contracts that are being renewed. Can you give us some sense of what's the biggest impact? Is it the fourth quarter contracts are some of the more dated stale, where the price increase will be most significant? Or are there still a lot to be repriced for first quarter that are pretty significant and what should be a decent step-up? Just trying to get a sense of that cadence.

It's pretty [level]. We've sort of worked hard to just have a sort of a pretty even sort of monthly renewal. So that's an ongoing monthly renewal. So there's no real big lumps coming in Q4 and at the end of the year or into Q1.

So that -- but it's a flywheel effect, right? So we're getting the benefit now from the contracts we negotiated sort of 3 months ago and that starts running through and picking up momentum. So the benefit does help us disproportionately into '23 from all the work that we've done so far in 2022.

At this time, we have come to the conclusion of our Q&A session. I will now hand today's call back over to Leslie for any closing remarks.

Thank you for joining us on the call today. If you have any further questions, please don't hesitate to reach out to Elizabeth and me. We look forward to seeing you all soon. Thank you.

This concludes today's call. Thank you for joining. You may now disconnect your lines.