Kevin S. Inda - Corporate Communications, Inc John M. Engquist - H&E Equipment Services, Inc. Leslie S. Magee - H&E Equipment Services, Inc. Bradley W. Barber - H&E Equipment Services, Inc..

Joe G. Box - KeyBanc Capital Markets, Inc. Nicholas Andrew Coppola - Thompson Research Group LLC Eric Crawford - UBS Securities LLC Seth R. Weber - RBC Capital Markets LLC Sean M. Wondrack - Deutsche Bank Securities, Inc. Neil A. Frohnapple - Longbow Research LLC Larry Robert Pfeffer - Avondale Partners LLC.

Good afternoon, and welcome back to the continuation of H&E Equipment Services' Fourth Quarter 2015 Earnings Conference Call. Today's call is being recorded. At this time, I'd like to turn the call over to Mr. Kevin Inda. Please go ahead, sir..

Thank you, Jennifer, and we want to thank everyone for dialing back into the continuation of our fourth quarter conference call. We apologize for the inconvenience, but we experienced a phone outage that prevented us from dialing back into the call in a timely manner.

Let me remind everyone that the Safe Harbor language we provided this morning applies to this call as well. Jennifer, you may now open the call up for questions. Thank you..

Thank you. And we'll go first to Joe Box from KeyBanc Capital Markets..

Hey, guys..

Hey, Joe..

So should I assume that we have an hour now for Q&A?.

Whatever necessary..

Okay. Well, look, I want to go back to one of Neil's earlier questions and you guys have added six new locations. I'm going to assume that those are probably dilutive to overall margins. I'm just trying to gauge where those rental incremental margins are actually going to go.

I think, Leslie, you said you expect it to normalize, but really what's normal? Is it a 40% margin, is it a 60% margin or is it less than that?.

I would say in the 40% to 50% range is more of how we view normalized incremental margin. And with the kind of inputs that I talked about on the previous call are kind of variables that we saw improving looking into 2016. If you'd like for me to walk through this again I could..

No. I can – I heard those comments. And I guess I'm just curious on the run rate and how you actually get to the 40% to 50%. Is it on the early part of the year we see it substantially lower and the end part of the year we actually finish above that? Any direction on that would be helpful..

I'm not really breaking it down and on a quarterly basis really in front of me. One thing that we didn't talk about is fleet growth has a really nice incremental margin.

And so if we did nothing with our fleet in 2016 from a fleet growth perspective, but we would have year-over-year fleet growth from 2015 on a full-year basis, so we'd have the benefit of that full-year fleet growth. And so that would generate nice flow-through margins alone. And then in addition to that, we talked about physical utilization.

We didn't expect the same challenges on physical utilization that we experienced in 2015, and then again the maintenance and expense improvement. So those are kind of the three variables that I see generating improved incremental margins..

To that last point, what exactly was the maintenance expense in 4Q?.

It was about $13.7 million. Is that right? Yeah, $13.7 million..

Which is up from the prior year by how much?.

One second, let me grab that for you..

I think it's around $1 million. Joe, while Leslie is looking that up....

Okay..

Benicia, California; Forestville, Maryland; and Savannah Georgia..

Okay, great. I appreciate that. Go ahead..

Joe, as a follow-up, maintenance and repair expense was up about $1.8 million from a year ago..

Okay, great. I appreciate that. And then just relative to SG&A, historically you guys have ramped throughout the course of the year from 4Q levels, even though we've seen the distribution business be lower in the last couple of years.

So with the new locations, should we think about that $57 million range as being a good bogey or should we look at something more in the mid-50s for each quarter?.

Well, I think with the new branches, I would look more to the $57 million as more of the – as more of a run rate..

Okay. One last one and then I'll turn it over. One thing I'm trying to understand is if you go back to your call from last quarter, I think the expectation was that there would be some opportunity for pricing in 2016. You guys have always said that when rental rates are north of 70% that should open up the opportunity to price.

So I'm curious what specifically has changed aside from just competition on some of those bigger projects..

Joe, I mean I think that's the biggest thing we're seeing. People are running at reasonable utilization levels, but when biggest player guides to negative rates we don't just ignore that.

We've got to look at that and I do think you're seeing some pretty intense competition between Sunbelt and United on these big projects, which we're going to catch a little flak from. But I assure you we are going to be very focused on rates and we're going to do everything we can do to be positive. I mean that's a focus of Brad's group every day.

And – but at this point, we think guiding to a flat rate is a reasonable assumption..

Okay. Thanks for the time, guys..

You bet..

Thank you. And we'll go next to Nick Coppola from Thompson Research Group..

Hey, good afternoon..

Hi, Nick..

And I apologize if this has already been asked, but looking at your earthmoving sales being down 40% year-over-year, can you just talk about how much of that is lumpiness or a tough comp from unusual sales in the prior year relative to what's going on with just kind of core underlying demand for earthmoving sales?.

Well, I think it's heavily weighted to a tough prior-year comp, specifically one very large sale we made to a single customer, a big package of equipment that went on that Sasol project in Southwest Louisiana.

And so I think it's more of a prior-year comp situation, but we are still today in the first quarter seeing reasonable demand on earthmoving equipment..

Okay. That's helpful.

And then can you just talk more about utilization trends in oil-intensive versus non-oil intensive areas?.

Yeah. A year ago our utilization in the oil patch was running around 77% and today it's more like 71%. So obviously a big decline there. Our crane utilization is down significantly from a year ago, 500 basis points, 600 basis points.

If you look at aerials and earthmoving equipment, both of those categories, which are big categories for us, are up year-over-year in utilization. If you get outside of the oil patch, our utilization is up year-over-year. So all in all, I think it's a pretty positive sign that the construction markets are healthy..

Right, right. That's very helpful. Thanks for taking my question..

You bet..

Thank you. And we'll go next to Steven Fisher from UBS..

Hi, good afternoon. It's Eric Crawford on for Steve..

Hi..

Hi, Eric..

Hello..

Hey.

So just real quick on rates, not to beat a dead horse, but curious how those trended on a year-over-year basis during the fourth quarter, each month's?.

Eric, we just – this is Brad. We don't typically speak about rates on a month-over-month basis. Year-over-year, Leslie spoke to earlier..

Yeah..

Some other comments I can give you about rates that may be helpful to you is that all regions had positive rate increases sequentially in Q4 over Q3 and that only one product type, cranes, had a year-over-year metric that was down, but they also had a nice increase from Q3 to Q4. So things look pretty steady and pretty positive.

On previous calls I had mentioned that in most cases all regions have sequentially continued to increase, and I think in Q4 we had one region that did not have sequential increases out of the six regions that we have. So things remain very steady there..

That's great color. Thank you. I appreciate that. I guess switching over to cash and use of cash in 2016, and I apologize if we already touched, I know we mentioned the dividend before on the last call.

But can you speak to new priorities for use of cash, how you view how secure, how safe the dividend is and whether you expect to pay down debt this year?.

Sure. Obviously we're at a point where we're going to be generating significant free cash. We generated over $100 million in 2015, and I think we'll do that or more in 2016. And the use of cash will be two things primarily – pay the dividend and pay down debt. We'll pay down our senior credit facility and de-lever the business..

That's fantastic. Thank you. And last one for me.

I appreciate the limited visibility on the distribution side, but just looking at rental specifically, if we assume no major weather disruptions in 2016 like we had with the May flooding last year, it sounds like with rates flat and with more fleet I mean your rental profitability should be higher year-over-year..

That is correct. We agree with that..

Excellent. Thanks so much, guys. Nice job last quarter..

Thank you. Thank you..

And we'll go next to Seth Weber from RBC Capital Markets..

Hey, good afternoon, everybody..

Hi, Seth..

Sorry, I just – I'd like to go back to the rate question again, sorry. I'm just trying to reconcile all these comments where you're coming out of the shoot, you've got positive sequential rate improvement here in the fourth quarter. It sounds like oil and gas markets are stabilizing, the industry seems to be acting fairly rationally with fleet.

And so it sounds like you're messaging that rates are going to get worse from here coming out of the blocks after a sequential increase in the fourth quarter.

So I'm just trying to – I understand there is competition, but I'm trying to piece all this together, if you could just again kind of tell us what you're seeing out there that makes you think it's flattish..

Sure. Seth, I think our concern is, as you know, most folks are aware Q1 is always the seasonal softest, particularly around utilization. John referenced a moment ago that some of our key product types, AWPs and earthmovings most notably, are actually incrementally ahead of where they were last year with physical on rent, OEC on rent..

Right..

So that's a good indicator. I think our largest concern we're seeing right now is that some of the larger competitors have guided to negative rates. Their fleets are significantly larger than our fleets. They're good operators, they have good coverage. They do a good job.

Our view is we're not abandoning the opportunity of the potential for positive rates. But from a guidance standpoint, we feel like flat to slightly up to slightly down is where we will be.

Now as the year starts to unfold and if everyone stays as disciplined as they are right now, as you just referenced, with purchasing and utilization maintains, there is no good fundamental reason that we can't all increase our rental rates.

But our view right now is kind of tainted by some of the comments – now I wouldn't say the actions but more of the comments that we've heard from larger competitors and what may be required on behalf of us to maintain our typically high utilization..

No, I appreciate that, Brad, but I mean one of the big competitors you're referencing is basically – I mean they're coming out – they're starting the year at kind of the level that they're guiding to for the year. So it's not really getting incrementally worse.

And so my comment – I am just trying to reconcile if you're coming – if you're starting the year in the plus category, it sounds like the math would suggest that things are going to get worse and it just doesn't seem consistent with the other messaging that you're giving, whereas the other guys are kind of starting there already.

So that's – you follow me?.

I do. And so let's put it in the context of this. In Q1 of 2015 we had 3% year-over-year rate increases. In Q2 it went down to 1% year-over-year. Q3 was about 1% again, and then of course we closed the quarter I think 0.6% up year-over-year. So that's consistent – it's kind of been declining.

So I think our view is generally – how the math actually works out could be a little different – but our view is kind of where we're starting may be where we end, and that would support our flat comment. Now if we had just ended the year 3% up over the prior year or over the prior period, our comments would be different.

I think the math that you may be thinking about would better apply. But it's so close that we kind of, our view is our rates just may not move much on the year more than we think they're likely to decline on average for the year..

Okay. I'll let that go. Just as a follow-up question. Can you talk about what you're seeing – we've heard kind of anecdotally that downstream activity is starting to pick up.

I mean is that something that you've seen as well, whether it's just turnaround projects or new shovels in the ground?.

Yeah. I think the downstream activity where refineries and the ongoing maintenance is picking up a little bit, and in talking to our industrial customers I think they all see more coming.

Utilization is a little soft right now on cranes – well, really only on cranes and we think that's going to resolve itself pretty quickly in the coming months because of the downstream petrochem activity..

Okay.

And then just lastly, the comment about the bad debt expense, is that related to an energy customer or is that just kind of general course of business?.

Well, our increase in bad debt expense is related to the oil patch, and I don't think it's any secret that small oil producers and oil field service companies are in a very challenging environment right now.

So I think we prudently increased our reserves there a little bit, something we're very much on top of and meeting on weekly, and we think we've got a very good handle on it. But that increase in our reserve is related to the oil patch..

And is that like single-digit millions of dollars kind of number or how would you size that?.

For the quarter, year-over-year, it's like a $300,000 increase..

Okay. All right. Thank you very much, everybody..

Thank you, Seth..

We will now take a follow-up from Joe Box from KeyBanc Capital Markets..

Yeah. Just a high-level question for you, John. Last cycle you guys added some new locations, I think at a time when there was extra fleet just sloshing around in the system.

Can you maybe just talk to the pros and cons of the branch expansion that you did last cycle and maybe how that differs to what you're doing now?.

Joe, the last cycle we took a bunch of idle equipment and did some greenfields and used that idle equipment to fleet up in those markets. And what we found is when you try to do a greenfield in a flat or declining market, it is a very, very challenging task and you meet incredible resistance from the existing players there.

So going forward, when you see us do a greenfield, I assure you it will be a market that is growing and we see plenty of opportunity. And we will not use the strategy we used last time in entering down or declining markets..

And then just relative on – relative to CapEx, can you talk to maybe the CapEx plans associated with fleeting up at these locations? And it sounds like you guys are taking a very flexible CapEx approach.

Should we think about you guys migrating toward maintenance CapEx levels, and then if there's any upside or downside that you guys see you'd manage the CapEx accordingly?.

Joe, I think that's a reasonable expectation. We are going to take a very measured approach to CapEx. We're going to closely monitor manufacturing inventory levels and try and keep our purchasing as close to the point of need as possible.

And with what we're seeing right now, we think we can react very quickly, be market conditions positive or negative. So I think your assumption that maybe we keep our CapEx to maintenance levels for right now with the ability to adjust depending on what we see going forward..

Got you. And I don't think you mentioned what the CapEx would be for the new locations..

We have not. I mean, Joe. typically you are going to – you know, your fleet CapEx is going to be $5 million-ish initially ramping up to $10 million range and, you know, you got $1 million in PP&E and – yeah, so....

Yeah, so that's our rule of thumb. I mean if you want to kind of generalize, $7.5 million of fleet year one plus $1 million PPE, that would kind of be it..

It would be close..

But again, I will tell you they range from somewhat smaller to in some cases they become significantly larger based on the opportunity..

Sure, sure.

So is it reasonable to think then maybe $180 million or so for maintenance CapEx, plus you know call it $5 million to $10 million per location that you've opened? Or is that too high?.

Look, it has a lot to do with the timing. So I don't know that you know we're prepared to give guidance on what that looks like in the annual period..

Okay, understood. That's it for me. Thanks, guys..

Thanks, Joe..

Thank you. We'll go next to Sean Wondrack from Deutsche Bank..

Good afternoon. I just had a quick question on the SG&A front. Obviously it was up a little bit, some of that had to do with branch expansions. I think if you parse that out, it was still up couple of hundred basis points year-over-year.

Do you expect this to be more of like the new run rate level as we move into 2016, or would you expect it to come down a little bit?.

No, as we said earlier, with the – primarily due to the branch expansions, we expected – you can look at this as more of the run rate..

Okay. Thank you.

And then quickly, could you please let us know the balances on your manufacturer floorplan tables, please?.

Sure. $62.4 million at the end of the year..

$62.4 million. Okay, thank you. And then also one last question on oil-related front. You spoke that oil-related utilization was at about 77%..

That was a year ago..

A year ago. It's kind of fallen to about 71%. And you talked about the health of your customers a little bit.

How do you view the health of your remaining customers in the oil patch and where are they on the cost curve? Do you think they're vulnerable or do you think that you could have further weakness there or are they pretty sound?.

Well, I think it's a mixed bag. I think the smaller players are vulnerable. I think it could be really challenging for those guys, and we've got plenty of customers out there, larger customers who have strong balance sheets that are going to be able to weather this.

But I think it's a mixed bag, but if oil stays around $30 long enough it's going to create some issues in the oil patch. But that's something we are very much staying on top of on literally a daily and weekly basis..

And Sean, I would say that we try to additionally mitigate. We don't wait for these guys to have bad debt or for their business to slow down or lose a contract.

We review and consider the health and vitality of each individual customer, who they're performing contracts for and the strength of their balance sheet, and we have tried to mitigate some of our what could be exposure, to John's point, likely weaker players who could get harmed easier.

So we've moved those assets away from those customers intentionally, we didn't just wait for them to come home, so we're managing every aspect of it that we can..

Okay. And then just one last thing, I don't know that if you've commented on this, I apologize if you stated this this earlier. What is your outlook for used equipment sales this year? Kind of seen in the market, you've seen margins come in a little bit.

Do you expect to sell more or less than last year? Is there any way you can kind of guide us there, please?.

Well, look, you can look at our fleet age at 31.4 months. We've got an exceptionally young fleet. We're – if anything our fleet sales are going to come down some, but that will be by design. If we are keeping our CapEx to more maintenance levels, we really have no need to sell fleet.

So obviously because of our distribution business, we will always sell a certain amount of fleet, but I would expect our fleet sales to come down somewhat because of our fleet age and just the fact that we don't need to sell fleet..

Okay. Thank you very much. Good luck next quarter..

And we'll go next to Neil Frohnapple from Longbow Research..

Hi, good afternoon. Thanks for taking my follow-up. Just a quick follow-up to Joe's earlier question, I apologize if I missed this.

Have you guys provided a maintenance fleet CapEx level sort of to keep the size and the age of your fleet constant?.

I think Joe's number on average, looking over the last couple of years, I think that $175 million, $180 million is probably a fair number..

Okay. And then just also wanted to ask about the decline in part sales and related margins in the quarter.

Was that primarily related to the weak crane demand or is weakness spreading to other businesses? And as a follow-up, would you expect part sales to be down on a year-over-year basis throughout 2016?.

The decline you saw in part sales is almost totally related to cranes. Crane markets are very weak and people aren't just doing rebuilds and remand jobs right now. So I think that's where it's related to and we do not expect parts and service sales to be down year-over-year..

You guys don't expect them to be down year-over-year..

No..

Okay. All right. Thanks very much..

And we will now take our next question from Larry Pfeffer from Avondale Partners..

Good afternoon, everybody..

Good afternoon..

Good afternoon, Larry..

So obviously you guys have plenty of free cash to support the dividends next year, but just curious if there are – in what scenario, if it's a dividend payout ratio, leverage ratio, just kind of interested in your thoughts of what would cause you to look at the dividend in the future..

I don't think cash going forward is going to be an issue for us. I mean, I think we're going to be in a very strong free cash flow position for the foreseeable future. If anything could limit us there to somewhere in the distant future I would think it would be our restricted payments basket..

Got you. I appreciate the insight. Good luck in the quarter..

Thank you..

And that concludes today's question-and-answer session. At this time, I'd like to turn the conference back over to any of the speakers for any additional or closing remarks..

Everybody, I apologize for the inconvenience this morning when we lost our phone lines and I appreciate you being on the call this afternoon. As we said, we think we continue to operate in an overall positive environment and we think we're going to have a solid year in 2016. So we look forward to talking to you after the first quarter..

That does conclude today's conference. Thank you for your participation..