McGrath RentCorp (MGRC) Q2 2015 Earnings Report, Transcript and Summary

Welcome to the McGrath RentCorp Second Quarter 2015 Financial Results Conference Call. At this time, all conference participants are in a listen-only mode. [Operator Instructions] This conference is being recorded today, Thursday, July 30, 2015. Now, I would like to turn the conference over to Geoffrey Buscher of SBG Investor Relations. Please go ahead.

Thank you, operator. Good afternoon. I am the Investor Relations Advisor to McGrath RentCorp and will be acting as moderator of the conference call today. Representatives on the call today from McGrath RentCorp are Dennis Kakures, President and CEO; and Keith Pratt, Senior Vice President and CFO. Please note that this call is being recorded and will be available for telephone replay for up to 7 days following the call by dialing 1-888-203-1112 for domestic callers and 1-719-457-0820 for international callers. The postcode for the call replay is 8555107. This call is also being webcast over the internet and will be available for replay. We encourage you to visit the Investor Relations section of the company’s website at mgrc.com. A press release was sent out today at approximately 4:05 PM Eastern Time, or 1:05 PM Pacific. If you did not receive a copy but would like one, it is available online in the Investor Relations section of our website or you may call 1-206-652-9704 and one will be sent to you. Before getting started, let me remind everyone that the matters we will be discussing today that are not truly historical are forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, including statements regarding McGrath RentCorp’s expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements are based upon information currently available to McGrath RentCorp and McGrath RentCorp assumes no obligation to update any such forward-looking statements. Forward-looking statements involve risks and uncertainties, which could cause actual results to differ materially from those projected. These and other risks relating to McGrath RentCorp’s business are set forth in the documents filed by McGrath RentCorp with the Securities and Exchange Commission, including the company’s most recent Form 10-K and Form 10-Q. I would now like to turn the call over to Keith Pratt

Thank you, Geoffrey. In addition to the press release issued today, the company also filed with the SEC the earnings release on Form 8-K and the Form 10-Q for the quarter. For the second quarter of 2015, total revenues increased to $96 million from $95.7 million for the same period in 2014. Net income decreased 17% to $8.5 million from $10.2 million and earnings per diluted share decreased 18% to $0.32 from $0.39. Second quarter 2014 results included a $0.8 million non-operating gain on sale of an excess property which contributed $0.02 per diluted share. Reviewing the second quarter results for the company’s mobile modular division compared to the second quarter of 2014, total revenues increased $4.8 million or 13% to $42.1 million due to higher rental and rental-related services revenues, partly offset by lower sales revenues. Gross profit on rents increased $3 million or 32% to $12.2 million. Rental revenues increased $5 million or 22% and rental margins increased to 44% from 41% as depreciation as a percentage of rents decreased to 17% from 18% and other direct costs as a percentage of rents decreased to 39% from 42%. Selling and administrative expenses increased 12% to $11.3 million, primarily as a result of increased employee headcount, salaries and benefit costs and higher allocated corporate expenses. The higher gross profit on rental and rental-related services revenues partly offset by higher selling and administrative expenses and lower gross profit on sales revenues resulted in an increase in operating income of $2.3 million or 77% to $5.3 million. Finally, average modular rental equipment for the quarter was $655 million, an increase of $70 million. Equipment additions supported growth across all regions and our portable storage business. Average utilization for the second quarter increased from 70.3% to 74.4%. Turning next to the second quarter results for the company’s TRS-RenTelco division, compared to the second quarter of 2014, total revenues decreased $4.2 million or 13% to $27.9 million, primarily due to lower rental and sales revenues. Gross profit on rents decreased $2.9 million or 26% to $8.3 million. Rental revenues decreased $2.5 million or 10%, and rental margins decreased to 38% from 46% as depreciation as a percentage of rents increased to 47% from 42% and other direct costs as a percentage of rents increased to 15% from 13%. Selling and administrative expenses increased $0.5 million, or 8% to $5.5 million, primarily due to lower allocated corporate expenses. As a result, operating income decreased $3.1 million or 35% to $5.9 million. Finally, average electronics rental equipment at original cost for the quarter was $269 million, an increase of $8 million. Average utilization for the second quarter increased from 59.3% to 59.5%. Turning next to the second quarter results for the company’s Adler Tanks division compared to the second quarter of 2014, total revenues decreased $1 million or 4% to $24.1 million, primarily due to lower rental and rental related services revenues, partly offset by higher sales revenues. Gross profit on rents decreased $0.7 million or 6% to $11.6 million. Rental revenues increased $1 million or 5% and rental margins decreased to 65% from 66%. As depreciation as a percentage of rents increased to 22% from 20% and other direct costs as a percentage of rents decreased to 12% from 14%. Selling and administrative expenses were flat at $6.9. As a result, operating income decreased $1.2 million or 18% to $5.5 million. Finally, average rental equipment for the quarter was $303 million, an increase of $16 million. Average utilization for the second quarter decreased from 63.2% to 60.6%. On a consolidated basis, interest expense for the second quarter of 2015 was flat at $2.3 million compared to the same period in 2014, as the company’s higher average debt levels were offset by lower average interest rates. The second quarter provision for income taxes was based on an effective tax rate of 39.5%, compared to 39.2% in the second quarter of 2014. Next, I would like to review our 2015 cash flows. For the six months ended June 30, 2015, highlights in our cash flows included: net cash provided by operating activities was $65.3 million, an increase of $10.1 million compared to 2014. The increase was primarily attributable to a decrease in accounts receivable and prepaid expenses and other assets partly offset by lower income from operations and other balance sheet changes. We invested $71.2 million for rental equipment purchases compared to $68.1 million for the same period in 2014, partly offset by $11.8 million proceeds from sales of used rental equipment. Property, plant and equipment purchases decreased $0.3 million to $5.8 million in 2015. Net borrowings increased $14.7 million from $322.5 million at the end of 2014 to $337.2 million at the end of the second quarter 2015. Dividend payments to shareholders were $13.2 million. The company has a board authorization to repurchase upto 2 million shares and repurchased shares since March of 2015. Through July 30, we repurchased 414,374 shares with an aggregate purchase price of $12.1 million and an average per share price of $29 and $0.21 With total debt at quarter end of $337.2 million, the company had capacity to borrow an additional $192.8 million under its lines of credit and the ratio of funded debt to the last 12 months actual adjusted EBITDA was 2.00 to 1. For 2015, second quarter adjusted EBITDA decreased $1.5 million or 4% to $38.7 million compared to the same period in 2014, with consolidated adjusted EBITDA margin at 40% compared to 42% in 2014. Our definition of adjusted EBITDA and a reconciliation of adjusted EBITDA to net income are included in our press release for the quarter. Turning next to 2015 earnings guidance, we have revised our previous 2015 full year earnings guidance range of $1.75 to $1.95 to an updated range of $1.55 to $1.65 per diluted share. For the full year 2015, we expect 2% to 5% growth in rental revenues over 2014. Sales revenue is expected to be approximately 20% than 2014. Rental equipment depreciation expense is expected to increase to between $76 million and $78 million driven by rental fleet growth. Other direct cost of rental operations primarily for rental equipment maintenance and repair are expected to increase to between $60 million and $62 million in 2015. Selling and administrative costs are expected to increase to between $100 million and $103 million to support business growth. Full year interest expense is expected to be between 9.5 million and 10.5 million. We expect the 2015 effective tax rate to be 39.5% and the diluted share count to be between 26 million and 26.2 million shares. Now, I would like to turn the call over to Dennis.

Thank you, Keith. Now, let’s take a closer look at each rental business for the quarter. Modular division-wide rental revenues for the quarter increased $5 million or 22% to $27.7 million from a year ago. This is the ninth consecutive year-over-year quarterly rental revenue increase for our modular division. During the second quarter, we experienced a 29% increase in division-wide year-over-year first month’s rental revenue bookings for modular buildings, with a 28% increase in California and a 29% outside the state. We’re also continuing to see rental rates rise for various sized products as demand exceeds readily available supply. Modular division average and ending utilization for the second quarter of 2015 reached 74.4% and 74.3%, respectively, an increase from 70.3% and 71.6% a year ago. This is the highest modular division second quarter average utilization level since 2009. Modular division income from operations or EBIT that the quarter increased to $5.3 million or by 77% from a year ago. This strong increase in profit was driven primarily by higher rental revenues and rental revenue margin expansion. Gross margin on rental revenues increased to 44% for the quarter from 41% a year ago. Direct costs associated with readying equipment and inventory center operations as a percentage of rental revenues decreased to 39% from 41% for the same period a year ago. This was accomplished despite a year-over-year 14% increase in building a container preparation and inventory center related cost associated with meeting continued strong order demand for both products. During the quarter, modular division EBIT results also benefited from higher profit on rental related services, offset by higher SG&A expenses and lower profit on equipment sales from last year’s quarter. The higher SG&A costs were primarily related to increased sales and operations staffing levels to support the recovery of a modular rental business as well as the continuing expansion of our portable storage rental business. Now, let’s turn our attention to Adler Tank Rentals and their results. Rental revenues at Adler Tank Rentals, our liquid and solid containment tank and box division, decreased $1 million or 5% to $17.7 million from a year ago. Adler Tank Rentals serves a wide variety of market segments including industrial plant, petrochemical, pipeline, oil and gas, waste management, environmental field service and heavy construction. Average utilization and total original cost of rental equipment was 60.6% and $303 million for the second quarter of 2015 compared to 63.2% and $287 million from a year ago. Second quarter average equipment on rent at original cost was $183 million compared to $181 million for the same period in 2014. Period and equipment on rent at original cost rose to $188 million from a $179 million a year ago, however average monthly rental rates slid to 3.23% from 3.44% or by 6% from a year ago. The reduction in rental rates is primarily due to lower crude oil prices and the significant decline in well head related drilling and completions activity, resulting in highly competitive upstream rental market conditions, in particular for 21K tanks. The oversupply of 21K tanks relative to demand in the oilfields is also putting downward pressure on rental price in midstream, downstream and other market verticals. Keep in mind our 21K tanks are a multipurpose product and as a primary containment source utilized in virtually all market verticals from groundwater collection to fracking to ethanol glycol or the icing fluid storage. We remain cautious in our outlook for our liquid and solid containment rental business for the remainder of 2015 due to the current excess supply of 21K tanks in the marketplace. Adler tank rentals income from operations for the quarter decreased $1.2 million or 18% to $5.5 million from a year ago. The higher percentage decrease in EBIT at 18% as compared to rental revenues at 5% for the quarter was primarily a result of lower profit on rental related services, higher loss and equipment sales and higher depreciation expense partially offset by lower equipment preparation cost all from the year ago. Now, let me turn our attention to TRS-RenTelco and their results. Rental revenues for TRS-RenTelco, our electronics division, declined by $2.5 million or 10% to $21.9 million from a year ago. The year-over-year reduction in rental revenues was driven entirely by lower communications test for rent [ph] business activity. We continue to experience a significantly slower wireless communications network upgrade environment compared to the first half of 2014. We had anticipated higher activity levels in this market vertical beginning in the second quarter that did not materialize. Although we anticipate some improvement in test equipment order activity in communications network upgrade in the second half of 2015 we have [Indiscernible] our expectation significantly. General purpose test equipment rental activity which had been slow throughout 2014 continued to improve during the second quarter. During the second quarter, the average rental billing level for these products was higher than for the same period a year ago. EBIT for the quarter declined by $3.1 million, or 35% from the same period in 2014. The reduction in rental revenue of $2.5 million was the primary contributor to lower year-over-year EBIT along with lower gross profit on equipment sales, higher laboratory cost and depreciation expense partially offset by lower SG&A expenses. The higher percentage drop in year-over-year EBIT at 35% compared to rental revenues at 10% is primarily due to equipment mix and depreciation expense typically making up between 70% and 75% of direct rental costs. In other words, within any given quarter, we only have a limited amount of variable cost associated with rental revenue generation that can easily and responsibly be taken out of the business. In particular with communications test equipment having much shorter utilization [ph] than for general purpose test equipment there is significantly in higher monthly depreciation expense that also much higher rental rates than for general purpose test equipments. As a result when communications test equipment is unutilized it impacts profitability more significantly than for general purpose test equipment due to its high repairing cost without it matching higher rental revenues and rates. Average equipment utilization was 59.5% for the second quarter compared to 59.3% for the same period in 2014. Average rental rates for the second quarter of 2015 declined by 13% to 4.56% from 5.25% a year ago, primarily due to the on-rent equipment mix increasing for general purpose test equipment and decreasing for communications test equipment. General purpose test equipment had longer depreciable lives [ph] and lower rental rates and communications test equipment. Now, let me take a moment and update everyone on reportable storage business. Mobile Modular Portable Storage continued to make good progress during the second quarter in building its customer following, increasing booking levels and growing rental revenues and profitability from a year ago. First month's rent booking levels and rental revenues for the quarter grew by 20% and 36% respectively, from the same period a year ago. EBIT for our storage container rental business was up two fold from the second quarter of 2014. We are targeting further geographic expansion during 2015. We are on track towards building a meaningful-sized storage container rental business with attractive operating metrics. Now for a few closing comments. As a result of our electronic test equipment division [Indiscernible] short fall to date coupled with a challenging outlook for communications market rental opportunities for the remainder of 2015 we were revising our 2015 full year EPS guidance to a range of $1.55 to $1.65 from $1.75 to $1.95. It’s important to emphasize that when there are shortfalls in rental revenues in our electronics business and in particular related to communications test equipment products with shorter depreciation [ph] the negative earnings impact can be significant as discussed earlier. Conversely when this communication test equipment is utilized the great majority of the rental revenue generated will drop to the pretax line. Over the past few years we have been through a significant cycle in the company. During this period, we launched our portable storage business expanded our modular business to the mid Atlantic region from Georgia to Washington DC, entered the liquid and solid containment rental industry to the acquisition of Adler tank rentals and created a national footprint for the business and shepherded the turnaround in early recovery of our legacy largest earnings MGN [ph] modular business to improving financial health from having lost approximately $1 of annual EPS due to the effects of the great recession. Electronics rental business performed well through the majority of this time frame and will do again in the future. As both a business manager and an investor in McGrath RentCorp, I can fully appreciate the challenges associated with getting four different rental businesses all performing at favorable levels consistently. We are well on our way to creating four large rental business with collectively materially greater annual earnings quarter [ph] than we have experienced to date. 21 consecutive quarters of year-over-year rental revenue growth should be a clear beacon of what we are building overtime. Cyclical challenges with our different rental business will occur from time to time, however as our meaningful modular rental business on each platform continues to recover and our newest investments continue to grow and improve their key metrics the impact of downturns in any one specific vertical market with that anyone business should be considerably less of an impact and overall company results. Company’s management is confident in the foundation for growth in place today supporting greater shareholder value in the future. Last, as noted in our Q1, 2015 10-Q in March 2015, the company entered into a share repurchase plan in accordance with Rule 10b5-1 and continues to be active in repurchasing its shares. And now Keith and I welcome your questions.

[Operator Instructions] We’ll take our first question from Scott Schneeberger with Oppenheimer.

Hi guys, its Daniel [ph] in for Scott. Could you elaborate on the end market driver in modular including education and what you are seeing here for the back half?

Yes. I’ll go by geographic regions probably the easiest way. If you start in the Mid-Atlantic, we’ve continue to be successful in that market in expanding really our educational business into a lesser degree a commercial business, although we’ve done well in that as well. We’ve provided innovative new classroom products into that market in various states and we continue to be successful with that, so very strong educational base in the Mid-Atlantic. For Florida, we had a strong educational booking season. We should see greater benefit from that equipment having gone on rents here over the May, June, July and August windows coming up and then getting a full three months or quarters work come in the fourth quarter, so a very strong rebound in the Florida educational market. Texas has been strong both commercially as well as with the educational dynamic, so that continues to be a very favorable geography for us. California, primarily commercial strength with some improving educational strength especially in the northern part of the state, we still have not seen any significant lift in Southern California particularly in educational rentals. However, we do have some favorable contracts that we have captured during this school season that should support us next year. And then to the extent we get a bond [ph] major pass next year that would be a very significant benefit in the years ahead.

Okay, great overview. Switching gears to oil and gas, do you guess any contingent impact on other business lines and adjacent regions from the softness in oil and gas sector? And a follow-up on that what your visibility in Adler’s oil and gas business currently?

Yes. On the oil and gas what we’ve seen is the pricing in the marketplace is most severely depressed in the oil and gas arena, the upstream oil and gas. There is some pressure in certain regions into the non-oil and gas market opportunities and so if we look at our pricing on various rental products that we offer most severely done in oil and gas particularly with 21,000 gallon tanks, but for other categories of product as well there is some pressure in some areas reflecting if you will some that contingent in the marketplace.

Okay. Thanks so much.

Yes. The other piece was visibility, I would just say in general, we do have a number of what I call longer term relationships with customers in the oil and gas arena, so that does provide some helpful visibility in terms of their plans and what they’re trying to do, offsetting that a little bit is just the general volatility and uncertainty in that marketplace. And I don’t think anyone has a perfect ability to forecast what lies ahead there. We’ve been through a lot of change over the six to nine months and its still somewhat priority as to where we go from here. But we do have relationships and some important customer there and in fact we’ve taken some share with certain parts of that market.

Okay. Thank you very much.

The next question is from David Gold with Sidoti.

Hey, good afternoon.

Hi, David.

Curious just want to get a tiny bit more color. On TRS side I know you commented you’d expected some pickup in the second quarter, but didn’t when this happening. Can you give sense for where you are looking from -- what areas you are looking for that pickup and what maybe the anticipated driver was, was it just traditional seasonality or something else that basically didn’t come to pass?

The anticipated communications network project opportunity just didn’t materialized during the quarter. And those are really coming from service providers like Verizon, AT&T, Sprint et cetera and these are to do basically upgrades or enhancements to their communication – wireless communication network. So in turn, the folks that we rent, test equipment materials, the contractors, communication, electro contractors that do that field work didn’t have a need to rent the gear that they have in past years. And all this ability on when that work gets let by the service providers is very cloudy. So it can come at certain times of the year we would expect and if its not, its not there. And of course it complicate that more is the impact of under utilized communication test equipment is significantly in the fact that it has, let’s say on average about if 50% shorter life than for general purpose test equipment. So you have a much higher depreciation cost or carrying cost for that equipment and on the other side you get a rental rates that cam be two to four times higher on average than for general purpose test equipment. So, when that equipment is not utilized you kind of get it hit both ways, get the higher carrying cost and you don’t have the rental revenue at the higher level to cover that, that’s why you see that 10% drop in rental revenues resulting in approximately 35% drop in EBIT is because that exacerbation of those two dynamics.

Got you. Okay. Makes good sense. And then you know just looking at the base of equipment there. Presumably plans from here and at TRS, you still need to add there for other areas of demand or do you think the equipment base stays flat for the rest of the year there?

I think we have to look at the communications and the general purpose sides independently. As I mentioned in the prepared comment, our general purpose business is actually lifting from where it was last year and we’re having to add equipment to support that. So that’s a good guy. For the communication side obviously we’re being very tempered there and actually looking to sell more to be able to get out from some of that depreciation expense. So, likely we’ll continue to support the general purpose side and then we’ll have see how that communication side plays out, but we’re certainly being very prudent with any expenditures for the con side until we see changes.

And David, the thing I would emphasize is, there’s nothing structurally different in the business. We don’t see any weakening of our competitive position. As you might imagine with any work that ultimately is done for carriers, you got some concentration among those end user customers and if one of them has a period where budgets are not released or activity levels drop you certainly can feel the impact and that certainly what we experienced so far this year.

Got you. Okay. Fair enough. Thank you.

[Operator Instructions] We’ll take our next question from Sean Egan with KeyBanc Capital Markets.

Hey, good afternoon guys. I was hoping to get a little clarity on the yield trajectory within your mobile modular segment, it seems like you kind of had a nice pace of improvement there. Can you help us understand what’s driving that if it’s more a function of mix impact versus you guys going out and pushing price in a more favorable market?

It’s a combination of factors, first and foremost the building of rental revenues over the last nine quarters year-over-year is starting to have an impact despite our large spend in our inventory centers, so we’re starting to get margin lift from that and of course with our modular business that’s our longest term rental product and the more predictable product of all our different rental products, that’s first. Second, there are various shortages on certain types and size that equipment in various markets and that helping to drive rental rates up on specific types of equipment. Third, we have a very strong market positions on various classroom products in both the Florida and Mid-Atlantic markets and that supports margin expansion as well. But those are really the primary contributors there. And I would also say that exceeding the great recession its my strong belief that our competitive positions in virtually all of our markets is much stronger than when we entered the great recession. I think in turn that supporting that. And again mind you this is occurring without any really lift in the Californian market related education, so I just want to kind of underscore that and that will come at some point in the near future.

Got you.

And I would add Sean, this is a focus area within the business. Our teams have been working very hard looking at how to price appropriately recognizing some of the improvement in the market. And I would say the impact you’re seeing in the numbers, we want to work hard to continue moving in that direction and we’re definitely seeing a lot of activity to do that.

Got you. And then you eluded this earlier but I wanted to drill down a little bit on the sequential decline in utilization in Adler, was that primarily related to upstream or is that kind of an illustration of kind of contingent impact that you could be seeing in other areas as well?

Well, I just going to point out, I think sequentially in the first average utilization was 61.1% for Adler. It was 60.6% in the second quarter, given just all the on and off rental activity we have in that business, it is down slightly I don’t know that I would read that as being overly significant. Dennis, I don’t know if anything you’d add.

I think especially when you deal with. This first half to your seasonality dynamics the ebb and flow coupled with obviously this new price of oil and all the different movement and realignment there. So I don’t think -- there is nothing material in fact if you look at the amount of equipment we currently have on rents year-over-year at a $188 million versus $179 million at the end of Q2, I think it’s a pretty good sign that we’re almost – we’re taking markets or adding new equipment, although we also have areas that you know we’ve to add equipment to the fleet and again they’re kind of challenging area, they are 21k product and so we both spoke too earlier. So I think we’re making good progress, but there is a reset occurring here that we’re monitoring closely, but we’re to not seeing any structural or significant issues in the marketplace.

And just another data point you’ll see in the Q but for the period end of June utilization at Adler was 61.7% and that’s up slightly from the quarter – first quarter ending utilization which was 61.1%. But again I think the big picture here is given the demand environment we’d obviously love utilization to be at and all together at higher level, but I don’t think that its deteriorating in any significantly but we’re also working hard to and trying to get some lift from where we are.

Okay. Thank you. Great. Thank you. And last one from me is on our portable storage segment, can you talk maybe little bit about where you’re seeing some of that strength, is it mostly market share gains, is it rising tide kind of lifting all shifts with the broader economic improvement. Can you put your figure on anything on particular?

I think both of the points you made they are all fits nicely. I mean, it’s both better market activity as well as better pricing.

And we have in some regional expansion with that business that also incrementally helps us.

Great. Thank you. That’s all from me.

Thank you so much.

It appears there are no further questions at this time. I’d like to turn the conference back to management for any additional or closing remarks.

Well, thank you all for joining us this afternoon. And we look forward to sharing with you our third quarter results coming up in late October. Thank you so much.