McGrath RentCorp (MGRC) Q1 2016 Earnings Report, Transcript and Summary

Welcome to the McGrath RentCorp's First Quarter 2016 Earnings Conference Call. At this time, all conference participants are in a listen-only mode to reduce background noise, but later we'll be conducting a question-and-answer session. [Operator Instructions] This conference is being recorded today, Tuesday, May 3, 2016. Now, I would like to turn the conference over to Keith Pratt, Chief Financial Officer. You have the floor, sir.

Thank you, Andrew. Good afternoon and thank you for joining us on today's call. We are here to discuss McGrath RentCorp's first quarter 2016 results, which were reported today after the market closed. Joining me on the call is Dennis Kakures, President and CEO. 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. Please note that this call will be available for telephonic replay for up to seven days following the call by dialing 1-855-859-2056 for domestic callers and 1-404-537-3406 for international callers. The passcode for the call replay is 87501814. This call is also being broadcast live via the Internet and will be available for replay purposes in the Investor Relations section of the Company's Web-site at mgrc.com. 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 the Company's expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements are based upon information currently available to the Company and the Company 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 the Company's business are set forth in the documents filed with the Securities and Exchange Commission, including the Company's most recent Form 10-K. With these formalities out of the way, I will turn to our review of the financial results. For the first quarter 2016, total revenues increased 4% to $93.7 million from $90.2 million for the same period in 2015. Net income decreased 4% to $6.6 million from $6.8 million and earnings per diluted share increased 4% to $0.27 from $0.26. In March 2016, the Company secured a new line of credit with a syndicate of banks. This new line of credit replaced the Company's prior $420 million line of credit. As a result, the remaining $0.5 million of prepaid debt issuance costs related to the prior line of credit were charged to interest expense during the quarter, which reduced net income by $0.3 million and earnings per diluted share by approximately $0.01. Reviewing the first quarter results for the Company's Mobile Modular division compared to the first quarter of 2015, total revenues increased $6.2 million or 16% to $45.1 million due to higher rental and rental related services revenues, partly offset by lower sales revenues. Gross profit on rents increased $4.1 million or 34% to $16.5 million. Rental revenues increased $4.7 million or 18%, and rental margins increased to 53% from 47% as depreciation as a percentage of rents decreased to 16% from 17% and other direct costs as a percentage of rents decreased to 31% from 36%. Selling and administrative expenses increased 10% to $12.5 million, primarily as a result of increased salaries and employee 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 resulted in an increase in operating income of $3.8 million or 88% to $8.2 million. Finally, average modular rental equipment for the quarter was $709 million, an increase of $68 million. Equipment additions supported growth across all regions and our Portable Storage business. Average utilization for the first quarter increased to 76.1% from 74.2%. Turning next to the first quarter results for the Company's TRS-RenTelco division compared to the first quarter of 2015, total revenues decreased by $0.1 million or less than 1% to $28 million due to lower rental revenues, partly offset by higher sales and rental related services revenues. Gross profit on rents decreased $0.7 million or 8% to $7.9 million. Rental revenues decreased $1.2 million or 5%, and rental margins decreased to 38% from 39% as depreciation as a percentage of rents decreased to 45% from 46% and other direct costs as a percentage of rents increased to 17% from 15%. Selling and administrative expenses decreased 5% to $5.8 million, primarily due to lower marketing and administrative expenses. The higher gross profit on rental related services and sales revenues and lower selling and administrative expenses were offset by lower gross profit on rental revenues which resulted in a flat operating income of $5.2 million. Finally, average electronics rental equipment at original cost for the quarter was $261 million, a decrease of $3 million. Average utilization for the [fourth] [ph] quarter decreased from 59.9% to 59.6%. Turning next to the first quarter results for the Company's Adler Tanks division compared to the first quarter of 2015, total revenues decreased $2.4 million or 11% to $20.5 million, primarily due to lower rental revenues. Gross profit on rents decreased $2.9 million or 27% to $7.8 million. Rental revenues decreased $2.5 million or 15%, and rental margins decreased to 54% from 63% as depreciation as a percentage of rents increased to 28% from 23% and other direct costs as a percentage of rents increased to 18% from 13%. Selling and administrative expenses increased 5% to $7.3 million, primarily due to increased headcount and higher sales and employee benefit costs. The lower gross profit on rental revenues together with higher selling and administrative expenses resulted in a decrease in operating income of $3.4 million or 67% to $1.7 million. Finally, average rental equipment for the quarter was $308 million, an increase of $7 million. Average utilization for the first quarter decreased from 61.1% to 50.3%. On a consolidated basis, interest expense for the first quarter 2016 increased $1.2 million or 49% to $3.6 million from the same period in 2015 due to the Company's higher average debt levels, higher average interest rates and $0.5 million accelerated amortization of the prior bank line of credit issuance costs. The first quarter provision for income taxes was based on an effective tax rate of 39.5% in 2016 and 2015. Next, I'd like to review our 2016 cash flows. For the quarter ended March 31, 2016, highlights in our cash flows included; net cash provided by operating activities was $39.6 million, an increase of $5 million compared to 2015. The increase was primarily attributable to an income tax refund received, partly offset by a lower decrease in accounts receivable and other balance sheet changes. We invested $22.8 million for rental equipment purchases compared to $30 million for the same period in 2015. Property, plant and equipment purchases decreased $2.2 million to $0.9 million in 2016. Net borrowings decreased $15.5 million from $381.3 million at the end of 2015 to $365.8 million at the end of the first quarter 2016. Dividend payments to shareholders were $6.1 million. At quarter end, the Company had capacity to borrow an additional $226.1 million under its lines of credit and the ratio of funded debt to the last 12 months' actual adjusted EBITDA was 2.22 to 1. For 2016, first quarter adjusted EBITDA increased $0.6 million or 2% to $36.1 million compared to the same period in 2015, with consolidated adjusted EBITDA margin at 39% in 2016 and 2015. 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 2016 financial outlook, the Company reconfirms its expectation that total Company operating profit, adjusted EBITDA and earnings per diluted share will be comparable to 2015. 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 first quarter. Modular division-wide rental revenues for the quarter increased $4.7 million, or 18%, to $31.2 million from a year ago. This is the 12th consecutive year-over-year quarterly rental revenue increase for our Modular division. During the first quarter, we experienced a 14% increase in division-wide year-over-year first month's rental revenue bookings for modular buildings with a 31% increase in California and 2% outside of the state. Modular division average rental equipment utilization based on original acquisition cost for the quarter increased to 76.1% compared to 74.2% a year ago. This is our highest first quarter Modular division average utilization level since the first quarter of 2009. Modular division income from operations or EBIT for the quarter increased to $8.2 million, or by 88%, from a year ago. Gross margin on rental revenues increased to 53% for the quarter from 47% last year, driven primarily by higher rental revenues with flat year-over-year building preparation costs. EBIT margin increased to 18% for the quarter compared to just 11% in 2015, chiefly driven by improved rental metrics, including higher gross profit on rental related services, partially offset by higher SG&A expenses largely to support growth in Modular division business activity levels. Now let me take a moment to update everyone on our Portable Storage business. Mobile Modular Portable Storage continued to make good progress during the first quarter in building its customer following and increasing booking in rental revenue levels from a year ago. First month's rent booking levels and rental revenues for the first quarter grew by 21% and 29% respectively from the same period a year ago. We are working hard to make each of our portable storage operating geographies increasingly successful. We are on track towards building a meaningful sized storage container rental business with attractive operating metrics. Now let me turn our attention to TRS-RenTelco and their results. Rental revenues for TRS-RenTelco, our electronics division, declined by $1.2 million for the quarter, or by 5%, to $20.9 million from a year ago. The year-over-year reduction in rental revenues was driven primarily by lower communication test equipment business activity and a more competitive environment. In fact, communication test equipment rental revenues declined by approximately 14% for the quarter compared to the same period a year ago. General-purpose related test equipment rental revenues improved by approximately 5% year-over-year. Average equipment utilization was 59.6% for the first quarter, compared to 59.9% for the same period in 2015. Average rental rates also declined for the quarter to 4.49% from 4.66% a year ago, largely due to the business activity mix shift from communication to general-purpose test equipment as well as a more competitive communication test equipment marketplace. EBIT for the quarter was flat at $5.2 million as the 5% reduction in rental revenue was offset by lower rental equipment depreciation and SG&A expenses compared to a year ago. Our electronics management and sales teams have done an excellent job in a softer test equipment rental environment in selling lower utilized rental equipment to reduce depreciation expense as well as to hold costs down in other operating areas. 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, declined by $2.5 million for the quarter, or 15%, to $14.4 million from a year ago. Average utilization and total original cost of rental equipment were 50.3% and $308 million respectively for the first quarter of 2016 compared to 61.1% and $300 million a year ago. First quarter average equipment on rent declined to $155 million from $184 million a year ago, and from $166 million during the fourth quarter of 2015. Average monthly rental rates were flat year-over-year. However, this was due to the change in the mix of utilized rental assets with lower rental rate tank assets decreasing and higher rental rate box inventory increasing. Without the decrease in utilization of tank assets, overall rental rates would have been lower year-over-year. The reductions in both utilization and rental rates from a year ago are directly related to lower crude oil prices and the significant decline in wellhead related drilling and completions activity. Upstream oil and natural gas rental revenue declined from 19% of total Adler rental revenues in the first quarter of 2015 to 11% for the same period in 2016. These dynamics have put increasing downward pressure on 21K multi-purpose tank utilization and rental rates in upstream, midstream and downstream energy sectors as well as in other market verticals. EBIT for the quarter decreased $3.4 million, or 67%, to $1.7 million from a year ago. The higher percentage decrease in EBIT at 67% as compared to rental revenues at 15% was primarily a result of higher equipment depreciation and SG&A expenses as a percentage of rental revenues of 28% and 50% respectively from 23% and 41% a year ago. We remain very cautious in our outlook for our liquid and solid containment rental business for the foreseeable future as market forces drive a material reset of both the oil and natural gas industries. Now for a few closing comments. We entered 2016 with many unknowns and forecasting challenges regarding the oil and natural gas industries' evolving structural changes and their near-term impact to our liquid and solid containment rental business. Our first quarter results for Adler Tank Rentals are reflective of just how challenging an environment we are facing. On the positive side, our modular business overall is recovering nicely with a long runway of increasing earnings potential in front of it, including the very important California education market. We are also turning on a high-powered lens on return on invested capital, ROIC, for each of our businesses. This includes a deep dive in the transactional analysis of rental asset models in different vertical markets under various rental rate and term scenarios. We endeavor to update our analytics in understanding what transactions are marginal in the returns and that we need to raise rental rates and/or institute minimum rental terms or just discontinue doing altogether as well as those opportunities that we should be doubling our cultivation and booking efforts. Our focus is to deploy less capital, and more selectively, for new rental assets over the next few years until we see sustainable higher ROIC levels. I have dedicated a section of this year's Letter to Shareholders on the topic of ROIC and it will be a regular area of discussion in my future annual updates. And now Keith and I welcome your questions.

[Operator Instructions] We will be moving to our first question. This one is from Joe Box from KeyBanc. Your line is open.

So I actually wanted to go back to that comment that you just made, Dennis, on the returns focus. Aside from the obvious weakness that we've been seeing at Adler and TRS, it doesn't seem like things are getting demonstrably worse than they've been, but ultimately what led you guys to the decision to put more return focus on the business and how should we expect to see it play out through the numbers over the next couple of years?

What focuses management very quickly is when you look at our return on invested capital over the past 15 years and you see that obviously for an extended period we were in the approximate 10% range, and that level has actually dropped today below 6%. That's a real eye-opener. It's not that we weren't in touch with it previously, but we've been putting more and more focus on it. And when you look at the amount of investment we made in our different businesses over the last three to four years, it's been very significant, and we need to basically move the ROIC levels back up, we need to rent what we have, invest less, and that in turn will help our profitability dramatically.

Is there a reason why you didn't consider this or called this the strategic review of the business, is that too strong of a term?

I don't think quite frankly we're trying to nuance anything here. My Letter to Shareholders actually devotes a nice page on it with a nice graph, et cetera. And to be quite honest with you, the numbers are what they are and they are right in front of us and we need to address them. So, call it what you like, it's extremely important aspect of our ability to have higher earnings as we go forward. We don't need a lot of capital to be invested in Adler or in our Modular business to be able to move the ROIC numbers up very nicely. And so we're very mindful of that and that's our focus and we're giving it very full attention.

And keep in mind, Joe, one of the primary factors that drove ROIC lower in the last few years was the pressure on the California modular business, and we're not seeing some better conditions for that business. We're very hopeful about the education bond. So this is a lot about getting our focus on maximizing that opportunity, and it's an opportunity that shouldn't require new capital outlays.

Got it, appreciate that. And then to begin with the business specifically, on Mobile Modular, you guys saw solid leverage on inventory center costs. But as you look at the backlog and work in front of you for the peak season coming up, how should we think about the growth in inventory center costs and just the revenue trajectory as we go through the year?

If we look at those costs on a full year basis, we've built in a plan with a modest increase, probably in the order of magnitude 2% to 5% increase year-over-year in those costs for the Modular business. And again, it's all demand driven. I mean those are costs we'd be happy to incur because it means there's demand for shipping product from our inventory centers and doing more of it than we did in the prior year. But that's what's in our plans for the year.

So presumably that's about 2% to 5% increase and we're talking rental revenue growth of 2x to 3x that?

Yes, you can look at the most recent quarter and see we had good growth in rental revenues, which is also a combination of better pricing in the market. Our fleet average rental rate was up 4%. We also had a slightly bigger fleet. So those were other factors that impacted the higher rental revenues.

Got it. Thanks, guys. I'll turn it over.

Our next question comes from the line of Scott Schneeberger from Oppenheimer. Your line is open.

Just following up on the ROIC review, that's across all business segments in all businesses, but I suspect that's more tied to maybe some areas of Adler. Should that be our inference, and if so or if not, what's with that process?

Certainly Adler is probably at the top of the list but we've also put our Modular business, our largest earnings engine, right with it. We're the leader in the industries and the markets in which we operate and we also are very candid about how we can run the business better and get even better returns. And with that being the business, that's recovering very significantly. We want to make certain that we're at the top of our game in managing return on invested capital. So both of those are very important focuses, as well as our other businesses, but certainly those two are getting the great majority of focus.

And so should we take away from that comment that perhaps you're working for stronger price in the modular space? You've addressed it a little bit what the environment is like but is that an area where competitively you feel you are leader?

There's no question that pricing is a very key element, and especially if you have assets turn off rent that may have been out there in the great recession, they come back, and then go at much higher rates. But it's also looking at the different types of transactions we do in general and are we receiving enough income or minimum terms for those particular assets. In reality, good rental companies and high [indiscernible], you don't need to be everything to everybody, and if you plan to be that, then you have to make certain you get paid accordingly. So what we're trying is like dissect it by product, by type of product and different terms and applications.

All right, thanks. And then maybe in the same bucket, with regard to your storage container rental business, where are you geographically? I know you slowed down the expansion of many business units coming into last year just to kind of control OpEx in front of the growth. Where do you stand with building that and is that in the same ROIC review or you're still gung ho that that's a business you want to be in and can optimize and just be a constant expansion?

We're still with that business, we love that business, we think it's a very nice ROIC return business, and if we're able to realize critical mass and better and better metrics in our different locations over time, one of the key elements to better returns on invested capital in that business is rental term, and it's finding those opportunities where term becomes longer. And if you look at our average rental terms for that business as we track them historically, they are increasing quarter-over-quarter, year-over-year, and that's a function of pursuing the right verticals that tend to have longer rentals and that can make a significant difference on ROIC. But at the end of the day, that business is likely going to have much less attention to it because it's still in a growth mode, but the metrics themselves that we're looking at more closely there is, what's occurring in a more mature branch versus the newer branch and are we able to move from certain margins to greater margins over time, and we've been demonstrating that in the branches that we've been in for an extended period of time. So the goal now is to take the other branches and regions that we have and ensure that those are moving on a similar track.

The only thing I would add is, if you look at where the invested capital is deployed, the storage container business is a relatively speaking smaller portion of the invested capital compared to the Modular business and the Adler business where there's a lot to work with.

Thanks, Keith. And just curious, how many markets are you in now with regard to the storage container rental business.

We are in the California, Texas, Florida, Mid-Atlantic and Midwest Greater Chicago area markets.

Okay, thanks.

And by the way, when we say Mid-Atlantic, it's really from Georgia up into New Jersey and in selected markets there.

Okay, thanks. And then lastly and I'll turn it over, just could you give us an update on the California fiscal financing situation as it pertains to your [indiscernible] rental business?

Currently, the state is in the best financial health it's been in for many, many years. And as you already are aware of, there on the November ballot will be approximately $9 billion educational facility bond measure, and those bond measures have been very successful over time in passing. And this particular one, if it is successful, which we expect it to be, could be a wonderful catalyst that Keith mentioned a moment ago for the educational rental business going forward. And we like our market leadership position in that business today as well. So we're very hopeful that that passes. In addition to that, on the same ballot is an extension of some of the current taxes that were instituted a few years ago on higher personal income tax and corporate taxes. And both of those measures, thus far in the polling are receiving very attractive favorable ratings by the electorate.

Okay, great. Thanks for that update.

Our next question comes from the line of David Gold from Sidoti. Your line is open.

Just a couple of points of follow-up there. So first is, I would love for you to go over sort of broadly on a Company-wide basis the biggest variances say today versus a quarter ago. In other words, guidance unchanged presumably because [indiscernible] have changed a little bit. So curious if you can give us some sense of, from your internal thinking calculations, what's most changed?

I'd say what's similar to what we expected for the year as a whole is we expected the Modular business to have a strong year, we expected the electronics business to be flattish year-over-year and we expected it will be very challenging as a year for Adler. And so, when we entered the year, I think we made these same comments back in February. That's what we expected. I think that's how it's playing out. I think very much incrementally and at the margin. It's probably a little tougher in Adler than we had expected. It's also proven to be a little stronger in modular so far. So those have balanced each other out to-date, but I don't think they're a lot different from our sort of overall view of what each of the operating segments could contribute.

Okay, perfect. And then part two, as we think about Adler from here, couple of difficult questions, how much worse do you think utilization can get given what you're seeing and how much more pain do you think there could be in that business at this point?

Utilization level in the first quarter with it not only being a very challenging energy sector environment but also being the most seasonally sensitive for Adler, I'd like to believe it doesn't get a lot worse than that. However, we're going to have to see how things evolve here. But my sense is, I'm hopeful that Q1, if it is lower at any time than Q1, it isn't a lot lower, but my sense is that Q1 was as challenging a quarter as we're likely to see this year. I'm hopeful of that, and again, I'm going to remain very humble about the outlook for the business just because there are so many unknowns with respect to the reset in the energy sector.

Fair enough. Part two along those lines, and presumably you're doing what you can there to drive profitability, but is there anything that you can do that maybe is within your control there, even presumably if you sold containers at this point of the pricing, can't imagine it's all that good, but basically are there changes or spots where you can find utilization at this point?

We've been focused for the last year approximately really trying to work other verticals that are much less sensitive. However, in this type of environment, lots of people are doing the same thing. So to be candid, this is a lot of pick and shovel work currently trying to build the new verticals including national account type program, et cetera. And there's not a lot of opportunity to sell excess equipment in this kind of market. And that's just a very candid assessment of the current environment. I will say this. Adler has the youngest rental fleet in the industry, it's the best built and it has the most, the largest number of market verticals that it can be deployed into in terms of being fungible.

Fair enough. Thank you, both.

Ladies and gentlemen, that now concludes today's Q&A session. I'd like to turn the call back over to management for closing comments.

I'd like to thank everyone for joining us today. We appreciate your continued support and we will look forward to seeing as many of you in the room for our Annual Shareholder Meeting on Wednesday, June 8, here at Livermore, and if not, be connected via the Web. And you can find location or that information on our Web-site for how to be able to access the link for the meeting itself. Thank you so much.

Ladies and gentlemen, thank you again for your participation in today's conference. This now concludes the program and you may all disconnect your telephone lines at this time. Everyone, have a great day.