WillScot Holdings Corporation (WSC) Q2 2019 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Welcome to the WillScot Second Quarter 2019 Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] I would now like to turn the conference over to your host, Mr. Matt Jacobsen, VP of Finance. You may begin.

Thank you, Teresa. Good morning. Before we begin, I'd like to remind you that we will discuss forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those forward-looking statements and as a result of various factors, including those discussed in our press release and the risk factors identified in our 2018 Form 10-K filed with the SEC and our Form 10-Q that we will be filing today. While we may update forward-looking statements in the future, we disclaim any obligation to do so. You should not place undue reliance on these forward-looking statements, all of which speak only as of today. We'd like to remind you that some of the statements and responses to your questions in this conference call may include forward-looking statements. As such, they are subject to future events and uncertainties that could cause our actual results to differ materially from these statements. WillScot assumes no obligation and does not intend to update any such forward-looking statements. The press release we issued last night and the presentation for today's call are posted on the Investor Relations section of our website. A copy of the release is also been included in an 8-K that we submitted to the SEC this morning. We will make a replay of this conference call available via webcast on the Company website. For financial information that has been expressed on a non-GAAP basis, we have included reconciliations to the comparable GAAP information. Please refer to the tables and slide presentation accompanying today's earnings release. Lastly, this morning, we are filing our 10-Q with the SEC for the second quarter of 2019. The 10-Q will be available through the SEC or on the Investor Relations section of our website. Now, with me today, I have Brad Soultz, our President and CEO; and Tim Boswell, our CFO. Brad will kick-off today's call with a brief overview of WillScot, summarize our second quarter results and provide an update on our key performance indicators and our markets. Tim will then provide additional detail on the financial results for the second quarter and discuss our outlook for the rest of the year before we open up the call up for questions. With that, I will turn the call over to Brad.

Thank you, Matt. Welcome everyone to WillScot second quarter 2019 conference call. Moving to slide five of our investor presentation, we'd like to highlight our performance, as well as the strong momentum in which we exited the quarter. WillScot delivered another outstanding quarter as we continue to execute our strategy, which is in resulting in a complete transformation of the company. The result highlights the value of scale, synergy realization in our business, when combined with our commercial strategy to drive lease revenue growth organically through rate optimization and penetration of our Ready-to-Work solutions. While Tim and I will provide additional context throughout the call, I'd first like to highlight five key aspects indicative of the strength of our business. First, $266 million of revenue in the second quarter, which is up 90% over the same in the second quarter of 2018. On a pro forma basis, our consolidated Q2 revenue was up 1.6% versus the prior year, as we continue to transition the acquired portfolios, emphasizing and expanding the high-value leasing and Ready-to-Work aspects of the business. Our U.S. Modular segment, which drives about 90% of our revenue, realized pro forma modular lease revenue increases of 10.5% over the prior year, offsetting declines in other lower value aspects of the business. The evidence of this success in our strategy is most apparent in our U.S. Modular Space average rental rates, which were up 16.1% year-over-year on a pro forma basis. This is the seventh consecutive quarter of double-digit rate growth and we expect this momentum to continue as we look ahead. Second, delivered $89 million of adjusted EBITDA, which is up 112% versus the prior year, at an adjusted EBITDA margin of 33.3%. On a pro forma basis, our adjusted EBITDA was up 23.5% and margins were up 590 basis. In addition to the impressive flow-through of the top line growth, ModSpace related cost synergies continued to ramp-up throughout the quarter, such that approximately 50% have been actioned and included in our result as we exited the quarter. These cost synergies, along with those of prior acquisitions, contributed $8.8 million of cost savings in the quarter on a cumulative basis. Third, accelerating adjusted EBITDA growth and continued margin expansion. With a strong start to the first half of the year, we're confident in achieving our estimated adjusted EBITDA run rate of approximately $400 million and adjusted EBITDA margins of 35% as we exit 2019. Fourth, accelerating free cash generation. Given the cost and cash expenditures associated with achieving those cost synergies, we're biased to the first half of 2019. We expect our discretionary free cash flow generation to accelerate in the second half of the year approaching a $200's million annualized rate as we head into 2020. And fifth, net income and free cash generation in the second half of 2019 accelerates deleveraging as we head into 2020. During the quarter we completed the redemption and the refinance of the unsecured notes, which will result in a reduction in annual interest cost of approximately $6 million. These accelerating earnings and inherent cash flow characteristics of our platform provide confidence that by the second quarter of 2020, we expect to be at or below 4x net-debt-to-adjusted-EBITDA, which is in line with our net leverage range of 3 times to 4 times. In summary, we're very pleased with our second quarter results and the trajectory upon which we entered the second half of 2019. Based upon the strong results in the first half of the year, we are raising our 2019 outlook for full year adjusted EBITDA to between $355 million and $365 million. We believe that growth levers driving our business are largely within our control and our year-to-date results provide us with the confidence that we'll achieve this updated guidance. We'll exit the year with the adjusted EBITDA run rate of $400 million and we will be deleveraging to below 4x by the second quarter of 2020. Turning to slide 6, I'd like to highlight the magnitude of the transformation we've undertaken since recapitalizing and returning the company to the public markets at the end of 2017. Since then, we've acquired and integrated three great companies. This is resulted in a more than doubling the size of the company by almost any metric. Just to highlight a few of these. By the end of 2019, we expect our revenue to have increased by approximately 140%. Our adjusted EBITDA will have increased by approximately 190%. We've added about 900 employees to our team, including 30 new markets where we now have a physical presence that we didn't have before. We've doubled our fleet and emerged as the undisputed leader in modular office market now serving over 50,000 customers. Lastly, I'll highlight the tremendous growth we've seen associated with the increase in penetration of our unique Ready-to-Work value proposition or VAPS. We've realized over a 45% increase in our VAPS delivered rates since 2017, all while executing the integration of the three acquisitions. Our customers, including those new to us, are embracing this value proposition and it's driving growth with highly accretive returns. I'd like to thank our customers for their trust in us and the entire WillScot organization for their continued performance. I remain convicted in my view that we have the right strategy and the right team to continue to drive long-term shareholder value. Turning to slide 7, we are realizing greater than 100% flow-through of incremental revenues on a pro forma basis. Starting at the far left, you'll note that our Q2 2018 adjusted EBITDA was $41.9 million. This would have included the Acton acquisition which we have then begin to integrate, adding ModSpace for our total pro forma adjusted EBITDA to $71.8 million. We estimate that we realized $7.5 million of the $8.8 million cumulative cost synergies related to the acquisitions in the second quarter. I'd note $1.3 million of the AIA were associated with the early stages of the Acton integration and we realized in our second quarter results the prior year. We then realized a $9.4 million increase as a result of organic growth, primarily driven by rate optimization and increased VAPS penetration, offsetting reductions in lower aspects of the business consistent with our strategy. All this building to our first quarter adjusted EBITDA as a result of $89 million and EBITDA margins of 33.5% on a pro forma basis. Turning to slide 8, I'll provide a snapshot of our key leasing KPIs in the U.S., realized during the second quarter of 2019 since they provide primary foundation for the run rate in which we exited the quarter. I'll note, I'm presenting the results on a pro forma basis as this best reflects the underlying trajectory of the business. First, I'll remind you as well our operational focus has been to safely and swiftly integrate the three acquired business with prioritization of an optimizing rate, extending VAPS penetration and asset utilization. As reflected in the top left chart, modular space average monthly leased rates of $612 was up 16.1% year-over-year reflecting an acceleration versus the first quarter. This outperformance is driven by the former ModSpace enacting units that are now returning and being redeployed at higher prices with higher penetration of our unique Ready-to-Work value provision. As mentioned before, this is seventh consecutive quarter of this double-digit rate growth and we do expect this momentum to continue. In the left-hand middle chart, U.S. modular space utilization of 74.1% was up 20 basis points year-over-year as we continue to rebalance and consolidate the acquired line of fleet from the more than 200 branches the individual companies were operating to the 120 branches we are now operating from. And then the bottom chart, pro forma modular space to rent or volumes on rent were down 4.2% on a pro forma basis given our transition of the acquired fleet to the Ready-to-Work solution and the integration activities. While port activity has remained at or above our expectations throughout the second quarter, as I mentioned on our first quarter call, the more broad spread and severe weather impacts, which were delaying some starts to new projects certainly extended through the second quarter. The related reduction in unit on rent volume has been weighted towards lower value and shorter lease durations, which are more susceptible to such disruptions. The net result was a very robust 10.5% year-over-year growth in U.S. pro forma modular leasing revenue, which is in line with our original expectations both for the remainder of 2019 and our run rate headed into 2020. Turning to Slide 9, in addition to the $70 million cost synergies associated with the acquisitions, there is over $140 million of annualized revenue growth opportunity. Our VAPS penetration levels continue to increase towards our longer-term stated goals. In the second quarter, the average rate of VAPS value per month across all office units delivered in the prior 12 months continued to accelerate to $276. This rate is up 21% over the LTM levels achieved the prior year. This continued outperformance is particularly pleasing given the last 12 months incorporated in the integration of Acton and ModSpace acquired portfolios and teams. We have been successful in combining our sales team who themselves have been successful introducing this unique value proposition to many new customers. The associated growth in revenue will occur over the next three years as the units currently on rent are returned once their current projects end and are redeployed at our current level of VAPS penetration. The realization is simply paced by our average 32-month average lease duration. We expect the demand for this value proposition will continue to increase over the next several years as we both expand our offering and increase penetration to our legacy customers as well as through customers of the newly acquired businesses. As we continue to increase this penetration this opportunity is expected to expand and extends in duration. Before handing it over to Tim, I'd ask you to turn your attention to Slide 10 in order to expand upon our demand outlook across our diverse end markets. First, I'd like to direct you to pie chart in the bottom left of the slide which breaks down our end market exposures. In addition to a very diverse group of end markets, our customer base is highly fragmented with no individual customer representing more than 3% of our revenue and the top 50 customers representing less than 15%. At an aggregate level we've seen no material shift in end market activity. Our best indicator for demand is a code activity generated by the field which has remained at or above targets and drives our order book for deliveries to new projects. I would also highlight the idiosyncratic growth levers inherent in our business associated with the value of M&A related scale, synergy realization, combined with our commercial strategy to drive lease revenue growth organically through rate optimization and penetration of our Ready to Work solutions. So, while there's clearly been some disruption both internally and externally in the first half of the year, our overall demand outlook remains positive and our CapEx guidance reflects an expectation of strong reimbursement of the business in the second half. I'd note that if that demand outlook changes, we have a flexible capital strategy investing to support growth as markets afford and balancing growth and long-term returns. One of the key strengths of our business model is the discretion and flexibility that we have over capital spending in the short-term coupled with our average 32-month lease duration and long-lived assets allowing us to reallocate or reduce capital spending and drive free cash flow to the extent markets do not support growth. We continually monitor our demand and have a disciplined process through which we control and allocate our capital. With that I'll hand it over to Tim who will provide additional context.

Thanks Brad. Please turn to Slide 12. As Brad said, Q2 was a great quarter for WillScot and it's our continuity in many of the same trends that we discussed in Q1. So much of this commentary will sound familiar. The top chart tiers show our year-over-year revenue and adjusted EBITDA as they're recorded in our financial statements. Revenues were up 89.7% and adjusted EBITDA $88.7 million was up 111.7% versus prior year marking our 9th consecutive quarter of sequential EBITDA growth. About 64% of the adjusted EBITDA growth is coming from the prior year contribution of ModSpace and the remainder is coming both from the synergy realization and organic growth in the combined leasing operations. The bottom chart show revenue and adjusted EBITDA growth year-over-year on a pro forma basis which is a better indication of how the combined portfolio have performed organically. Total revenue was up 1.6% on a pro forma basis with 9.2% year-over-year growth in modular leasing revenue, partly offset by a decline in sales and delivery of installation revenue. This is obviously a continuation of a revenue mix shift favoring our long-duration leasing operations which is improving both the profitability and the predictability of our business. Similar to Q1, in the bottom pro forma charts, we saw tremendous operating leverage in the platform and flow-through to adjusted EBITDA in Q2. Of the $16.9 million increase in pro forma adjusted EBITDA approximately $7.5 million came from incremental cost synergies dropping to the bottom-line as planned. This $7.5 million was incremental to approximately $1.3 million of synergy savings we have realized from the Acton and Tyson acquisitions in Q2 last year. Of the remaining $9.4 million increase in pro forma adjusted EBITDA sales and delivery revenues were down year-over-year representing approximately a $3 million headwind. So, adjusting through that this implies over $12 million of adjusted EBITDA growth that resulted from the $15.8 million increase in modular leasing revenue or flow-through in excess of 75%. If you include the cost reductions that we executed, flow-through was over 123%. Altogether, pro forma adjusted EBITDA was up over 23% versus prior year and pro forma margins were up 590 basis. Looking at the quarter sequentially relative to Q1 is also useful and quite straightforward, modular leasing revenue has increased 5% sequentially with that dollar growth offset by the seasonal ramp-up in our direct variable costs that we talked about last quarter and which are expense in the period. Delivery and installation revenues increased 12% sequentially, reflecting that pickup in activity with margins expanding again to 14.2% in Q2. Contribution from new and rental unit sales was down approximately $0.5 million sequentially and SG&A was essentially flat and adjusting for non-recurring items. We expect a similar formula will hold true sequentially in Q3. Direct cost should continue to ramp and offset modular lease revenue growth in the period. I'm still cautious regarding delivery and installation margins and would expect them to contract a couple of hundred basis points, as delivery volumes began to exceed return volume. Contribution from sales will continue flat to down sequentially. You'll recall sale revenues will be down $35 million to $40 million year-over-year on a pro forma basis due to one large ModSpace sale project last year, most of which fell in the third quarter of 2018. So you really can't model new and rental units sales up last year, rather these are progressing sequentially flat to down. With SG&A flat again in the Q3, overall margins like they contract a bit before we realized additional cost reductions in Q4. Revenue to our original forecast, we will have effectively shifted a portion of our earnings from Q3 into Q2. Overall, we're thrilled that the quarter and our trajectory had remainder of the year. On slide 13, we've already highlighted the mix shift between average monthly rate in the bottom right and average volumes on rent and utilization at the top right. And while the contribution from price and volume is a bit different than we expected six months ago, and then that sort of biased our markets quite minimal and it is clear that rates up 16% in the U.S. for delivering more value for transactions to our customers. I'll skip slide 14 since the U.S. segment drives everything we've already discussed at a consolidated level. In Q3 timing on the slide 15 regarding the other North American segment. In the bottom left chart, the margin drop in Q2 was driven almost entirely by a lower margin rental unit sale. So they're not indicative of where we think margins are headed in that segment, averaging Q1 and Q2 margins is the more reasonable assumption going forward. Similarly in the top right chart, we deployed a portion of our Canadian dormitory fleet in Q2 to portions of Alberta that were impacted by wildfires. These were on short-term leases, and therefore, inflate the average rental rate. So, revert back to Q4 and Q1 monthly rates, and do not extrapolate up Q2. Slide 16 is our usual reconciliation of net loss to adjusted EBITDA. In Q2, total restructuring and integration costs again drops by 42% sequentially from $16.1 million in Q1 to $9.4 million in Q2. In addition to the restructuring charges, we incurred $6.2 million prepayment premium, when we redeemed the 10% unsecured notes. We wrote-off $1 million non-cash deferred financing cost from the unsecured notes, and booked a $2.8 million non-cash impairment of a favorable lease intangible on a large former ModSpace facility that we exited. Again, we highlighted these in the interest of transparency and illustrate the path we see in consistent earnings generation as we complete the integration work and realize the savings from our recent refinancing activities. Containing that theme, slide 17 shows where we can't overall on synergy realization, integration and restructuring costs as well as real estate proceeds. On the left, our Q2 run rate now includes 49% of the $71 million of total annual cost synergies that we originally identified. We remain on track to deliver 80% of the total synergy value in our Q4 2019 run rate. As we said before, we do see incremental categories of opportunity heading into 2020. For example, we have deployed internal and third-party resources to explore opportunities in the area of transportation and logistics and will report on that later in Q3 or Q4. In the middle chart, we see the $8 million of remaining integration and restructuring costs in the remainder of the year. So those average head largely run through the P&L at this point. And in the right-hand chart, we generated $9 million of net proceeds from real estate sales in Q2, as of the total of $40 million from the ModSpace acquisition that we intend to monetize. We continue to be very pleased with the asset valuations we are seeing. And our field and operation personnel have their hands full and they're doing a great with the real estate consolidation. Together the realization of the cost synergies and the completion of the integration in the monetization of surplus real estate will all support free cash generation in the second half of the year, as top line run rate continues to build. And we saw this transition beginning in Q2. Before we move to free cash flow, let's spend a few minutes on page 18 explaining the changes to our full year outlook. For total revenue, we narrowed our full year outlook to the lower half of our original range. This is simply an acknowledgement that we have indeed transitioned the business away from new and used unit sales and are more heavily weighted towards modular leasing revenues, which are in line with our original expectations. The net result of that is a higher quality, higher margin's and more predictable in our revenue streams, due to period of our lease duration. We raised the low end of our original adjusted EBITDA guidance based on the strong first half results and second half results that are generating in line with our original expectations. Simply taking the midpoint of our revised EBITDA and revenue guidance suggests that margins are trending 100 to 150 basis points above original expectations, due to the more attractive mix of sale and leasing revenue as well as the contribution of pricing and value-added products related to volume within our revenue guidance. Lastly, on net CapEx, we expect to be towards the top end of our original range. Feedback from the field right now regarding market outlook and the remainder of the year as well as our VAPS performance to-date with support this level of investment although as Brad mentioned we reserve the rights of adjust as we get new data. I'll note the revised range also include between $10 million and $15 million of investments to populate VAPS inventory in acquired ranges, improved infrastructure in branches that are now handling much larger volumes and a complete fleet production in the ModSpace manufacturing facility, prior to shutdown in June. High risk [ph] because they are more integration-related CapEx items and not indicative of what we would consider to be normal spend levels. Overall, we're excited to focus on the top-end of our original EBITDA guidance range and reconfirm that we are on track to deliver an expected EBITDA run rate of $400 million and margins of at least of 35% heading into 2020. Based on this revised outlook, we updated the free cash flow bridge on page 19 and expect between $60 million and $90 million of free cash flow in the remainder of the year, which effectively narrows the full year range around the midpoint of our original guidance. In the top chart, cash consumption of $25 million in the first half of the year was unchanged from Q1 which means Q2 free cash flow was neutral and transitioning in the right direction. In the bottom chart moving left to right the midpoint of our EBITDA outlook increased by $5 million. Our expectation for cash interest in the second half reduced by approximately $3 million thanks to the refinancing and we have shifted the CapEx outlook to the top-end of our original range. The net impact of those changes is effectively a narrowing of the original free cash flow range around the midpoint and should be weighted more heavily towards Q4 as lease revenue EBITDA and free cash flow ramp-up sequentially into 2020. This is all consistent with what we shared at the offset of the year and we are committed to executing the plan. Moving to slide 20, before turning back to Brad we executed an opportunistic $190 million tack-on in May to our 6% 2023 secured notes and used the proceeds to pay down our ABL. We then used cash and ABL availability to redeem our 10% unsecured notes in June taking advantage of the flexible prepayment features that we structured last year when financing the ModSpace acquisition. And we did so sooner then we had anticipated based on the strong performance of the business. The net result of these transactions is approximately $6 million of annual net interest expense savings beginning in Q3 and our weighted average cost of debt is now under 6.2%. With nearly $490 million of availability, we have ample liquidity in the ABL and we are on track to achieve our four times leverage target by Q2 of 2020. We appreciate the support of all the investors who participated in these transactions in Q2. One last compliance-related matter, earlier in the fall when Brad highlighted the extraordinary growth and changes that we've implemented since 2017 there was a slide that mentioned we will transition from an emerging growth company filing status to a Large Accelerated Filer no later than Q4 this year. This is due to WillScot having equipped a market capitalization threshold as of June 30, as well as our expectations delivering over $1 billion of revenues fiscal year. This will pull-forward our five new timelines next year and we will also be implementing the new ASC 842 lease standard later this year. We will provide additional detail on these changes in our 10-Q, but I did want to flag them for you, and also thank our team who are doing an outstanding job of preparing WillScot for this next chapter's above and beyond. With that, I'll hand it back to Brad on slide 21 for the closing comments and the Q&A.

Thank you, Tim. Well, we're extremely proud of all that we've accomplished in the second quarter of 2019. We're very confident in our revised 2019 outlook and our ability to achieve the adjusted EBITDA run rate of $400 million by the fourth quarter with discretionary free cash flow generation approaching a $200 million annualized rate as we head into 2020 and altogether deleveraging to 4x net debt to adjusted EBITDA by the second quarter of 2020. I remain convicted in my view that we have the right strategy and the right team to continue to increase long-term shareholder value. We appreciate you taking the time to join us today, and for your interest in our company. We look forward to speaking with you many soon – with many of you very soon. That concludes our prepared remarks. Now, we'd be happy to take your questions. Teresa, please open the line.

[Operator Instructions] And your first question comes from Kevin McVeigh with Credit Suisse.

Great. Thanks. Hey Tim or Brad, can you frame -- it looks there if my math is right, there was about a 760 basis points headwind from the lower sales volumes in the D&I. Just any thoughts around that? And then I've always thought that D&I as a potential area where you can make some margin progress as well. Just any thoughts around that as you start to look at kind of the next phase of synergies post ModSpace?

Yes. There are two things going on. This is Tim. Hi, Kevin. So as we've said for some time now WillScot historically in the ModSpace more recently had a higher mix of new sale revenue in their total revenue stream. It's lumpy. There is some risk. And our strategy is to only sell standard equipment for standard projects and the situations where we would also otherwise lease a life asset. So we have the emphasize them and say the sales mix that you see in the year-to-date numbers is indicative of how we intend to operate the business going forward. So you can get them out of that proportionally to what you see year-to-date. The D&I question is the really good one. And I was thrilled to see another sequential quarter of D&I margin expansion. I think it was 14.1% or 14.2%, which is outstanding. So we're really happy about that. We're excited about it. And we agree there is future opportunity. As I mentioned my remarks, we've dedicated some of our talented operations and third-party resources to focus on that as we head into 2020. Now mix does impact D&I margin. So as we get into a period here later in the year where we expect some sequential unit on growth, we'll as a result have more deliveries then returns. And as I mentioned my remarks that could put some temporary pressure on the D&I margin. But I agree with you, there's certainly medium-term opportunity.

Awesome. And then just real quick I'll get back in the queue. Hey, Brad, if I heard you right, is the 32-month is the average lease durations. Is that up two months, because I thought it was in the 30-month range and just any thoughts on that?

Yes, if you'll remember Kevin back in 2017 WillScot alone was 35 months, 36 months. The Acton mix brought it down. ModSpace has changes. So it's just a reflection of the evolution of the acquired portfolios. But yes, it's up 32 -- two from 30.

Awesome. Thank you.

And your next question comes from the line of Scott Schneeberger with Oppenheimer.

Thanks, good morning. Guys you covered it very well broadly. But I'd just like to hone in on the guidance a very strong first half. Curious you certainly -- on adjusted EBITDA increased the low-end still kept the high-end. How do you feel you're tracking relative to that high-end? And what would you characterize as the primary good and bad swing factors that could help and hurt here in the back half? Thanks.

So the sales question is always something that can move here quickly one direction or the other. I'd say our expectations in the second half are pretty modest there. The delivery and installation margin I believe continues to be an opportunity. The irony in this business as you know is the rates on new deliveries and the technical volume of new deliveries as you get into the second half of the year, actually don't impact the full year results that much. So really, the other items that can have a short-term impact around the costs side, honestly if deliveries were much stronger than we expected, we actually incur more direct cost in the P&L as well as potentially refurbishment spent, which is why we kept the CapEx range where it is.

The only thing I would add Kevin. I think we are...

Scott.

Or Scott. I'm sorry, Scott. We're centered on the range would be the realization of the cost synergies. So we've got 50% action and then our run rate I believe in the second quarter. We think we've got everything well on track to be at 80% in the fourth quarter. But any plus or minus that on timing I don't think there's any risk than magnitude would be the other variable.

Excellent. Thanks guys. And then, I just want to go back to rental rates and margin and other North America. Tim, you outlined it pretty well and as far as how we should think about modeling margin there. But could you talk about the rental rate drivers? And what you see a little bit longer term in that geography? Thanks.

Yes. So as you know we pricing part based on duration of these. So you'll charge a fair amount more for a short-term lease then you would offer a rate to your three-year lease. And we also have different sizes of equipment that can some times have a mix impact on rental rates. And those types of things get magnified a bit in the other North America segment just due to a smaller scale. So in Q2, we do have a small dormitory fleet in Western Canada and we deployed a number of those assets on a one or two-month rentals. So a very short-term with some wildfire release. And that release the average run rate in Q2. I don't have another trend there in that market right now to point to that would cause me to expect anything other than what you just saw in Q1 of this year and Q4 of last year. So I think that's kind of the right way to think about rental rates in that segment.

All right. Thanks for that. And just one more for me. When you were discussing your slide about end market, you've indicated really not much change. But since construction is such an important market and closely watched, if you could just give some of your thoughts and maybe customer feedback from the field with regard to that end market? Thanks.

Certainly, just the revenue and then Brad you can maybe talk customers. We compare this -- these 15 end markets on just -- in total revenue generated on a pro forma basis year-over-year. And frankly every second on here is up with significant strength in construction with the exception of government or the public side. And you know there's, obviously, been some noise there. But it's really encouraging to see all the other end markets up. And frankly the proportions really haven't changed. So we're not seeing anything really interesting I guess from an end market mixed change perspective.

Yeah, Tim framed it up well. There is -- there has been no material change in mix. I mean as I mentioned on the call these weather disruptions, I don't get too excited about them but they were certainly more broad spread and a bit more severe this year then normal. I mean the way we look at that is it just delays a project from starting. It doesn't change the fundamental demand if you will. And I think aside from that looks incredibly pleasing is these customers almost across that end market segments are realizing the value of the Ready to Work solution. So instead of delivering empty assets very -- invest to their small incremental amount. So with the furniture and we’re realizing that 40% unlevered IRR on that minor investment. So I think that's the way we see it. And as I mentioned we -- the feedback from the field right now and that's co-related by the inquiries of both we're seeing is in line with our expectation. So we expect demand to be robust as we go ahead. And so we're planning from a capital guidance perspective as well.

Okay. It sounds good. Great work. And I’ll turn it over. Thanks.

And your next question comes from the line of Courtney Yakavonis with Morgan Stanley.

Thanks guys. I just wanted to dig into a little bit more about the change in revenue guidance and just on the units on rent being down this quarter. So, obviously, it's been partially whether, partially some of the integration. But if you can just address how things progress sequentially through the quarter in terms of volume? Did you see a pickup going into the typical seasonal build? And then remind us again, what you're embedding now in the revenue guidance for the full year per units on rent?

Yeah Courtney, this is Tim. So the biggest business driver of our change in revenue guidance is strictly related to sales. So we have two say line items new unit sales and rental unit sales. And all we're doing right now is just acknowledging that we haven't deemphasized those, whereas, the company on a pro forma basis inclusive of ModSpace would have higher mix of those items historically. That's just a strategic shift that we have articulated since the outset of the ModSpace acquisition. So when we talk about expectations through the remainder of the year, as well as the run rate going into 2020 that's really driven by the lease revenue streams, which is where we got the long 32-month lease duration that gives us the predictability and the visibility in the business that's kind of right where we want it to be, albeit with a different mix of pricing value-added products and units on rent that you highlighted. So the unit on rent trajectory from here, I think the best way to think about it is we are seeing the order book continuing to billed as Brad mentioned and you would also typically expect a modest seasonal tapering of units on rent as you go into Q4. So I think the best way to think about unit on rent for the remainder of the year is kind of flat to where we were in Q2. It will ramp a bit in Q3. But then taper a bit in Q4 and I'd say flat from Q2 is the best way to think about it.

Okay. So, on a year-on-year pro forma basis that you are expecting to be down?

Yes. That would imply it remains down. So, first flat in Q2 plus or minus a percentage point. I think that's the right kind of range of dollars.

Okay. Got you. And then also just trying to understand. I know you give some guidance on expecting margins to dip in the third quarter before reaccelerating. But when I look at your EBITDA guidance, it does -- I think it implies a pretty significant shutdown close to like 30% for the second half of the year. So, given that you're planning to exit the year at a 35% rate. Just trying to understand the dynamics what's going on there? Any other variable costs that may be shifting et cetera?

Yes. That sounds a bit severe as of the second half EBITDA margin percentage. The biggest driver from Q2 into Q3, I'd expect to be the continued ramp in our direct variable cost as well as some eventual contraction in the delivery and installation margin. And then if you do typically see a -- we've got a couple of things in Q4. Yes there is additional cost coming out of the business in addition to a typical seasonal ramp down in direct variable cost. So those are probably the two biggest factors and our math here says that I think a higher second half EBITDA margins than you articulated. So I think I have to check that.

Okay. Got you. And then just lastly. I know you raised the CapEx guidance to about $10 million. I know you mentioned that there's still some flexibility there. But I do think you called it some increased spending for VAPS. So just given that you are seeing VAPS penetration increase. And the contribution to rate move up to about $276. Is it just going to be a longer-term or a higher capital requirement to get that VAPS as part of your core strategy? Or is that kind of the wrong way to be thinking about it?

Yeah. There's little change in terms of the growth CapEx requirement in our view from value-added products. The only change that we highlighted today and probably didn't fully contemplated, the lots of years is every newly acquired branches that we're setting up. In some cases we have to setup a vast warehouse and populate them with inventory. So I do that as kind of a one-time investment across some of our newer branches, which on a net basis is helping or contributing to the higher end of the CapEx range. In fact it is not a huge contributor. The other two contributors there are some branch improvements that we've done. Again if you -- on average our rents is now double the volume. We've had expansion workdays paved some yards that type of investment as well as the ModSpace manufacturing facility. Phoenix on rent down, we otherwise wouldn't be buying a lot of new fleet. And there was some runoff of production in that facility, that frankly, if it was any other year we wouldn't have been buying that fleet. So, it was the right thing to do with what we had. But maybe a little bit different than you'd expect in our normal year. And like I said, those facilities are closed at this point.

Okay, great. Thank you, guys.

And your next question comes from the line of Phil Ng with Jefferies.

Hey! guys. AMR accelerated pretty nicely in the U.S. 16% pro forma growth is quite impressive. Is there a good way to kind of parse it out, like-for-like pricing versus some of the VAPS penetration initiatives? As well as maybe any way to think about the bump that you got from incorporating kind of WillScot pricing approach on the acquired fleet? I know that blocked process but any color would be helpful.

No. We are keenly interested in this topic and following it closely. And very pleased with the results, similar to what we said last quarter, about 60% of the percentage growth is coming from core box rates. And the remainder is coming from value-added products. Although, value-added products per unit is growing at a much faster rate north of 30%, just on smaller revenue base. But like-for-like pricing on the core box is up double digits so -- which is unusual. And that is driven by applying the WillScot kind of pricing techniques, across the acquired fleet. So the dynamic here that will continue for sometime, is every month a acting unit or a ModSpace unit and these and some WillScot units that were running three, four, five years ago will come back to our branches and we turn around the customers at today's rates and full value-added products. That is the strategy going forward and the fleet churns on approximately a 3-year cycle.

Yeah. That's great. Are there any pockets that had surprised you more? I mean, it definitely -- the play you've laid out a while back. But it's certainly come in pretty stronger than we would've expected.

Yeah. I think -- Phil this is Brad. I would -- I think we've mentioned this in all of the last calls as well. One of the pleasant surprises in the ModSpace integration was that their sales force had already begin to push rates if you will. They were looking at some of the same rate optimization tools we were doing. But probably more importantly, they'd really begin to push the furniture as a value-added products and service. So that mindset was already there. And I certainly, think that's contributed to the outperformance if you will, in the continued acceleration in this metric.

Got it. That's helpful Brad. And then, from a D&I perspective, just from a margin standpoint, quite impressive. Can you talk about what's driving that? And you talked about -- you obviously deploy more resource on this opportunity. Can you talk about what the debt potential would be going forward?

We don't want to get ahead of ourselves. But I'll share a few facts. So, effectively what's been happening thus far is other than TIM mentioned, a little bit of the mix of returns versus deliveries. It's just then, pushing rate if you will. Beginning to apply some of the tools and methodologies Scotsman has been using for the boxes and the VAPS. As we look forward, I mean, you're a little over $200 million revenue. We certainly think we can improve that, as we further enhance. And apply our optimization tools. And it's about $200 million of cost. So as Tim mentioned, we've got our team organized. We've engaged third-party expertise, to really help us dig into that $200 million spend. And we'll look at everything. We'll look very strategic from kind of make by should we in-source more of that activity et cetera for the route optimization et cetera. So, I would say the, spend is around $200 million, the revenue is a little more than that. We think we can improve both. We're not going to attempt to quantify it nor will we attempt to layout the time line, until we have a proper plan and we expect to do that kind of later into the third quarter or more like in the fourth quarter.

Got it. Sounds like a great opportunity going forward. Just one last one for me. Appreciating the pivot on your strategy to kind of deemphasize the unit sales component and focusing more on the leasing side. How long will it take to kind of flush this initiative out? And when will you get to a good level? Should we kind of be at a normalized level by the end of the year? Or is it going to be a multiyear event?

Yes. Kind of repeat what Soultz said and I mentioned I think in response to Kevin's question. I think taking the year-to-date sales revenue that you see proportional to the rest of the leasing business is a good place to be going forward.

Okay, awesome. Thanks a lot guys.

And your next question comes from the line of Ross Gilardi with Bank of America Merrill Lynch.

Thanks guys. Good morning.

Good morning, Ross.

I want to ask you about your free cash flow. I mean you on slide 30, I mean it looks like your Q is going to show that you generated real free cash flow $1.6 billion in the second quarter that's not a pro forma number, that's real free cash flow I think I wanted to confirm that? And it seems like that's a pretty big milestone. But it's in the back of the deck. So I'm just trying to understand the significance of that? When you talk about $60 million to $90 million of free cash flow in the second half of the year is that some type of pro forma number? Or is -- are we going to see that on the cash flow statement on an actually reported basis?

That's the plan Ross and it's always been the plan. And that's kind of where the rubber meets the lead the road. In fairness to Brad, he did mention it on his introductory comments. It's a big transition and we're heading in the right direction, right. We have said, all along that the topline run rate continues to build. We saw that continue in Q2. The investments in terms of restructuring, closing branches etcetera precede cost synergy realization on a cash basis. And we've seen that play out. We now have 49% of the cost synergies in our Q2 run rate. And I think we have definitely $8 million or so remaining on the restructuring side of things. And you will also have the real estate program that's now ramping up as well. So you mix all that together and yes the formula is stronger free cash generation in second half of the year. And we try to bridge that even further little more precisely than other companies would.

Okay. And that -- But that $200 million number that you talk about going into next year at the -- I think at the $400 million EBITDA level -- run rate EBITDA level that is more of a pro forma number, correct? And how do I think about truing up that run rate into next year for all of the other not one-time expenses, but sort of ongoing things tied to your capital structure and integration cost and restructuring and so forth?

That $200 million just comes from the simple math of $400 million of EBITDA run rate, $100 million of cash interest and roughly $100 million of net maintenance CapEx that we expect to invest in a volume-neutral environment. So with our vertical results discretionary free cash flow, we need to maintain our earnings stream. We need to pay our interest. After that we can make discretionary growth capital investments like we are in this year in value-added products and services and had in the past with fleet but sitting here right now. We've good ideal capacity in our yards. So it is -- I agree with you it's illustrative. But a significant change thanks to the greater scale of the business.

Got it. Thanks. And then the last one I wanted to ask you was, your pro forma time utilization is up 20 basis points in your Modular U.S. Space it's up -- if that's -- it's up but it's up a fair amount less than it was in the first quarter. Is that weather? And what I'm really getting at is do you have runway to continue growing time utilization? Or does it start to flatten out from here and any implications for pricing related to that?

That's really needed on rent question, there was a question earlier about what you're expecting in that department as we go through the rest of the year? And I think it's flat sequentially to quarter-to-quarter and U.S. Modular Space fleet is a reasonable benchmark to put up. That's what we see right on. We're not doing any immaterial de-fleeting which would impact denominator of the utilization calculation. So it's really kind of question for -- units on rent growth from here.

And just touching on your run rate question, I mean this business is operating at 82% for a couple years prior to the global financial crisis. So, as we kind of look at our individual markets, we kind of engineer more towards an 85%. So that 74% there is plenty of runway with the current fleet to continue to grow.

Got it. That’s helpful. Thanks Brad.

And your next question comes from the line of Ashish Sabadra with Deutsche Bank.

Thanks for taking the question. A follow-up question on pricing, so pretty strong momentum in the quarter. Looks like VAPS you still have a wrong runway there. How should we think about pricing optimization, both on the initial lease term? But also can you give us some color on if you made any changes on the monthly leases, if you've implemented any of the pricing optimization on that front?

Hi Ashish, this is Tim. So the second part of question is no. We haven't changed anything tactically. That's not worthy in terms of how we approach units that are beyond their minimum contractual term. We could add significant flexibility on that portion of the portfolio. But we really haven't done anything other than apply Williams Scotsman's pre-existing practices to the entire portfolio. I think, the churn of the acquired fleet is a big driver here and will continue to be a big driver. And we are constantly managing our price optimization engine. That's a living breathing practice here within the company.

That's very helpful. And just when we think about -- just to follow-up on the prior questions around you, yes, there were some slides that are related to disruption. But just as we think about, where are you in terms of integration and outside inside sales or at external and internal sales interactions and all of those things. Where would you say from an integration perspective have all those things are from a -- just a progress on that front. Thanks.

Yes, so the weather once seems to certainly have subsided the late May, early June in parts of the U.S. before that, but as a broadbrush. As we've mentioned the -- on our prior calls, the integration-related impacts, there were two primary aspects. One was an order pipeline disruption that happened kind of coincidental with the November cutover and the combination of the sales team that's been recovering nicely. And then as I mentioned before, we've been consolidating acquired fleet from what was about 200 branches down to the 120 we'll have going forward. So, we're making great progress there. There is still a little more work to do on the branch build-out as Tim mentioned. And the final rebalancing of the fleet, but we are well on our way. And as mentioned before, very confident in the outlook we're putting forward.

That’s great and congrats on the solid results.

Thanks.

And your next question comes from the line of Brent Thielman from D.A. Davidson.

Great. Thank you. Congrats on the quarter. Brad or Tim, I was just curious on the code activity that you're seeing. Is there any trend toward customers interested in committing to kind of longer-than-average initial lease durations for new units going out?

It's always an interesting one. So first of all just to reiterate, as Tim said, we really haven't seen a material mix in activity across the end markets. So, I would say that has remained balanced. If you look at how the entire company is compensated Tim and I and everyone else included a heavy element of that is lease value or lease term written. So that's the rates times, the duration times, the volume, right? So there's plenty of incentive to push for longer durations. We're just practically seeing it relatively stable over the years. So customers would realize a lower rate if they engage in longer durations. Our sales representatives would make more commissions et cetera. So there's every incentive for that to occur. We just have historically seen this spread between initial lease durations of that kind of 11-month plus or minus one month. And average lease total durations that you've seen kind of flow in that 30 to 36-month range.

Yes. Duration is greatly important. And as you think about the rent change, heavily weighted towards short-term rentals. And then it's contributing to the two-month increase in the overall portfolio duration that Brad talked about earlier. But that redeploying assets through longer duration leases, loaded with value-added products is a big part of the strategy here. And that's why, it's part of every employee it's kind of compensation structure.

Okay. Fair enough. And then I guess I wanted to take your temperature on as the rate growth is fantastic this quarter. I guess, do you think you can sustain double-digit rate growth in the 2020? I guess beyond any sort of unforeseen economic pressures that might arise? I'm just wondering what would prevent you from keeping this momentum going?

Remember the outside of the year, we said, we'll do it all year long, right? So that's factual. That was embedded in our original guidance and this is higher admittedly than we thought back in January. So the dynamic of acquired units churning and being redeployed to customers will continue for several years’, right? So it's a little bit hard to dissect how much of the rate depth is coming from that versus our own. Upfront pricing changes, the other term and rental rate changes and then value-added products is quite discrete exactly what's going on there. But the good news is between those four things, you've got levers that you can manage to drive a rate in the business. That's one of the things that we love about the business model. We've got four levers to manage the run rates. And between duration, pricing, value-added products and units on rent, you've got four levers to manage these revenues. And that's exactly what you're seeing in 2019.

Okay. Appreciate the response. Thank you.

And your next question comes from Manav Patnaik with Barclays.

Hi. This is actually Greg calling in. I wanted to ask about the VAPS delivered rate, which has been -- sequentially has been growing really nicely. I was just hoping if you could contextualize, what's helping drive that? I think you brought up some of the furniture sales. But I'm just wondering, any other moving pieces like improving the individual branch performance up to best-in-class levels or anything like that that's going to help continue to drive that VAPS delivery rate?

No. It's effectively, Greg, just delivering more and more of our units, as they churn through the branches, full of the Ready to Work value proposition. So you'll recall we introduced that back late 2015, 2016 in the WillScot legacy business. We've seen that continue to accelerate. We've stated on prior calls that we think our long-term target would be to see this increase to $400 per unit per month. That would reflect about an 80% penetration, meaning 80% of our units were delivered fully equipped with that. So what you've seen through the integration with three companies, combining the sales force, bringing in new customers, we've continued to see that accelerate. We're at $276. So we're well along the way towards our long-term goals. But it's simply units that used to take -- or customers that used to take units empty, they would then have to equip them with furniture, now they're happy to take the units as a turnkey from us, so they can get onto their projects and be productive faster and safer.

Okay. That makes sense. And then, quickly, I guess, on the oil and gas part of your business. I know, it's a relatively small piece, but it seems like the upstream market has been a little weaker than expected year-to-date. So just wondering, what you're seeing there and what you're expecting? Thanks.

Yes. I mean the oil and gas, the energy altogether is only about 8% of our total revenues and the majority of that is midstream, utilities, et cetera. So it's a small piece, probably most concentrated in our other segments, as Tim has mentioned. And I characterize that as steady. We really haven't seen a lot of volatility in that very small aspect of our business.

And your next question comes from line of Sean Wondrack with Deutsche Bank.

Hey, guys. You've answered most of my questions. So I'll stick to a couple. Firstly, Tim, can you clarify what was pro forma LTM-adjusted EBITDA as of 2Q, 2019?

We will pull it up for you [indiscernible]. You're talking about the – the full update?

Yes. The LTM, I think, it was around 3.10 as of the last quarter, somewhere in that neighborhood. Okay. So, yes, I'll come back to that one. Secondly, you guys have done a really good job integrating ModSpace, Acton and some of these smaller acquisitions associated with those. But in terms of the M&A environment right now, now that you're sort of turning the corner and digesting ModSpa, are there other opportunities out there for you to tuck-in?

Yes. Obviously, we don't comment any detail on the strategy in particular M&A. We characterize -- I think, as we said on the last call the digest of the ModSpace is well on its way. We're certainly in a position where we'd have the capability and capacity to pursue and integrate -- or an acquisition and integration. We're just true to our statement since we returned the company in the public market. So we won't overpay and we're not going to overlap or so. We're not compelled to do anything and we have a great business year with great indicative strength. And plenty of runway and these idiosyncratic levers that I mentioned before to continue to grow as we are. We are an inquisitive company. So if the right opportunity came along, we certainly can pursue that.

Great. And then, just in connection between the acquisition and ModSpa and other competitors, do you feel your team is getting better renovating these units and basically prepping them to be Ready to Work? And is there a know-how transfer that's going on between sort of employees of ModSpace formerly and WillScot employees. Can you talk about that a little bit?

Yes. That's been pretty straightforward and quite easy. I mean, as Tim mentioned before, even the WillScot branches that continued almost all effectively doubled. But what you really had is, a group of ModSpace employees and the WillScot employees coming together. So cross-training is pretty fast and effective, if you will, in the branches. And ModSpace did a great job maintaining their fleet. So this was -- if you take it down to a direct labor and skilled trades at the branches, this was kind of more like a peer to peer combination than anything else.

Got you. Got you. And then my last one is just concerning the debt complex. Obviously, you called or took out the 10% unsecured bonds. Congratulations on that. That's great. You have your one tranche the 7 and 78 is coming callable in I think December. And then the second tranche the 6 and 70 is callable next summer. Are you considering coming to the market given that your debt is all second lien secured and maybe undertaking a global refi to bring your capital structure to a more unsecured structure?

But overall that will be market dependent. Clearly comment on hypothetical future refinancing activity, but your observation is around the timing of callability as it relates to the 2022 notes absolutely right. There's 7 and 78s relative to 6.2-ish percent weighted average cost of debt. So, and then you've improved upon that seven investments [indiscernible] on most recent offerings. So, definitely opportunities going forward and into the medium-term to optimize the debt structure. And Sean I think the answer to your first question on LTM performance 3.26.

3.26. And then Tim is it fair to say that -- or -- and maybe how do you think about this? Over the long-term would you want to basically have an unsecured capital structure for this company? Or are you fine with the secured as it is?

We're really happy with the structure revenue and we will look at all options as we contemplate future refinancing activity.

Got you. All right. Thank you very much.

I'm showing no further questions at this time. I would now like to turn the conference back to Brad Soultz.

Okay. Thanks Theresa, and thanks everyone for joining us. I think we'll be speaking with many of you soon and look forward to if not speaking again then we talk about our third quarter results. Thanks and have a great day.

Ladies and gentlemen this concludes today's conference. Thank you for your participation and have a wonderful day. You may disconnect.