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McGrath RentCorp (NASDAQ:MGRC)

Q4 2008 Earnings Call Transcript

February 25, 2009 5:00 pm ET

Executives

Geoffrey Buscher – IR, SBG Investor Relations

Dennis Kakures – President and CEO

Keith Pratt – SVP and CFO

Analysts

David Gold – Sidoti & Co.

Jim [ph] – Oppenheimer & Company

Jamie Sullivan – RBC Capital Markets

Gerry Heffernan – Lord, Abbett and Company

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the McGrath RentCorp Fourth Quarter 2008 Conference Call. At this time, all conference participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator instructions)

I would now like to turn the conference over to Geoffrey Buscher of SBG Investor Relations. Please go ahead, sir.

Geoffrey Buscher

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. On the call today from McGrath RentCorp are Dennis Kakures, President and CEO, and Keith Pratt, Vice President and CFO.

Please note that this call is being recorded and will be available for telephone replay for up to 48 hours following the call by dialing 1800-405-2236 for domestic callers and 1-303-590-3000 for international callers. The pass-code for the call replay is 11125293. This call is also being broadcast live via 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 at approximately 4:05 PM Eastern Standard Time or 1:05 Pacific Standard Time today. 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 1206-652-9704 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.

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. The company also announced for the first quarter of 2009 10% increases of the cash dividend to $0.22 per share for the quarter representing on an annualized basis approximately a 4.3% yield on the February 24, 2009, closing stock price of $20.26. For the fourth quarter to 2008, total revenues increased from 71.5 million in 2007 to 78.5 million in 2008. Net income decreased 23% from 12.1 million to 9.3 million, and earnings per diluted share decreased from $0.48to $0.39.

Reviewing the fourth quarter results for the company's Mobile Modular division, Mobile Modular total revenue decreased 0.2 million or 1% to 40.1 million over the same period in 2007. Rental revenues decreased 0.1 million while sales revenues decreased 0.5 million in 2008 compared to 2007. Gross profit on rents decreased 0.3 million or 2% to 16.9 million from 17.2 million in 2007 due to lower rental revenues and lower rental margins. Rental revenues decreased 0.1 million over 2007 while rental markets were 65% in 2008 compared to 66% in 2007. Selling and administrative expenses increased 0.8 million or 12% to 7.5 million from 6.7 million in the same period in 2007, primarily due to increased depreciation expense for the new ERP, other IT infrastructure upgrades and the new Florida Inventory Center.

The combined effect of the lower sales revenue, lower gross profit on rent and increased selling and administrative expense was a decrease in pre-tax income of $1.3 million or 10% to 11.7 million for the fourth quarter 2008 compared to 13 million for the same period in 2007. Finally, average Modular rental equipment for the quarter was 475 million, an increase of 29 million from the fourth quarter of 2007. Average utilization for the fourth quarter decreased from 82.8% in 2007 to 81% in 2008.

Turning next to fourth quarter's results for the company's TRS-RenTelco division, fourth-quarter total revenues increased 2.2 million or 8% to 30.8 million compared to the same period in 2007 as a result of higher sales revenues. Gross profit on rents decreased 2 million or 19% to 8.7 million as compared to the same period in 2007. Rental revenues decreased 0.1 million or 1% as compared to 2007 and rental margins decreased from 46% to 37%. Rental margins decreased due to higher rental equipment depreciation cost and higher costs of rental operations.

Selling and administrative expenses increased 1.4 million or 27% to 6.6 million from 5.2 million in the same period in 2007, primarily due to higher personal and employee benefit costs and increased marketing and advertising expenses. The higher cost reflects the hiring of key personal and the ramping of our TRS environmental business. TRS was also negatively impacted by a stronger US dollar against its Canadian dollar denominated revenues.

Pre-tax income decreased 3.7 million or 56% to 3 million for the fourth quarter of 2008 from 6.7 million for the same period in 2007 as a result of lower gross profit on rents and sales and higher selling and administrative expenses. Finally, average electronics rental equipment at original cost for the quarter was 261 million, an increase of 33 million from the fourth quarter of 2007. Average utilization for the fourth quarter decreased from 71% in 2007 to 66.3% in 2008. On a consolidated basis, interest expense of the fourth quarter of 2008 increased 3% to 2.7 million from 2.6 million for the same period in 2007 as a result of the company's higher average debt levels partly offset by lower average interest rates. The fourth-quarter provision for income taxes was based on an effective tax rate of 38.9% down from 39.6% in the fourth quarter of 2007.

Next I would like to review our 2008 relate cash flows. We continue to generate strong cash flows to invest in a business and return value to shareholders. For the 12 months ended December 31, 2008, highlights in our cash flows included

Net cash provided by operating activities was 98.7 million, an increase of 3.8 million from 2007; we invested 88.3 million for the acquisition of Adler Tanks, 95.8 million for rental equipment purchases, 13.6 million for property, plants and equipment, primarily for the build out of our new Florida Inventory Center and investment in new ERP, partly offset by 29.3 million in proceeds from used equipment sales.

Dividend payments to shareholders were 18.6 million. Net borrowings increased 107.7 million for the year from 197.7 million to 305.5 million, primarily to finance the acquisition of Adler Tanks. We had total debt at year end of the 305.5 million. The company had capacity to borrow an additional 85.5 million under its lines of credit. We continued to have a solid low average balance sheet. For 2008, fourth-quarter adjusted EBITDA decreased 2.5 million or 7% to 35.1 million compared to the 37.6 million in 2007. Consolidated adjusted EBITDA margin for the fourth quarter decreased from 53% in 2007 to 45% in 2008. Our definition of an adjusted EBITDA and a reconciliation of adjusted EBITDA to net income are included in our press release for the quarter.

Turning next to 2009 earnings guidance, we currently face more uncertainty in forecasting our annual outlook than in any recent period. We expect 2009 financial reserves to be driven by lower business activity levels and more competitive pricing in our core Modular and electronics rental operations compared with 2008, partly offset by various cost reduction initiatives and the full-year contribution from Adler Tanks which was acquired in December 2008. We expect full-year earnings per share to be in a range of $1.30 to $1.45 per diluted share. The impact from the delay in the completion of the 2009 California state budget, the related spending reductions and other macroeconomic factors could cause results to be lower than currently forecasted.

In 2009, we expect low single digit growth in rental revenues and lower sales revenues. We expect lower rental revenues in our Modular and electronics rental operations offset by the full-year contribution from Adler Tanks. Selling and administrative costs are expected to increase by approximately 8 million to 9 million compared to 2008 as a result of the Adler Tanks acquisition. Various cost reduction action have been taken to prevent selling and administrative cost increases in other parts of the business, while continuing and increasing investment in key long-term growth initiatives. Full year interest expense is forecasted to be approximately 11 million to 12 million. We expect the 2009 estimated effective tax rate to be similar to the 2008 rate, which was 39.1%.

At this point, I would like to turn the call over to Dennis.

Dennis Kakures

Thank you, Keith.

Let’s go right to our results for our Modular rental business, Mobile Modular had flat rental revenues quarter over quarter and for all of 2008 was up a modest 3% to 103 million. In California, we had a good volume of educational rental opportunities in 2008 and were successful closing a higher percentage. However, there was significant downward pressure on rental rates in order to capture this business. This is a function of lower cost utilization entering 2008, the state fiscal crisis and tighter school budgets. For non-residential construction projects, we saw a significant slowing of business activity levels in the second half of the year, and only minimal opportunities throughout the year for residential related construction projects.

We also experienced a higher level of returns than anticipated in our California commercial business segments for the year. In Florida, we had strong year over year educational rental revenue growth as we benefited from a higher run rate in the second half of 2007 and favorable booking levels offset by higher than expected returns in 2008. We continue to benefit from the popularity of our Campus Maker classroom product, class size reduction, and the phasing out of older model curved portable classrooms. We also experienced a difficult commercial rental environment in Florida in 2008 with decreasing demand and a very competitive pricing environment.

In 2008, in the Texas market we experienced continued favorable demand in booking for both educational and commercial related market segments. We had strong quarter over quarter and year over year rental revenue growth. Our educational business activity was driven by modernization and student growth needs and our commercial business benefited from healthy petrochemical and industrial business activity.

In North Carolina and Georgia in 2008 we made good headwind establishing the Mobile Modular brand name. We introduced both the hybrid class product as well as an enhanced commercial product into these markets during the year. We made favorable progress in building our rental revenue base but we faced very tight competitive markets along the way. We also expanded our mid-Atlantic Modular business marketing efforts in Maryland and Virginia in 2008. Our marketing pick and shovel efforts will take some time to pay off in these new geographies. However, we are confident that over the long term, we will achieve meaningful success. For the Modular division overall, we experienced a 4% quarter over quarter reduction in our average rental rates. Modular utilization stood at 81% at year and 2008 compared to 80.8% at the end of the third quarter 2008 and 82.8% at the end of 2007.

Now let me turn our attention to TRS-RenTelco and their results. Our test equipment business had flat rental revenues quarter of quarter. However for all of 2008, rental revenues grew by a healthy 10% to 93 million. We benefited from a strong pipeline of opportunities throughout the year; however the competitive nature of the markets created continued pricing pressure. Combined with our higher level of returns during the second half of 2008 compared to a year earlier, with customer order activities slowing later in the year due to concerns with the economy, there was significant downward pressure on both gross profit and margin on rents, especially during the fourth quarter. Sales revenues were up markedly during the fourth quarter from a year ago as we moved proactively to sell lower utilized equipment. Lower gross profit and margin sales in the quarter are the result of our tactics to eliminate recurring depreciation sooner rather than later in anticipation of a more challenging 2009 market environment.

In 2008, we had a net addition of 23 million in original cost of test equipment inventory or an increase of approximately 10% to 256 million. The majority of the increase was related to technology freshening and business growth. Ending fourth quarter utilization in 2008 was 64% compared to 69.3% a year ago. This is a good indicator of a slowing opportunity conversion rate that we began experiencing in the fourth quarter. Our average monthly rental rate declined to 12.5% in the fourth quarter of 2008 from 4.8% a year ago. The factors contributing to this decline was the replacement of lower cost TRS acquired equipment with new higher cost-based equipment and the competitive market environment as we continued to push to grow our market share.

Now let us turn our attention to our recent acquisition of Adler Tank Rentals. Due to our planning efforts for the integration of Adler Tank Rentals late last year, we were able to hit the ground running entering 2009. We have moved at add sales positions, built additional rental inventory, integrate various back-office, administrative and accounting functions, assess facility needs and begin development of an integrated marketing plan. Despite the potential distraction during our initial integration window, Steve Adler and his team have done a very good job of staying focused on business development and their customer relationships. The Adler team’s energy and enthusiasm for the business is very evident in their communications and actions. Mike Buckland, a member of McGrath RentCorp’s executive management group is working day to day with Steve and other Adler employees to assist with operations and to learn the business intimately. The operating cultures and value systems of Adler Tank Rentals and McGrath RentCorp are very similar and this has made for a smoother integration process.

Now for some further comments on 2008 and our future. The company surpassed 300 million in total revenue for the first time in 2008 despite a very turbulent financial market, regional market challenges and a quickly deteriorating macro economic environment. We fought hard for what we achieved in both revenues and earnings. In 2008, we were also able to execute on our strategy to leverage our business to business rental acumen to both position the company for additional sources of long-term growth and to further diversify our product offerings and geographic footprint. We did this by spawning two organic growth product areas in portable storage containers and environmental test equipment and by acquiring Adler Tank Rentals, which is engaged in the hazards and non-hazards liquid and solid containment rental business.

With these new initiatives investments made in 2008, we view ourselves as now having five distinct rental engines from which to grow. Each rental business has its own specific products, core markets and industry dynamics. However, we should benefit from various customer, facility and operational synergies between these rental businesses. With this broad platform business to business rental product, we believe that we have now set the table for future growth from a product diversification standpoint. That being said, we will continue to proactively explore acquisition opportunities to grow and create a critical mass and earnings potential for each of these rental engines.

We also brought our new Modular business operating software application online this past October. This system will support the scaling of the Modular business in the years ahead. It also is a platform that we will eventually plan to have all of the company’s rental businesses operate, including our recent entry into the tank rental business. Finally, we secured a new $350 million five-year credit facility with favorable terms in May 2008 with a syndicate of banks. This new agreement replaced an existing $190 million line of credit. I would like to publicly thank Keith Pratt, our CFO and Dave Whitney, our Controller, for their excellent work in securing this long-term financing in the time frame they did and with the terms negotiated.

Although we believe we have positioned the company favorably for longer-term meaningful growth, 2009 has many challenges in front of it. Our guidance range of $1.30 to $1.45 per diluted share attempts to estimate how rental market challenges, macroeconomic events and the financial crisis may impact our results. Needless to say, this has been the most difficult forecasting period that I have experienced in my over 25 years with the company.

Now for some of our challenges in 2009. Foremost, is the California fiscal crisis. In late December 2008, the lack of a balanced budget in effect forced California’s Pool Money Investment Board, the PMIB to cease making short-term loans to public agencies to begin their infrastructure projects. This resulted from the state difficulty in selling general obligation bonds or promotional papers due to the prolonged unresolved budget crisis. In turn, the action by the PMIB folks on new public agency infrastructure projects dependent upon the PMIB short term loans were moving forward.

Fortunately, a balanced budget was just passed path and signed into law. However it is contingent upon seven propositions passing on a special election set for May 19. The timing on when the PMIB will begin making these short-term loans is currently undetermined. It could be as soon as a few weeks or a few months. The uncertainty of the timing of the flow of these monies makes it very challenging for us to project new educational rental business volume in California in 2009. The good news is that there is an approximately 2.3 billion of voter approved modernization state bond capacity available to support an increasing backlog of projects. The additional good news is that in the recent November 2008 elections, over $20 billion in local educational bond money for both new construction and modernization projects were passed.

Let me address some additional charges we are facing this year. Residential construction activity can best be described as minimal. We don't expect any meaningful recovery in this sector until mid-2010 at the earliest. We expect non-residential construction opportunities to be fewer in 2009 compared to last year and very price sensitive especially for a single lot equipment. With the price of oil finally below $40 a barrel, we expect to see lower refinery and petrochemical business activity levels in our Texas and California Modular operations. The impact of this dynamic is challenging the model with great accuracy. Our electronics rental business has grown very nicely over the past few years. However, due to the severity of the macroeconomic business environment, activity levels slowed considerably in December from earlier in the year and continues to decline in the first quarter of 2009. Market share and critical mass have been and will continue to be extremely important to our long-term financial success. As long as the current recession continues, we expect downward pressure on rental rates and operating margins to persist.

Probably an offset some of these market challenges in the 2009 are the following items. The counter cyclical nature of portions of our rental business and the dynamics of limited capital availability making rentals attractive. In looking at our classroom business, keep in mind that even in the most challenging macro economic cycles, student populations typically don't change much and having adequate classroom space is still required. Although California has its challenges, we shouldn't forget the $30 billion worth of voter approved state bonds available for infrastructure development of bridges, levies, water resources and other large engineering type projects over the next few years. We will also benefit from a full year of Adler Tank Rentals contribution. The acquisition was accretive to earnings in its first partial month of operations for McGrath RentCorp. Although we are in a very severe recession, we fully expect all of our new organic initiatives, environmental test equipment, portable storage and our Modular’s mid Atlantic expansion to grow in market presence and rental revenues in 2009.

Finally, the management team has been working since the third quarter of 2008 on various austerity measures to support lowering expenses. Here are some of the items that either have already been or will be implemented to reduce expenses in 2009. We have frozen salary levels; we have reduced bonus potential by 25%; we have reduced equity grant levels by 25%; we have made a 50% reduction in the company's annual ESOP 401(k) contribution; vacation recruital has been reduced by one week; mandatory furlough days have been established; manufacturing projection and other staffing reductions have occurred and we are continuing to assess the need for additional production; a higher percentage of healthcare expense will be worn by employees with management taking a higher percentage than others; we have made reductions in IT projects; we have delayed or eliminated investments in personnel, infrastructure and training. Finally, we made reductions in general expenses such as travel, office expense, temporary staffing and meetings.

As you can tell from the list I just read you, a number of our expense reductions have a direct impact on our employees. We have been blessed over time by having our ranks filled with very knowledgeable, highly capable and tenured individuals. The value of such a workforce is immeasurable towards our long-term success, but it is especially valuable in a very challenging macroeconomic environment to have the maturity level and understanding of one's employees as we do in knowing what needs to be done for the continued health of the company.

As a result of our growth strategy new initiatives, we believe we are well positioned today to become a larger and more profitable company as economic conditions improve. While we expect the next 18 to 24 months to be an extremely challenging operating environment, we would expect McGrath RentCorp to fare better than many companies due to the counter cyclical nature of portions of our rental businesses, our strong cash flows and low leverage balance sheet. Longer term, we believe that our strategy of investing in earnings engines in more diverse business to business rental market segments will generate growth in income and share value while maintaining our financial strength, protecting our balance sheet, providing attractive dividends and making the company more resilient to future economic cycles. Over the years, we have viewed processions opportunistically in that there can be a broader selection of potential investments as better values to support our long-term earnings growth.

And now Keith and I welcome your questions.

Question-and-Answer Session

Operator

(Operator instructions) And our first question is from the line of David Gold, Sidoti & Company. Please go ahead.

David Gold – Sidoti & Company

Hi, good afternoon.

Dennis Kakures

Hi, David.

Keith Pratt

Hi, David.

David Gold – Sidoti & Co.

Couple of questions, first, you have a said a lot more last few minutes, but essentially when compare – when I look at the fourth quarter numbers and then I look at the guidance that you have put out, well fourth quarter just wasn’t that bad so to speak, you have given sort of a few reasons, but wondering if basically has something more happened in the last six weeks that is really pushing you take the more aggressive stands or was it the returns that you are seeing, or is it just more conservatism?

Dennis Kakures

Well it is a combination of iron’s David. Certainly in our electronics business we have continued to see an erosion in the billing rate and so that has built in the projection. In the California market in particular, with the budget situation that only recently has been resolved. And then determining when there will be flow of monies to initiate new projects is as of the big question mark there. So, later in the year that comes into play or start that impacts new projects coming online in rental revenue billings for the year, so that is very difficult to judge at this point. So those are the two biggest items there. Those are, California is a very important market to us and electronics as a whole even though the pipeline has remained fairly good in the new year to conversion into order activity isn't occurring as we would like to see it. So, – but those are the two most important areas.

David Gold – Sidoti & Co.

I see. Okay. And then we dove down a little bit more by division, you obviously you commented that essentially you would expect some modest growth and it is really the contribution from Adler presumably, but –

Keith Pratt

Yes. Adler is actually offsetting weakness in the Modular and electronics businesses.

David Gold – Sidoti & Co.

Right. So when we look at though the two businesses presumably, can you give a sense Keith for, which do you expect to be more painful or painless here?

Keith Pratt

Yes we have looked that out and what I would say is both are feeling the pain. Yes if you look back in ’08 it was really a tail of two businesses Modular has had a more flattish year, electronics taking the year as a whole had very nice growth in rental revenues. I think as we look into ’09 for both of the businesses, we see pressure on the rental operations part of the business, pressure on the volume of sales, and also pressure on the gross margin structure. And I would say both business is in our efforts to forecast them are showing significant pressure.

David Gold – Sidoti & Co.

And I mean Adler business though is holding up in spite of the issues in the petrochemical standpoint?

Dennis Kakures

Yes. Adler’s business from the plan that we have put together at the end of 2008, we are still on track for that and we feel good about that. Fortunately for Adler a lot of their business isn’t dependent upon oil field exploration, they have a very broad base of end users and the oil exploration fee is not a significant part.

David Gold – Sidoti & Co.

Got you and then just one other. Keith on the interest expense that you are forecasting presumably I – looking for quite a bit more interest given the Adler acquisition and so can you just sort of walk us through that basically, I mean this, the thing that you use only I guess excess cash flow to pay that down pretty quickly, because I guess it is just not a big jump year-to-year given the acquisition late in the year?

Keith Pratt

You are right with your observation David. The key thing to note about our debt structure is the vast majority of our debt is actually variable rate debt and it is tight the LIBOR is the index. So, when we look at the interest expense we are currently experiencing we are definitely benefiting from the low level of LIBOR. To give you a feel for a total cost of debt last year, overall for the year, the debt was costing us close to 4.5% as we look at what we are experiencing today and we look at our estimates for the year as a whole in ’09, we will probably be somewhere in the 3.5% to 4.0% range. Again that is assuming that LIBOR stays close to its current very low levels, but if we stay in that range, we expect to meet the interest expense forecast that I mentioned in the guidance comments. So, essentially its lower interest rates are helping to offset the higher level of debt. And I would say that is an improvement from what we would have expected even three months, so it is good.

David Gold – Sidoti & Co.

Okay. Got you, perfect, very good. Thank you both.

Dennis Kakures

Thank you, David.

Operator

Thank you. And our next question is from the line of Scott Schneeberger with Oppenheimer & Company. Please go ahead.

Jim – Oppenheimer & Company

Hi, Dennis and Keith. It is Jim [ph] for Scott.

Dennis Kakures

Hi, Jim.

Jim – Oppenheimer & Company

Just to better understand the push and pull of the – how the California budget just was passed and you still had propel and de-funds that were through ’09, I guess year marked, plus, I know that the budget cuts were made with potential stimulus funds expecting to come back in at some point in ’09, can you just kind of talk about, you know, I know it is tough to gage these – exactly the timing of such, but just but, the landscape within those three, how that is going to look in ’09 and I guess how you thought about that when thinking about your guidance for ’09?

Dennis Kakures

Well, I think I can address that, but let me first say that the challenges for ’09 are all around timing, you know the funding is in place for school projects for modernization, it appears now that with the federal stimulus package that is going to help backfill some of the cuts that they had to do in the state projects, which would have put pressure on the general fund, which is were various rentals for class room products are paid from, so there is lot of goodness that has occurred here in just a last couple of weeks. But it really has everything to do with timing and quite frankly with the budget having been passed assuming that the May 17 propositions pass favorably it will be 50% plus one vote needed for those. But I am feeling much better now as we can term that those mechanisms everything is going to be in place, but in terms of when the state starts releasing money to be able t initiate new projects can impact us significantly because if they are released in the next few weeks we get a much bigger up-tick from that from the standpoint of school districts and you initiate projects or take them out of the stock status. Whereas if money is not released still closer to summer in any significant fashion there maybe some districts that differ until next year or start projects later in the year. So, that is the real wild card. It is timing and the – again good news is there is plenty of money for a modernization project in California which has already driven our rental revenue activity for schools over the last four or five years, but it is the disperse net and (inaudible) projects. So, that is – we are thinking our guidance is an appropriate level of conservatism.

Jim – Oppenheimer & Company

Okay. And I guess the second question I have, I know that a few days ago one of your larger supplier in the TRS segment, Agilent took on the numbers as they are doing headcount reductions and they are seeing lower activity levels which is what you are stating, but is that potentially a source of opportunity there just from the perspective of customers renting that equipment, as opposed to buying or –?

Dennis Kakures

Well, I would say perhaps the bigger dynamic that you are alluding to if there is really – if capital is tight for customers and they are buying less from Agilent or from Tektronix or the large equipment manufacturers they may have a tendency to rent that equipment versus bond because they don’t have the capital, they want to use the capital for other means. So, there is count on cyclical dynamics here with that business that can come into play in tighter capital credit markets.

Jim – Oppenheimer & Company

Thank you

Operator

Thank you. And our next question is from the line of Jamie Sullivan with RBC Capital Markets. Please go ahead.

Jamie Sullivan – RBC Capital Markets

Hi, good evening.

Dennis Kakures

Good evening.

Keith Pratt

Hi, Jamie.

Jamie Sullivan – RBC Capital Markets

So, I guess from the guidance you are seeing it is appropriately conservative around some of the timing issues, but if – does it consider that potentially the May 17 vote does not go through?

Dennis Kakures

I would say that our expectation in the room is that we will have a balanced budget because if that vote is unsuccessful on May 17 everything we get have to be reset then the state is in a much more challenging position as we would where – if with the school districts would sell for sell, but our belief system is that voters of California understand the seriousness of matters I think we have a centrist Governor who really has worked both sides of the IO and that I think the state the Electra is ready to get this behind us. We will take our medicine; there are a lot of good things in here for the future in terms of being able to live within your mean. So, our expectation is that May 17 those will pass successfully and again we will learn more between now and then about the dynamics of that election, but I feel at least today my temperature of cage on it is that it will be successful.

Jamie Sullivan – RBC Capital Markets

Sure. Okay. Now, does the timing of the budget and when money starts to flow will that be impacted by the timing on the school year as well – I know typically it is kind of bumping up again when your education bookings season is usually in full swing, just wondering if you could comment on some of the moving parts there.

Dennis Kakures

We view – just say most of our booking in the first six months of the year and then the actual installation work occurred starting in most cases it is in May or then most of it starting then in during the summer while school is not in session. So it could be that there is a real bottom link of activity the further this goes that summer will be crammed with work and there is only so much that can get down in that window. And the other piece is true that the districts are – those districts are not ready or would have less time to get ready in terms of preparing for the project etcetera. So the later pushes out in terms of a flow of monies to where districts can get started that it will directly impact what our bookings will be for this year and in turn what level of rental revenues were recognized for the year of equipment going out.

Jamie Sullivan – RBC Capital Markets

Sure, okay. And again, you're focused more on modernization not on number of teachers employed by the state, is there any relation there?

Dennis Kakures

Well in terms of – you may be speaking to class size reduction and number of class rooms etcetera, we – at this point we haven’t seen any dynamics of these to believe that there is only going to be any significant teacher reductions. There will certainly be some district by district, every district has their own really budgeted deal within the districts, some have cut-out non-essential programs, some will perhaps make some adjustments in class size reduction, but we are not seeing anything or hearing anything on a broad scale. But again the good news is the federal stimulus package is injecting some significant amounts of money into the state in both at the Governor’s discretion of the back fill the general fund, as well as for specific programs that otherwise were being cut in the states budget. So –

Jamie Sullivan – RBC Capital Markets

Okay. If I could move to some of the commentary on return, can you talk about that a little bit, where you are seeing the returns, what kind of – what surprised you there in the volume of returns?

Dennis Kakures

I think let’s talk about California first. Certainly residential construction, we saw increased returns in 2008 as homebuilders couldn’t sell homes their phase, you know their phase, they are not building the second phase for project, but what they will do is to economize they will – the have wonderful homes so they will put their sales office in an unsold home. We also saw in the non-residential construction side earlier returns on equipments and we believe that is driven by the fact that they are going to have as much work going on, they are actually going to complete the projects they have quicker and sooner. They are also economizing on cost as well. And there is some that is just related to the coincidental, you know the timing of things just coming back when projects complete, which you know they are in an orderly fashion. So, we kind of have that combination of items in California with respect to (inaudible) with some of the returns or increased returns in Florida that is certainly on the school side, it is really budget driven and economizing by districts. They have eliminated some non-essential programs, music art, those types of items and with their budget situation they are trying to be as feudal as they can be. The have relaxed some of the requirements for this year and class size reduction, so perhaps some districts have already geared up for that know that they really don’t need to meet those ratios for another year or so and we have some returns related to that. The other pieces or two there has been some student population reduction in Florida. So, there has been future compaction of classes’ space.

Jamie Sullivan – RBC Capital Markets

Okay.

Dennis Kakures

However long-term in Florida we cover to get other these are – you know these are items that are directly related to budget and the flatter education in their model.

Jamie Sullivan – RBC Capital Markets

Sure. It sounds like the California dynamics, those really haven’t changed since, as I would say November, but the new pattern in the returns has been in the Florida area where has the return pattern in California has accelerated beyond –-

Dennis Kakures

I think the California accelerated and Florida was more of a dynamic that’s been occurring you know some have got here and when you go back and look at the entire year, you know, we are telling this, you get a clear picture of what’s been occurring over time here so.

Jamie Sullivan – RBC Capital Markets

Right. Okay, and is there – as you look out is there potential for returns in California to continue this acceleration or do you feel as if they sort of reached a bottom here or what are your thoughts?

Dennis Kakures

Well, I would say on the. I think it is very difficult to determine, we have lost in our numbers in terms of the residential construction side, we have lost about half of that base of business about 8% of our module run revenue base 8% to 9%, we are probably down beside that 4% to 5% now. We could see some further erosion there potentially. On the commercial construction side, we may see some further pressure on the single-wide standard commercial units, we may then again benefit on the larger construction project, these engineering projects, which are typically large complexes multi-year terms. So, there are some countering elements there that can support. On the class-room side we may have seen the low point, especially since we have a balanced budget now assuming the initiatives pass though the – the proposition pass in May because the money is there, the pent-up demand is there for these projects so we may grow as we see in the bottom on that, but we will learn more as the year progresses.

Jamie Sullivan – RBC Capital Markets

Alright. And quickly I guess on TRS, do you plan to continue the sort of de-stocking of the high cost equipment that were utilized, is that –?

Dennis Kakures

Just that you know that’s addition in part of running that business. So, what we do every quarter is we do a very thorough impairment assessment and really focus on the cash flows and what we not mean the thresholds, we are proactive on dealing with that equipment. We’ve enhanced that process and we started doing that last year to be able to get ahead of the way in anticipation of the greater, the general macro economic climate deteriorating and so I think we have done a very good of job identifying that equipment that is of potential issue, we did that last year and we moved quickly and we continue to assess that on a very frequent basis. So, – and the goal of all of that as we stay in front of any potential impairment and again, we are doing a good job with that I am not only concerned in any particular area right now as we continue to do our diligence on that.

Keith Pratt

We just say the implication of all of that as we look at ’09 we could see some pressure on the sales margin for our used equipment sales for the business.

Jamie Sullivan – RBC Capital Markets

Right, okay. And then last question, on the pricing side, is it – are you being more aggressive on trying to gain share or are you seeing competitors come in and price almost that is at a rational level that win business maybe comment on both sides of the business on the pricing side and then I will step up.

Dennis Kakures

It needs to say you see both dynamics, you know you see a case and you will see people doing things that are probably not good economics, but we don’t see a lot of directional behavior in our market, it really has lot to do with trying to build critical mass and you know sharply and attends for little bit and been able to keep your equipment utilized. You it is one thing about our business is when you own assets and you are already incurring a depreciation expense, it is good to be generating some level of the revenue on those assets. So, we have always taken that approach, I think that has served us well over time it also helps us to maintain customer relationships and be in position as things get better to be able to ramp-up utilization levels, as well as pricing levels. Similar dynamics really in both businesses and on the margin side we – in particular because of the building of inventory in California, we have spent a pretty aggressive pricing environment that also relates to school districts being much more frugal in their budgeting prophesies and looking for a dollar everywhere they can get it. Interestingly in Florida a very different market in terms of pricing where pricing has remained very stable over time and that has everything to do with the fact that of the campus made for classroom product that we have there in that we don’t have a competitor that builds a similar product.

Keith Pratt

And Jamie, what we are seeing particularly on the Modular is fewer new rental opportunities or fewer units going out on rent than are coming back and then we have got a rate differential as well in many markets where the unit that comes back of rent was at a higher rate than the unit that we are putting out on rent which is at a lower rate reflecting the market conditions that Dennis has described. So that all puts pressure on the yield and that’s what we are seeing in the business.

Jamie Sullivan – RBC Capital Markets

Right. Okay well thanks for taking all my questions guys.

Dennis Kakures

Thank you very much.

Keith Pratt

Welcome.

Operator

Thank you. (Operator instructions) Our next question is from the line of Gerry Heffernan with Lord, Abbett and Company. Please go ahead.

Gerry Heffernan – Lord, Abbett and Company

Good afternoon everybody. Keith, Dennis, how are you?

Keith Pratt

Fine, Gerry. How are you?

Dennis Kakures

Well.

Gerry Heffernan – Lord, Abbett and Company

Good. Two real main questions, one, could you discuss the dividend and discuss the decision to increase it by – in the way that you did given the loss going through as you – where did austerity measures and just looking ahead to a difficult market here?

Keith Pratt

Gerry, in terms of the dividend, clearly we have got a track record of paying a dividend and we are seeing steady increases. In terms of as to how we have looked at this year, we look a lot at the health of the operating cash flows of the business. We feel that those operating cash flows will still be healthy in ’09 and we still think the long-term financial foundation of the company is very solid and its ability to continue generating healthy cash flows is solid and with that in mind, we felt it was appropriate to make the increase to the dividend.

Dennis Kakures

Gerry, I might also mention that our lease up [ph] we have had a lease up in the company since the middle 1980s and our employees also participate in that dividend.

Gerry Heffernan – Lord, Abbett and Company

Understood. Certainly, your business is a strong cash flow business always has been having confidence in that going forward and raising the payout there and certainly puts you in a small minority of how people are willing to do that in this day and I find they have a very interesting decision on your part. In regards to the current economic backdrop the difficulties that are going on and all of the things that you have talked through on the call so far, what is the silver lining in all of this, what is going to occur in this current downturn period that is going to – that will enable you to position McGrath to move ahead even stronger even more profitably in the years 2011 through 2015?

Dennis Kakures

Good question Gerry. I think first and foremost is we have over this past year we have really – we have selected our additional legs to the business that we talked about for a number of years and we are clear in our thinking about our ability and strategies to grow those business. Recessions really create a lot of opportunities for companies if they know how to use them properly. We feel with the capital that we have and our ability to do various items that I won’t speak to in detail, but during windows like this that we can really get a leg up on our competitors and be in a very favorable position as business activity picks up. So, I think most important is that we can really over the next 12 months to 18 months work on really growing these businesses in terms of getting the right people in place, innovating with the right types of assets, being able to operationally get things really organized and efficient. If all those kind of nuts and bolts side means that we have been very good at over time. And if sometimes for our business activity windows give you a chance to really do some things that you can’t otherwise and work sited about out future. We have got a lot of new engines here that really have some significant potential, let alone the strength of our historical core modules in electronic engines.

Keith Pratt

I think, Gerry, we have kept the leverage of the business relatively low certainly compared to some players in the various rental businesses. (inaudible) is a very solid financial foundation and we are building diversity and where the cash flows of the business come from. We are going to have more geographic diversity, more product diversity, and at the same time operationally we are keeping the focus on provide high quality assets to our customers and maintain a high level of service and if we do all that the franchises that we are building in each of these rental markets should be stronger in the outer years.

Gerry Heffernan – Lord, Abbett and Company

That’s great gentlemen. Thank you very much.

Dennis Kakures

Thank you.

Operator

Thank you. And our next question is a follow-up question from the line of David Gold with Sidoti & Co. Please go ahead.

David Gold – Sidoti & Co.

Hi. Just curious if in-light of everything you can give a sense for how we should think about free cash flow this year and we tied to that presumably if both businesses are slowing on an organic basis, presumably we are not really out there spending that much fine new equipment, right?

Keith Pratt

David I think the question is best answered as you indicated by looking at the capital spending that’s probably the biggest variable that will impact the total free cash flow for the year. We spent $96 million in 2008 and if I look at the drivers for ’09 I think you can tell from our comments and as you look at the utilization we are seeing the Modular and electronics business that are traditional core businesses are likely to require less new capital in ’09. Then if we look at the other initiatives that we have going the environmental test equipment, the portable storage in some of the new Modular markets, we want to continue to invest in those and with the addition of Adler, we expect Adler to grow and we will be putting new capital in that business. So, if we net all of that, I will have – we will have still a lot of uncertainty in the business I would say that the CapEx is likely to be broadly similar to what we did in ’08, but it is a different mix with the new initiatives getting more of the capital and I would also say given these tough economic conditions there is probably more potential for spending less capital in the traditional businesses as the economic conditions continue to be tough for the whole year or tougher than we had initially expected.

David Gold – Sidoti & Co.

What do you see as sort of a floor if you were taken to the count – you need to buy some for Adler presumably and you need to keep the initiatives going? In other words, on a similar level how much of that is for the two main businesses and how much of it for those other initiatives in Adler?

Dennis Kakures

The way I would respond to that David is just a – Adler is a new enterprise for us. We need to build assets to support that business and take advantage of market activity throughout the country and so we will support that business appropriately and that is independent of what we do with our other businesses and I think that is the extend of the color of the we would give on that.

Keith Pratt

The other thing David I would point out it we throttle the CapEx based on market conditions and whether we believe we are going to get a good return on those investments and we don’t have to commit to spending that capital very far ahead of the time of deployment.

David Gold – Sidoti & Co.

Got you. Okay thank you.

Operator

Thank you. That concludes our question-and-answer session for today’s call. I would now like to turn the call back over to management for any closing remarks.

Dennis Kakures

We'd like to thank everybody for joining us today in our Q4 2008 call. We will look forward to chatting with you all again on our Q1 call in May. Thank you all so much.

Operator

Thank you. Ladies and gentlemen, this does conclude the McGrath RentCorp fourth quarter 2008 conference call. If you would like to listen to a replay of today’s conference you can dial 303-590-3000 or you can dial 1-800-405-2236 and enter access code 11125293 followed by the pound sign. We thank you for your participation, you may now disconnect.

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Source: McGrath RentCorp Q4 2008 Earnings Call Transcript
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