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McGrath RentCorp (NASDAQ:MGRC)

Q3 2010 Earnings Call

November 1, 2010 5:00 p.m. ET

Executives

Geoffrey Buscher - IR, SBG Investor Relations

Keith Pratt - SVP and CFO

Dennis Kakures - President and CEO

Analysts

David Gold – Sidoti & Co.

Scott Schneeberger – Oppenheimer

John Gibbons – Odin Partners

Les Bryant – UBS Financial Services

Operator

Welcome to the McGrath RentCorp third quarter 2010 conference call. [Operator Instructions.] This conference is being recorded today, Monday, November 1, 2010. Now I would like to turn the conference over to Geoffrey Buscher of SBG Investor Relations. Please go ahead.

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 7 days following the call by dialing 1-800-406-7325 for domestic callers, and 1-303-590-3030 for international callers. The passcode for the call replay is 4375366.

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 today at approximately 4:05 pm Eastern Time, which is 1:05 pm Pacific Time. If you did not receive a copy, but would like one, it is available online in the Investor Relations section of our website, or you may call 1-206-652-9704 and one will be sent to you.

Before getting started, let me remind everyone that the matters we will be discussing today that are not truly historical are forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, including statements regarding McGrath RentCorp's expectations, beliefs, intentions or strategies regarding the future.

All forward-looking statements are based upon information currently available to McGrath RentCorp, and McGrath RentCorp assumes no obligation to update any such forward-looking statements.

Forward-looking statements involve risks and uncertainties, which could cause actual results to differ materially from those projected. These and other risks relating to McGrath RentCorp's business are set forth in the documents filed by McGrath RentCorp with the Securities and Exchange Commission, including the company's most recent Form 10-K and Form 10-Q.

I would now like to turn the call over to Keith Pratt.

Keith Pratt

Thank you Geoffrey. In addition to the press release issued today, the company also filed with the SEC the earnings release on Form 8-K and its third quarter 2010 form 10-Q. For the third quarter 2010, total revenues increased 10% to $83.2 million from $75.5 million for the same period in 2009. Net income increased 2% to $9.7 million from $9.5 million for the same period a year ago. Earnings per diluted share remained flat at $0.40 compared to the same period in 2009.

Reviewing the third quarter results for the company's mobile modular division compared to the third quarter of 2009, total revenues decreased $2.8 million, or 7%, to $37.2 million due to lower rental and sales revenues.

Gross profit on rents decreased $4.2 million, or 30% to $9.8 million, due to 7% lower rental revenues, with rental margins decreasing to 47% from 62% in 2009. Lower rental margins were a result of lower rental revenues combined with $2.6 million higher other direct costs for labor and materials to support higher activity levels in our inventory centers and flat depreciation.

Selling and administrative expenses increased 9% to $7.3 million as a result of increased investment in our mid-Atlantic and portable storage growth initiatives. The lower gross profit on rents, rental-related services, and sales, combined with increased selling and administrative expenses, resulted in a decrease in operating income of $6.4 million, or 53%, to $5.7 million.

Finally, average modular rental equipment for the quarter was $494 million, an increase of $16 million. Average utilization for the third quarter decreased from 71.1% in 2009 to 67.8% in 2010.

Turning next to third quarter results for the company's TRS-RenTelco division, compared to the third quarter of 2009, total revenues increased $3.5 million, or 15%, to $27.3 million, due to higher rental revenues. Gross profit on rents increased $3.4 million, or 55%, to $9.2 million. Rental revenues increased $3.3 million, or 18%, and rental margins increased to 42% from 32% as depreciation as a percentage of rents decreased to 42% from 53%.

Selling and administrative expenses increased $0.6 million, or 14%, to $5.3 million, primarily due to investment in our TRS environmental growth initiative. As a result, operating income increased $3.1 million, or 92%, to $6.5 million, from $3.4 million.

Finally, average electronics rental equipment at original cost for the quarter was $246 million, a decrease of $1 million. Average utilization for the third quarter increased from 60.4% in 2009 to 67.7% in 2010.

Turning next to third quarter results for the company's Adler Tanks division, compared to the third quarter of 2009, total revenues increased $6.3 million, or 95%, to $13 million, primarily due to higher rental and rental-related services revenues.

Gross profit on rents increased $4.1 million, or 122%, to $7.5 million. Rental revenues increased $5.1 million, or 102%, and rental margins increased to 75% from 68% as depreciation as a percentage of rents decreased to 14% from 18% and other direct costs decreased to 11% from 14% in 2009.

Selling and administrative expenses increased $0.8 million, or 35%, to $3.1 million, primarily due to higher personnel and benefit costs and higher advertising and marketing costs. As a result, operating income increased $3.6 million, or 238% to $5.1 million.

Finally, average rental equipment for the quarter was $109 million, an increase of $46 million. Average utilization for the third quarter increased from 65.1% to 78.3%.

On a consolidated basis, interest expense for the third quarter 2010 decreased $0.1 million to $1.6 million from the same period in 2009. As a result of the company's lower average interest rates, partly offset by higher average debt levels, the third quarter provision for income taxes was based on an effective tax rate of 38.8% compared to 39.1% in the third quarter 2009.

Next, I'd like to review our 2010 cash flows for the nine months ended September 30, 2010. Highlights in our cash flows included net cash provided by operating activities was $66.1 million, a decrease of $23.4 million, or 26%, compared to 2009. The decrease was primarily attributable to increased accounts receivables in 2010, mostly due to higher business levels at Adler Tanks and Enviroplex, partly offset by other balance sheet changes.

We invested $93.4 million for rental equipment purchases, compared to $51.4 million for the same period in 2009, partly offset by $19.8 million in proceeds from used rental equipment sales in 2010. Property, plant, and equipment purchases increased $3.8 million to $5.2 million in 2010.

Dividend payments to shareholders were $16 million. Net borrowings increased $25.2 million, from $247.3 million at the end of 2009, to $272.5 million at the end of the third quarter 2010.

With total debt at quarter-end of $272.5 million, the company had capacity to borrow an additional $94.5 million under its lines of credit, and the ratio of funded debt to the last 12 months' adjusted EBITDA was 2.18 to 1.

For 2010, third quarter adjusted EBITDA increased $0.6 million, or 2%, to $34.2 million, compared to the same period in 2009. We have consolidated adjusted EBITDA margin at 41% compared to 45% in 2009. Our definition of adjusted EBITDA and a reconciliation of adjusted EBITDA to net income are included in our press release and form 10-Q for the quarter.

Turning next to 2010 earnings guidance, at this time based on the results for the first 9 months of 2010, and our outlook for the remainder of the year, we are narrowing our previous 2010 full-year earnings guidance range of $1.30 to $1.45 per diluted share to an updated range of $1.35 to $1.40 per diluted share.

Now 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's rental revenues for the quarter decreased by $1.6 million, or 7%, from a year ago to $20.9 million. Sequentially, from the second quarter 2010, rental revenues rose by $0.5 million, or 2%.

This was the first sequential quarterly increase in rental revenues since the third quarter of 2008. However, income from operations decreased by 53% to $5.7 million from a year ago.

This significant reduction in the income from operations compared to the much-smaller decrease in rental revenue was due primarily to substantially higher inventory center labor and material costs, and secondarily to lower rental-related services and sales gross profit levels.

The increased inventory center costs were associated with a number of larger, highly customized commercial building complexes and the preparation of a higher volume of classroom buildings during the quarter in the California market.

We are continuing to see a flow of larger commercial construction project opportunities in California, primarily associated with state infrastructure development and public works projects. These projects are for waterway, public transit, healthcare, roadway, and other public infrastructure improvements. State bond monies, as well as federal stimulus funds, have helped to support an increase in these larger projects during 2010.

We're also experiencing larger commercial construction project opportunities in both our Texas and mid-Atlantic markets. Although we have experienced higher business activity levels for larger commercial construction projects this far in 2010, more general residential and non-residential construction opportunities remain sluggish throughout all of our markets.

Utilization at the end of the third quarter was relatively flat at 67.4%, compared to 67.9% at the end of the second quarter. Monthly utilization has stayed within a very narrow range of approximately 0.5% through the first nine months of 2010.

We believe the relatively flat utilization range year-to-date, coupled with the modest sequential quarterly increase in rental revenues during the third quarter, reflects a more stable modular rental market. It's important to keep in mind that our modular rental business results tend to behave differently than other types of businesses during an economic recession and recovery.

During the downturn, due to the large installed base of rental contracts, the orderly return of equipment over time as customers' needs are fulfilled tends to lower rental revenues gradually. The same dynamic applies during a recovery in that new rentals coming online add to the lower installed base of rental contracts and builds over time. In other words, typically there are not dramatic swings down or up with rental revenue levels in the near term.

Although market conditions for our modular division have improved in 2010 compared to last year, we expect it to remain a very price-competitive environment in all of the markets in which we operate until utilization levels begin to rise across the industry.

Keep in mind that as our modular business returns to growth, it will require limited new capital investment to increase rental revenues, and we would expect to see a disproportionate share of this revenue convert to the pre-tax line.

Now let me turn our attention to TRS-RenTelCo and their results. TRS-RenTelCo's rental revenues for the period increased by $3.3 million, or 18%, to $21.8 million from a year ago. However, income from operations nearly doubled to $6.5 million from 2009's level.

In addition to the higher rental revenue level, our electronics business also benefitted from lower depreciation expense and higher gross profit on equipment sales quarter-over-quarter. The pipeline of order opportunities during the third quarter was very strong, and this trend is continued into the fourth quarter. We are seeing favorable demand both domestically and internationally across a number of end markets including semiconductors and communication products and networks.

Although our rental revenues in our electronics division have grown very favorably thus far in 2010, we continue to disciplined in what level of inventory to carry on specific products, what orders we elect to pursue, and what rates.

We're also doing a good job of taking cost out of the business by selling underutilized equipment and eliminating its associated depreciation expense. These disciplines and the management of our inventory and pricing levels should benefit us in driving greater profitability over an extended period of time through good and bad economies.

During the quarter, our gross margin percentage on sales was 48%, an increase from 43% in the second quarter of 2010, and speaks to the health of the customer and broker sales markets. As a result of our higher business activity levels and more tightly managing our rental inventory, average third quarter utilization increased to 67.7%, compared to average second quarter of 2010 utilization of 66.2%.

Finally, rental rates have been trending upward during 2010, with our third quarter yield on equipment on rent improving to 4.36% compared to 4.13% a year ago. This is a reflection of healthier market conditions in 2010 and our inventory selection discipline.

Keep in mind that although we are continuing to experience a favorable pipeline of opportunities and healthy business activity levels early in the fourth quarter, we typically experience higher equipment return and lower booking levels in the second half of the fourth quarter. This is primarily due to many electronics and communications related businesses ramping down operations toward year end and the holidays.

Although our outlook for electronics business for 2011 is still evolving, we are hopeful that the favorable market conditions that have existed during 2010 will continue next year.

Now let's turn our attention to Adler Tank Rentals. Our tank rental business more than doubled rental revenues, to $10 million from a year ago. The strong increase in rental revenues was directly related to higher business activity levels supported by new branch locations, a larger sales force, and expanding Adler's rental equipment inventory.

We are serving a wide variety of market segments, including industrial plant, petrochemical, pipeline, oil and gas, waste management, environmental field service, and heavy construction. Quarter-over-quarter income from operations was up over threefold to $5.1 million, as the business more fully leveraged prior quarter new employee and other infrastructure investments.

Business activity levels and bookings have continued very favorably into the fourth quarter of 2010. Period-end utilization for the third quarter 2010 increased to 77.4%, compared to 76.8% at the end of the second quarter of 2010.

Looking forward, we are very enthusiastic about the prospects for Adler becoming an increasingly significant contributor to McGrath RentCorp's earnings.

Now let me take a moment and update everyone on our organic initiatives. First, TRS-Environmental, our environmental test equipment rental initiative, continued to make very favorable strides in growing its number of opportunities, rental customers, and rental revenues during the third quarter of 2010.

We increased bookings by 16% and rental revenues by 35% sequentially over the second quarter of 2010. This is chiefly due to gaining more traction with customers in an improving marketplace and slightly longer rental terms.

Our outlook heading into 2011 is very positive. We believe that as the economy improves, and project work increases, coupled with our country's increasing sensitivity on environmental matters, we can become a significant rental provider in the environmental test equipment industry.

Our portable storage initiative also made good progress during the quarter. Rental revenues grew by 32% sequentially over the second quarter, and have grown each quarter since the business was launched in 2008.

We are working hard at expanding our portable storage business in the California, Texas, and Florida markets, and we're continuing to explore smaller fleet acquisition opportunities to accelerate our growth. We're also continuing to add sales professionals and operations staff in growing the business. Looking forward, we are excited about the momentum and opportunities for growth in our portable storage initiative.

Lastly, our mid-Atlantic modular expansion continues to achieve favorable growth. Rental revenues grew by 24% sequentially over the second quarter, and have grown each quarter since the beginning of 2009. We are seeing improving commercial market activity, especially for larger building complexes, and are continuing to make good progress in capturing new educational classroom rental business with our innovative classroom products designed specifically for these markets.

Our outlook for growing the base of rental revenues and profitability for the mid-Atlantic region going forward is very positive. Although these new initiatives are all relatively small today compared to our legacy rental business in Adler Tank Rentals, collectively, between our environmental test equipment, -portable storage, and mid-Atlantic initiatives, they are contributing on an annualized basis approximately $8.4 million in rental revenues based on a third-quarter 2010 run rate. This is up from a run rate of $6.5 million in the second quarter.

It should also be noted that these results have been achieved in a very challenging economy. That being said, we believe that we will be able to grow the current base of rental revenues for each of these initiatives to much higher levels as we move forward in an improving economy.

During 2011, we plan to continue to invest capital for rental equipment purchases and in SG&A to support accelerated growth of Adler Tank Rentals and our portable storage, environmental test equipment, and mid-Atlantic modular initiatives. It's essential that we take full advantage of various market and competitive dynamics that currently exist in order to attract more customers and create higher revenue levels in these businesses sooner rather than later.

Now for some closing remarks. This is our second consecutive quarter-over-quarter increase in both rental revenues and net income coming out of the great recession. Although net income was up only slightly relative to our rental revenue growth, this was primarily related to the significantly higher modular inventory center costs associated with processing highly customized buildings during the quarter. In the quarters ahead, we will benefit from the rental revenue from these projects with limited matching expenses.

Our California modular business has been very challenged over the past few years. However, we have seen improving business activity levels for both the commercial and educational sectors throughout 2010 and our outlook as we head into 2011 is brighter than a year ago.

Although our California K-12 public school modular classroom business is an important income contributor to our overall company results, keep in mind that it currently only represents approximately 12% of total company rental revenues. With McGrath RentCorp's broader platform of rental products and geographies today, it has, and will continue to, support earnings if weakness hits one of our business units, and also produce more substantial earnings growth as the macroeconomic picture improves.

Despite the 7% reduction in modular revenues quarter-over-quarter, company-wide rental revenues increased 15% from a year ago. This is the highest rental revenue quarter in McGrath RentCorp's history. It's clear from these results that our strategy of creating additional earnings engines through greater product and geographic diversity is working.

And now Keith and I welcome your questions.

Question-and-Answer Session

Operator

[Operator Instructions.] And our first question comes from the line of David Gold with Sidoti & Company. Please go ahead.

David Gold – Sidoti & Co.

First, historically third quarter's always given you a good look based on what comes in and what goes out on the classroom side, and so curious if you could flesh out or give a little bit more color on your expectations for - obviously you mentioned that you think business is stabilizing, but based on what you saw come back versus go in, right? Since we don't have a full quarter to look at, can you give us a better sense for how you think, say, the next two or three quarters play out in that business?

Dennis Kakures

I'll summarize it this way, we had a better booking year in 2010 than we did in 2009, so that's positive. We even saw some late Florida activity in September and October related to classrooms getting prepared to potentially move to the student teacher ratios at the classroom level as opposed to the school level. So that's good news because we don't believe that amendment change is going to pass. So that's a very positive item for us going forward.

But right now, with school activity what's returned is returned, what's gone out has gone out. We expect the fourth quarter for that to be fairly stable and again, it feels to us like it was a better performance year on the educational side this year than last year. So that's the best way I can summarize it at this point.

David Gold

So on that basis, from here we would expect some sequential growth then in the fourth quarter?

Dennis Kakures

Well that's a function obviously of what happens with the commercial business as well, so there's a number of factors there and as we look at the fourth quarter currently, with October behind us, business activity has been healthier than last year at this time. So at this point, we feel pretty good about the fourth quarter, but again there's two months to go.

David Gold

And then I guess part two of that, just a little bit more sense of the distribution costs. I presume those were opportunities where we should see some benefit from revenue near term?

Dennis Kakures

You're talking about the increased inventory expenses?

David Gold

Right.

Dennis Kakures

We typically, when we prepare equipment in the inventory center, the great majority of those costs are typically incurred within the quarter. Some get amortized over the term, and some get capitalized, but the great majority is expensed within the quarter. And then especially with larger complexes, which are typically multi-year contracts, we get the revenue stream for the next couple of years, with limited expenses associated with that.

David Gold

So were those big opportunities that came up all at once, or just from a timing perspective, at least on the classroom side, was there catch up there? It was a big number -

Dennis Kakures

Some of it was more compressed in terms of some of the volume exceeded what we planned for, and when that occurs to get the work done we'll typically use some overtime and use of outside subcontractors. That hurts us a bit on the cost side, and that's what we experienced in the third quarter.

David Gold

So from here on out maybe more natural growth based on the historic seasonal pattern?

Dennis Kakures

It's a function of - we would expect right now, unless there was a real pent up demand on larger complexes in Q4, that we would see a significant reduction in inventory expenses for labor and material in Q4. It's never a bad thing when it happens, because what it does is it gives us recurring rental annuity for typically a multi-year term. So currently, right now, we're expecting significantly lower IC expenses in Q4.

David Gold

One last one, then I'll get back in the queue. 2011 SG&A, your comment. Can you give a sense for how significant the growth might be?

Keith Pratt

It's too early, David. As you know, customarily when February comes around and we've finished up the full year and announced our results that's typically when we'll make guidance comments. I think in all of the other things we've discussed, as we continue to invest in the growth initiatives and we see the opportunities to build those businesses faster and more deeply in the market. If that does require investment in new equipment it also requires some SG&A, so that's been part of the story this year. I would expect you'll see more of that next year, but it's a little too early to give a final quantification of what those numbers are going to be.

David Gold

Sure, but maybe is it possible at least on those new initiatives to give a dollar value for what the step up might be? Or is it just too early, in which case a guess - what you're basically saying is the growth in SG&A would be higher than the growth you'll see in revenue next year?

Dennis Kakures

The way I would respond to that is that the great majority of SG&A is tied to growth, so if growth is not occurring, we're not going to spend the money in SG&A for new positions. So right now in our financial planning for next year we're looking at a number of positions to support growth in Adler and our new initiatives, in electronics, and even some replacement positions in our modular business. But those are a function of the trend of business activity levels, how demand is occurring, and so it's very revenue-based in terms of our spend. So if we're spending on SG&A significantly for positions, it really means the markets are recovering more fully and we're seeing increased demand.

Keith Pratt

And part of the reason we can't answer today is as an example, if we leverage an existing branch and grow that more we can get some operating leverage from that. On the other hand, if we open a new branch, whether it's for Adler or Portable Storage, or another part of the business, typically that's diluted initially for that branch. So it's going to be the choices we make as we finalize our plans around how much of those two things we do next year.

Operator

[Operator Instructions.] And our next question comes from the line of Scott Schneeberger with Oppenheimer. Please go ahead.

Scott Schneeberger – Oppenheimer

I'm just curious to hear some commentary with regard to pricing in the modular category, classrooms specifically, and how you're feeling about that. It must be fairly competitive, but it sounds like you're feeling better about volume. If you could differentiate the two please?

Dennis Kakures

It's still highly competitive from a pricing standpoint in the California market. Florida continues to have very stable pricing, predominantly because of our innovative hybrid product there. Mid-Atlantic has been very favorable pricing as well, classroom wise, because we have a special product there. California continues to be very competitive. It will be that way until inventories get better utilized. So competitive landscape, especially in California.

Scott Schneeberger

And with regard to the customization of the commercial projects, could you just give a little bit more detail as to what that is and I gather from what you've said before that that's largely wrapped up with regard to the investment end of it, and you will reap some benefit going forward. I'm just curious if there's A) a tailwind in the fourth quarter of the investment end of that and B) just what specifically is going on with those.

Dennis Kakures

Let me answer the latter part of your question first. I think we've really taken and absorbed those expenses in Q3. There could be some minor trailing items, but they won't be material. We should see a significant drop in those expenses in Q4. With respect to the type of work, when you do customization to a building, whether you're taking an existing office configuration and you're really demoing the building, there's labor for that, there's disposal. We're adding new office space, we're adding restrooms, we're adding kitchen facilities, coffee bars. You could be adding special lighting systems. Just anything you could imagine really in a commercial office environment or in a restroom or kitchen type facility. So those can be extensive and as I mentioned earlier the great majority of those typically, unless they're adding long-term value to the building, are expensed within the quarter. So that's some color on the type of modification work that we did during the quarter.

Scott Schneeberger

A couple more detail questions, but first, just taking it up higher level, with regard to modeling, typically the fourth quarter in rental revenue is in the ballpark of 25% or 26% of full year. Fairly steady. Anything that would lead us to believe that rental revenue would be much out of that range this year on a seasonality factor? And then also if you could speak to sales on what you think as far as trends in the fourth quarter there.

Keith Pratt

I'll start with sales. Typically sales are strongest in the third quarter, and I think if you look from a modeling perspective I would just look at the level of sales we experienced in TRS as being more balanced over the course of the year. Enviroplex sales generally are strong in the third quarter. They can be pretty healthy into the fourth quarter, just depending on timing of projects. But overall I would say sales are generally a little lower in the fourth quarter than the third quarter. And then in terms of seasonality you really have to look division by division.

As Dennis mentioned in the prepared remarks, both TRS and Adler have entered the fourth quarter with very good booking trends. Both those businesses very healthy. In both cases there is some seasonality at year end that we'll have to navigate, but those businesses are performing very nicely. We're off to a very good start in the fourth quarter. They may soften a little bit as we approach year end and then typically get going again to their full potential during the course of the first quarter.

Scott Schneeberger

And then again, using it as a branch into other segments, just curious if there was - Adler in the Gulf Coast, I'm just curious - any oil spill impact? I know that's not a business that you wanted to be in. I'm just curious if that had any affect on the third quarter at all.

Dennis Kakures

It's very minimal. We purposely limited our exposure to the Gulf because it has a beginning and an end and we really needed equipment to support long-term customers in our regional markets.

Scott Schneeberger

And then you mentioned I think higher return levels in fourth quarter for TRS-RenTelCo and I think Keith you just hinted at that with regard to seasonality, but -

Keith Pratt

Normal.

Dennis Kakures

That's normal.

Scott Schneeberger

Okay, just making sure there wasn't anything unique there. One final question. Again, this is following up on a prior one. With regard to SG&A I understand you're not going to spend it if you're not putting it up on the revenues, and you had a nice revenue quarter and made that investment in spending, which should bode well for the future. I’m just curious as you get into next year if you continue to see strength on the top line are you going to continue to press the lever with regard to SG&A and cap ex if you could differentiate the two? I'm just curious to see if we will get P&L leverage next year if we continue to see strong revenue growth. And then also just what you're thinking on cap ex.

Dennis Kakures

It really depends on the business. You've got five rental businesses, and it really depends on how well each one is doing. And without question some of the SG&A investment this year we'll be leveraging even further. No different than Adler this year. We leveraged some of our spend from last year and earlier this year as we progressed later in the year. So we're beginning to leverage in all of our businesses the SG&A spend and I think you can see it more specifically in Adler. And then going forward, we just need to measure it as we get a sense of the business activity levels. Of course, in the rental business you have to have assets on the ground and available for when business hits, and we've always been students of that, and we don't want to miss opportunity. So we will spend our monies wisely in adding new equipment as well as in adding personnel and we will look to leverage as best we can and at the same time we want to take full advantage of coming out of the recession on opportunities. Those are items that will really pay off significantly in the years ahead if we take advantage of them especially during this window when things are beginning to ramp.

Keith Pratt

And Scott, if I could just try and add to that. As you'll see in the segment disclosure there's a lot of information there, but as you comb through that and in particular look at the income from operations on a percentage basis, you'll see for example on Adler operating margins increased from 23% a year ago in the third quarter to 39%. TRS increased from 14% to 24%, and really the only weak spot as we've discussed was Mobile Modular, and there we had a shrinkage in revenue. We had the higher costs in our inventory centers, and we saw operating margins compress from 30% to 16%, but I'd really use those comments to segue back to your question and say I think the company is very well-positioned for earnings leverage, particularly if we see modular start to stabilize and we see the comps more reasonable as we enter 2011. And then it's really going to be just a matter of what level of investment we wanted to make to support further growth in the business. But we're getting operating leverage with two of our divisions today. As they've grown revenues, they've enhanced the profitability profile and I think that says that our investments are really showing payback.

Operator

Our next question comes from the line of John Gibbons with Odin Partners. Please go ahead.

John Gibbons – Odin Partners

Can you just give us a little help for those of us who try to follow. I take your point about the classroom business not being as important as it was four or five years ago, but I'm still trying to understand what went on in the California budget and is there anything you can tell us about how that process played out and what that did to the ability of school districts to either build or rent or whatever they were trying to do given the uncertainties that anyone running a school district had during the budget process. Did the budget finally come with some clarity for school spending in general?

Dennis Kakures

I think if you look at our situation, we depend greatly on the fact that are there bond monies available for modernization. The operating budgets for the most part are getting funded sufficiently enough so that districts are able to operate, although districts certainly economize, they've increased class sizes, especially in some of the smaller grades, because some of the penalties have been taken off on doing that.

But for the most part, the key for us is are there bond monies for modernization projects. And there are, and there's bond availability left to be sold in the market, and the state as they receive that has been deploying it fairly rapidly. So if you kind of look at 2010 versus 2009, 2009 there was paralysis. School districts didn't know what to do because the budget situation was such a dilemma for them. 2010 there were bond monies available. The state was able to do some bond sales, especially in the early spring. And then districts also got their feet under them so to speak, and understood what they would have.

We now have a budget. Is it going to need to be addressed with the new governor and legislature next year? Without question. And we'll just have to see how things work through. But for the most part, as long as bond monies are available for modernization, and there's been a very healthy level at the local school district level for bond monies and parcel taxes, that bodes well for us. And now that the paralysis really went away in 2010, we've seen much more bidding activity and districts looking forward in terms of getting the modernization projects going.

The other item I might also add is that in California this is the first school year in which they're looking at potential growth in K-12 student population from the projections and it's slowly going to get more substantial by the projections over the next five to six years. So that bodes well for us.

The classroom business is very important to us but I think again, as you mentioned in your question, it's only 12% - the California piece is only 12% of total company rental revenues today, and at some point that's going to start recovering fairly favorably and we'll certainly benefit from that along with the significant engines who are building with electronics and Adler and our new initiatives.

Operator

Our next question comes from the line of Les Bryant with UBS Financial Services. Please go ahead.

Les Bryant – UBS Financial Services

I just have one division I'm trying to get my mind around, and that's Adler, your newer division. Are you tied in with the [fracking] of wells, oil wells and drilling, which are Adler tank?

Dennis Kakures

Yes we are. And in particular, gas shale. That's correct.

Les Bryant

So you're in West Virginia and Pennsylvania area?

Dennis Kakures

That's correct. Also in the Haynesville and Barnett shale in Texas, the Eagle Ford in Texas. If you looked at any of the major shale plays in the U.S. we're participating.

Les Bryant

I knew your growth was coming from somewhere, and I thought it might be there.

Dennis Kakures

And remember, it's broad. That's only a certain part of the business, and we're fairly well diversified.

Les Bryant

Yeah, I've seen some of your tanks here at some road projects and so forth too in California.

Operator

Thank you and at this time there are no further questions. I'd like to turn the call back over to Dennis Kakures.

Dennis Kakures

Well thank you everyone for joining us on our Q3 call today. We'll look forward to chatting with you again in mid to late February with our Q4 call. Thank you so much and have a wonderful evening.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

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