McGrath RentCorp (NASDAQ:MGRC) Q2 2013 Earnings Conference Call July 31, 2013 5:00 PM ET
Geoffrey Buscher – Investor Relations, SBG
Keith Pratt – Senior Vice President & Chief Financial Officer
Dennis Kakures – President & Chief Executive Officer
David Gold - Sidoti
Joe Box – KeyBanc Capital Markets
Scott Schneeberger – Oppenheimer
Les Bryant - UBS
Welcome to the McGrath RentCorp second quarter 2013 financial results 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) This conference is being recorded today, Wednesday, July 31, 2013. I would now like to turn the conference over to Mr. Geoffrey Buscher with SBG Investor Relations. Please go ahead, sir.
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, Senior Vice President and CFO. Please note that this call is being recorded and will be available for telephone replay for up to seven days following the call by dialing 1-800-406-7325 for domestic callers, and 1-303-590-3030 for international callers. The pass-code for the call replay is 4627691.
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 Eastern Time or 1:05 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 21-E 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 related to McGrath RentCorp’s business are set forth in the documents filed by McGrath RentCorp with the Securities and Exchange Commission, including the company’s most recent Form 10-K and Form 10-Q.
I would now like to turn the call over to Keith Pratt.
Thank you, Geoffrey. In addition to the press release issued today, the company also filed with the SEC the earnings release on Form 8-K and the 10-Q for the quarter. For the second quarter 2013, total revenues increased 4% to $87.1 million from $83.8 million for the same period in 2012. Net income decreased 6% to $9.8 million from $10.5 million and earnings per diluted share decreased 10% to $0.38 from $0.42.
Reviewing the second quarter results for the company’s mobile modular division compared to the second quarter of 2012, total revenues increased $1.7 million or 6% to $29.5 million due to higher sales, rental related services, and rental revenues. Gross profit on rents decreased $1.6 million or 16% to $8.7 million, primarily due to a decrease in rental margins to 44% from 53%, partly offset by 2% higher rental revenues. Lower rental margins were a result of $2 million higher other direct costs for labor and materials and $0.1 million higher depreciation.
Selling and administrative expenses increased $0.3 million or 3% to $6.8 million, primarily as a result of increased personnel and benefit costs. The lower gross profit on rents partly offset by higher gross profit on rental related services and sales revenues combined with increased selling and administrative expenses, resulted in a decrease in operating income of $1.1 million or 29% to $2.7 million. Finally, average modular rental equipment for the quarter was $541 million, an increase of $20 million. Equipment additions were primarily to support growth in the Mid-Atlantic region and for our portable storage initiative. Average utilization for the second quarter increased from 65.8% to 66.8%.
Turning next to second quarter results for the company’s TRS-RenTelco division compared to the second quarter of 2012, total revenues increased $2.5 million or 8% to $33.1 million, due to higher sales and rental revenues. Gross profit on rents increased $0.3 million or 2% to $12.4 million. Rental revenues increased $0.5 million or 2% and rental margins were flat at 49% as depreciation and other direct costs as a percentage of rents were flat at 38% and 13% respectively. Selling and administrative expenses decreased $0.1 million or 2% to $6.3 million, primarily due to decreased salary and benefits cost related to the exit of the environmental test equipment business in November 2012. As a result, operating income increased $0.7 million or 8% to $9.1 million.
Finally, average electronics rental equipment at original cost for the quarter was $264 million, a decrease of $1 million. Average utilization for the second quarter decreased from 66% to 63.5%. Turning next to second quarter results for the company’s Adler Tanks division compared to the second quarter of 2012, total revenues increased $3.7 million or 18% to $24.3 million due to higher rental, rental related services, and sales revenues. Gross profit on rents increased $0.3 million or 3% to $11.8 million. Rental revenues increased $1.7 million or 11%, and rental margins decreased to 67% from 72% as depreciation as a percentage of rents increased to 19% from 18%, and other direct costs as a percentage of rent increased to 14% from 10%.
Selling and administrative expenses increased $0.8 million or 15% to $6.1 million, primarily due to increased personnel and benefit costs. As a result, operating income decreased $0.1 million or 1% to $7.3 million. Finally, average rental equipment for the quarter was $260 million, an increase of $42 million. Average utilization for the second quarter decreased from 70.3% to 65.8%. On a consolidated basis, interest expense for the second quarter 2013 decreased $0.2 million or 9% to $2.2 million from the same period in 2012, as a result of the company's lower average debt levels and lower average interest rates. The second quarter provision for income taxes was based on an effective tax rate of 39.2% unchanged from the second quarter 2012.
Next, I would like to review our 2013 cash flows. For the six months ended June 30, 2013, highlights in our cash flows included; net cash provided by operating activities was $66.2 million, an increase of $1 million compared to 2012. The increase was primarily attributable to a lower increase in prepaid expenses and other assets partly offset by lower income from operations and other balance sheet changes. We invested $56.2 million for rental equipment purchases compared to $73.3 million for the same period in 2012, and proceeds from sales of used rental equipment were higher by $2.2 million. Property, plant and equipment purchases decreased $4.7 million to $4.2 million in 2013. Net borrowings decreased $23 million from $302 million at the end of 2012 to $279 million at the end of the second quarter 2013.
Dividend payment to shareholders were $12.1 million. We have total debt at quarter end of $279 million, the company had capacity to borrow an additional $251 million under its lines of credit, and the ratio of funded debt to the last 12 months actual adjusted EBITDA was 1.76 to 1. For 2013, second quarter adjusted EBITDA decreased $0.2 million or 1% to $38.3 million compared to the same period in 2012, with consolidated adjusted EBITDA margin at 44% compared to 46% in 2012. Our definition of adjusted EBITDA and a reconciliation of adjusted EBITDA to net income are included in our press release for the quarter.
Turning next to 2013 earnings guidance, we have revised our previous 2013 full-year earnings guidance range of $1.85 to $ 1.95 to an updated range of $1.65 to $1.80 per diluted share. For the full year 2013 we expect 2% to 4% growth in rental operations revenues over 2012. Sales revenue is expected to be approximately 5% lower than 2012 but gross profit from sales is expected to be approximately 10% higher than 2012. Rental equipment depreciation expense is expected to increase to between $67 million and $69 million, driven by rental fleet growth. Other direct costs of rental operations are expected to increase from $46 million in 2012 to between $48 million and $50 million in 2013.
Selling and administrative costs are expected to increase to between $88 million and $90 million to support business growth and continued investment in Adler Tanks and our portable storage initiative. Full year interest expense is expected to be approximately $9 million. We expect the 2013 effective tax rate to be 39.2% and the average diluted share count to increase to between 25.6 million and 25.8 million shares for the full year. Now, I would like to turn the call over to Dennis.
Thank you, Keith. Although we are disappointed that company-wide rental revenues increased by only 4% and EPS declined by 10% from a year ago, we are pleased with the underlying favorable business activity levels and momentum we are seeing overall in our rental business portfolio. The primary factor for the quarterly earnings shortfall of $0.04 from a year ago with higher inventory center expenses in our modular division because of preparation of rental equipment related to increased order activity; and secondarily, lower results in Enviroplex.
Modular division rental revenues for the quarter increased by $0.4 million or 2% to $20 million from a year ago. This was the highest year-over-year percentage increase in quarterly rental revenues since the second quarter of 2008, five years ago at the beginning of the great recession. Rental revenues also increased sequentially in the second quarter from the first quarter 2013, $5.6 million or 3.3%. During the second quarter we experienced an 8% increase in division-wide year-over-year first month rental revenue booking for modular building with an increase of 12% outside of California and 1% within the state.
Over the first six months of 2013, we experienced a 20% increase in division-wide year-over-year first months rental revenue bookings for modular buildings, with an increase of 35% in our market outside of California and flat within the state. Many of these booked orders shipped either late in the second quarter or will ship in the third quarter of 2013, and thus are not fully reflected in our quarterly rental revenue levels to date. The business activity and opportunity levels in our Texas, Florida, California, and Mid-Atlantic modular building markets during the first half of 2013, are collectively the strongest that we have experienced in half a decade and we are seeing this strength continue in the third quarter.
We are also beginning to see rental rates begin to rise in certain building sizes and types in each of our geographic markets including California. This is being driven by demand exceeding readily available supply in some instances and shortages of various building sizes or types in other. Modular division ending utilization for the second quarter of 2013 was 67.6% compared to 65.6% a year ago and 66.1% at the end of the first quarter of 2013. With the strong business activity we are seeing across all of our markets, we are cautiously optimistic that we will see further increases in utilization during the second half of 2013.
Modular division income from operations for the quarter decreased by $1.1 million or 29% to $2.7 million from a year ago. The reduction in operating income is primarily due to the increase in overall divisional booking levels and related higher investor center cost for labor and material to prepare and modify equipment for rental. In fact, inventory center cost primarily for equipment preparation were approximately $2 million higher than the second quarter 2013 and to the same period in 2012.
The great majority of these expenditures are to support booked orders, many of them with significant customization work and with either contractual or anticipated multiyear rental terms. Coming out of the great recession, these building preparation inventory center costs are compounded by needing to redeploy various rental assets that have been sitting idle for extended timeframe which tend to have higher processing cost than inventory that turns more frequently. We are also making significant expenditures in attempting to pre-prep as much equipment as possible at our inventory centers. This allows our sales and inventory center teams to book more transaction and produce more buildings and serving short notice market opportunity.
We also tend to receive higher rental rates for short notice transaction as a result of our competitors inability to meet customers expedited timeframe. Unfortunately, due to our heavy volume of orders, we have made limited headwinds building up a meaningful supply of sizes and types of buildings to meet these short notice market demands. Keep in mind that almost all of our inventory center cost for building preparation and modification work are expensed in the quarter in which they are incurred. However, we benefit from the associated rental revenue stream from such expenditures in the quarter ahead.
We also had higher SG&A expenses during the quarter from a year ago primarily related to increased sales and operations staff level to support the recovery of our modular rental business. Finally, some of these increased costs were offset by higher gross profit on rental related services and to a lesser extent, higher gross profit and sales of equipment from a year ago.
Now let's turn our attention to Adler Tank Rentals and their results. Rental revenues at Adler Tank Rentals, our tank and box division, increased by $1.7 million or 11% to $17.7 million from a year ago. These results were significantly below our internal projection. This shortfall was chiefly related to various larger rental projects coming off rent over the first half of 2013, primarily related to natural gas and oil shale fracking projects. We also were impacted negatively by a much more competitive fracking rental market, specifically for 21K standard tank. This impacted both rental rates and terms for these in-market transactions. This is also reflected in Adler's division-wide rental revenue mix of fracking related rentals declining to 11% compared to 23% a year ago and 15% at the end of the first quarter of 2013.
In effect, we saw declines of 49% year-over-year and 24% sequentially from the first quarter of 2013 in fracking related rental revenues. Despite this decline in fracking rental activity, we were able to grow our non-fracking related in-market 29% from the same period in 2012. Further, for the first half of 2013 across all vertical markets, first month's rent in units booked were up 43% and 45% respectively over the same period in 2012. Additionally, second quarter 2013 first month's rent and units booked were up sequentially than the first quarter 2013, 34% and 31% respectively. We saw increased bookings year-over-year in each of Adler Tank Rentals regional markets.
However, these strong increases in new business only partially countered the headwinds of equipment return. Adler is serving a wide variety of market segments including industrial plant, petrochemical, pipeline, oil and gas, waste management, environmental field service, and heavy construction. By design, we have pursued and been successful in generating higher business activity level across the broader mix of non-fracking and historically less volatile vertical markets.
Ending second quarter 2013 utilization for tank and box division increased to 68.7% from 67.5% a year ago and 63.5% at the end of the first quarter of 2013. Further, the equipment utilization for Adler continued to increase early in the third quarter of 2013 to 69.5% through the 25th of July. Despite an 11% increase in rental revenues for the second quarter 2013 from a year ago, Adler divisional income from operations for the quarter was flat at $7.3 million compared to the same period in 2012. This is chiefly due to higher inventory center labor and material cost to process increased levels of outgoing equipment, cost to support geographic expansion and infrastructure investment primarily in filling key sales management and operations staff roles, as well as in establishing new facility. And sales bonus cost associated with increased booking level, all as a percentage of rent.
Over the past 18 months, Adler Tank Rentals has entered eight new U.S. markets. In addition to having relocated excess 21K tank inventory to serve these new as well as established markets, we have continued to purchase new rental equipment to support the mix of tanks and boxes needed in each region. This is supported by the fact that although average equipment utilization for the quarter is down approximately 5% points from a year ago, we had an average of $171.4 million of equipment on rent during the second quarter of 2013, compared to $153.6 million a year ago.
Further, the dollar value of equipment on rent at the end of the second quarter 2013, increased to $181.4 million from $153 million a year ago. We are continuing to execute in building our national footprint to support higher rental revenue and earnings levels in the years ahead. Ideally, we would like to see narrow and more consistent utilization ranges. However, we are at a critical junction in our growth and it is essential that we have the right mix and depth of inventory on the ground in all the markets in which we operate in order to respond to a variety of end market needs. As Adler Tank Rentals continue to mature as a national company, we will gain greater knowledge on the drivers of demand for various tank and box rental products in all of our regional markets and in turn we would anticipate a narrowing of utilization swings period over period.
Now let me turn our attention to TRS-RenTelco and their results. TRS-RenTelco, our electronics division, rental revenues for the quarter increased by $0.5 million or 2% to $25.3 million from a year ago. If you remove renal revenues from last year's second quarter related to our environmental test equipment business that we sold late in 2012, the year-over-year growth in rental revenues was a healthy 6%. We experienced some rental revenue growth headwinds with higher returns and less robust new activity in specific general purpose test equipment product in end-market during the second quarter. However, communications products and network bookings continued to remain favorable. In part, we believe the softness in general purpose test equipment rentals during the second quarter is related to the federal sequester and aerospace and defense related budget.
We are uncertain as to the potential full year impact to electronics business related to these federal budget impact dynamics. During the second quarter of 2013, we saw our yield on equipment on rent increase to 5.03% from 4.72% a year ago, and 4.88% in the first quarter of 2013. This is primarily due to a greater mix of communications equipment and to a lesser extent market pricing. Communications test equipment assets have shorter depreciable life but higher rental rates than general purpose test equipment.
Divisional income from operations for the quarter increased by $0.7 million or 2%, to $25.3 million from a year ago. The higher percentage increase in profitability as compared to rental revenues was primarily related to higher gross profit on equipment sales, and lower SG&A and laboratory expenses, both as a percentage of rental revenues from a year ago. Gross profit on equipment sales increased by $0.2 million to $2.5 million compared to the second quarter of 2012. SG&A and laboratory expenses for the quarter as a percentage of rental revenues declined to 24.9% and 12.9% respectively from a year ago.
In the second quarter TRS-RenTelco utilization was 63.3% down from 65.7% a year ago and flat from the end of the first quarter 2013 and continues to be in an acceptable range. Although, average utilization is lower and average total equipment was relatively flat from last year’s second quarter, the higher average rental rate for the period produced an overall average yield on total equipment of 3.19% in 2013 compared to 3.12% in 2012. In producing these favorable operating metrics, we continue to benefit from our disciplined approach to equipment purchases in inventory management, appropriate depreciable equipment life, and our highly skilled efficiency driven and experienced workforce.
Now let me take a moment and update everyone on our portable storage business. Mobile modular portable storage continued to make good progress during the quarter in building its customer following, increasing booking levels and growing rental revenues from a year ago. Rental revenues for the second quarter 2013 grew by 28% and income from operations also grew favorably from a year ago. As discussed during our first quarter call, we entered the greater New Jersey, New York market in April. We are continuing to execute on plans for larger geographic footprint for our storage container rental business. At the same time, we are striving to create higher business activity levels and greater critical mass in each of the markets in which we operate.
We also continue to explore smaller fleet acquisition opportunities to accelerate our growth. It should also be noted that we have favorable room to grow rental revenues within the current cost structure. As the economy continues to improve and with the infrastructure and quality team we are continuing to build, our portable storage business should benefit very favorably. Looking forward, we continue to believe that we have an excellent opportunity to become a meaningful player in the portable storage rental industry.
Now for a few closing comments. We are lowering full year guidance to a range of $1.65 to $1.80 despite favorable new business activity across all of our rental businesses, as well as utilization gains in both our modular building and tank rental businesses. However, we continue to have limited foresight on when equipment will come off rent. The equipment returns we experienced in our tank and box rental business over the first half of 2013 have put us at a significant deficit to the rental revenue goals we began in the year. Adler Tank Rentals has also been negatively impacted by lower standard 21K tank rental prices, and shorter rental terms for equipment serving natural gas and oil shale fracking projects as compared to a year ago.
In addition to the uncertain rental revenue growth outlook for Adler Tank Rental, we expect continuing high direct cost of renal operations in our modular business due to increased booking activity and related equipment preparation expenses, and we are somewhat cautious of the general purpose test equipment market primarily related to the continued federal sequesters impact at TRS-RenTelco. Consequently, we have tempered our expectations for earnings per share for the rest of 2013.
To be clear, a rental revenue shortfall with Adler Tank Rentals is the primary reason for adjusting guidance lower than the full year in 2013. We will work diligently to make up as much as of this rental revenue shortfall as possible by year-end. More importantly, we believe each of our core rental businesses are fundamentally sound, strategically well positioned, and well capitalized both financially and organizationally, to thrive in the years ahead. Here's how we support this statement.
Modular building. We believe we are at the beginning of a meaningful recovery for historical (inaudible) modular building business. Bookings, rental revenue and utilization level as well as both factual and anecdotal regional economic information, reflect this today. We have significant earnings leverage and rental assets that we already own. We are the industry leader in key geographies in which we operate, including California, Texas and Florida, the three largest modular classroom and building rental markets in the U.S.
Tank and box rentals. Through the thick of the great recession, we were able to ramp this business well beyond our most optimistic projection. We have grown our fleet of rental assets from approximately $45 million when we acquired Adler Tank Rentals to over $250 million today. We have the youngest, most innovative and safest built renal fleet in the industry. We also now have a national footprint to fully leverage in the years ahead. Electronic test equipment. TRS-RenTelco is one of the two largest general purpose and communication test equipment rental companies in the America. We have a stellar end-market reputation for excellence in the mix and depth, cutting-edge technology of products, order execution and service, and have the industry's best financial operating metrics.
Finally, storage containers. Our portable storage business unit is small today compared to the other rental businesses but has a very significant growth opportunity going forward. This was another business that we started since the beginning of the great recession. Creating exceptional customer experiences is the key to winning business and increasing market share in this industry, which is a core strength of ours. Mobile modular portable storage became profitable in 2012 and we are moving very quickly to build out a selective national footprint. We are a small fish in a very large sea of opportunity in the portable storage industry.
McGrath RentCorp also has a very strong balance sheet with a funded debt to last 12 months actual adjusted EBITDA ratio of 1.76:1. And with current capacity to borrow an additional $251 million under our lines of credit. We can be very opportunistic in growing our business line with the availability of such funding. We are committed to making each of our rental businesses meaningful in size and earnings contribution, and with the best operating metrics by industry. We continue to make favorable strides during the second quarter 2013 towards achieving these goals.
Last, I realize that my comments regarding McGrath RentCorp's future outlook are significantly more positive than our actual earnings results for the second quarter, as well as our revised earnings guidance for the remainder of 2013. However, what's most important is to share as candidly as I can, with the investment community on the latest and most relevant facts, trends and other information that I believe will have the most meaningful and long-term impact on the company's earnings trajectory and share value. And now Keith and I welcome your questions.
(Operator Instructions) Our first question comes from the line of David Gold with Sidoti. Please go ahead.
David Gold - Sidoti
Couple of things. One, I was curious if you can bridge a little bit more the gap between the prior guidance and current. I know you talked about $0.04 during the quarter, presumably from inventory cost, but curious, presumably, should we think about it as that same $0.04 impact over the next couple of quarters and what are? And I know you called that the things, the factors, but I was curious, order of magnitude, how large you took the [mark]?
Yeah, David, this is Keith. The way I would look at it is, when we look at the full year guidance, really a change in the Adler profitability is about 80% of the change to the guidance. And if you look at that Adler change, it's primarily rental revenue for all the regions that Dennis spoke to earlier. With that business we were expecting over the course of the year to see rental revenues build by quarter and see an uptick in utilization and the second half of the year was going to be very important. The second quarter is going to be very important. As we really evaluated everything at the midpoint in the year, we just weren’t making as much progress as we had planned and that’s the key factor.
I would say secondarily at Adler, our direct cost of rental operations were higher in the first half than we planned. That’s largely maintenance and repair work on equipment, some tank reconditioning. We did more of that than we had planned for and that’s squeezed the margins further. But Adler is really 80% of the reset. The balance is really in our modular business as Dennis detailed. Where we are spending more again in direct cost of operations in support of those higher booking levels for business that we are capturing and in the process of starting to ship.
And David I might add, that those expenditures in the modular business in Q2, that’s really what we want to see. I mean if we are seeing those types of expenditures to that magnitude, than we are really seeing the business really begin to lift in terms of bookings. And what we should start seeing even if we have additional expenses in Q3 and we are going to have a higher run rate in a sense through the end of the year, we will start now getting rental revenue associated with the prior expenses that we have made. So there should be some good momentum here. But quite frankly, to the extent that we are having those higher expenses, that would bode well for utilization and rental revenues going forward.
David Gold - Sidoti
That makes sense. And on that note, two things in the mobile modular side. First, the bookings there, particularly outside of California, are running at slower pace than they were in the first half of the year. Is that just a function of tougher comps or seasonality, or what's sort of going on there, because I know that your commentary fairly positive on that front.
Well, I would just say that it's really hard to look at Q1 and Q2 increases for six months versus the first quarter, because it's an eclectic mix and some of what you get in some years of Q1, you will get the next year in Q2. So it's really kind of hard to calibrate that. You know I will say this, that year-to-date, just to give you some further breakdown percentage wise and we are talking [$1 million], but in our Florida market we are you about 48% in SMR in first month's rent. Texas, we are up about 29% and then Mid-Atlantic we are up about 34%.
So evenly, you have to kind of look at the first six months together to be able to get year-over-year. So that just kind of gives you some sense. All those markets are performing very favorably in terms of their year-over-year activity through the first half of the year.
David Gold - Sidoti
Got you. One other -- actually two other quick ones. One of them, what's your outlook thinking mobile modular on the R&M, repair and maintenance side. Presumably, like you say, it's sort of double-edge, it's the good news/bad news of cost today, equal revenue tomorrow. Do you expect that level to remain a little bit higher, a. And, b, when you think about it more broadly, are there -- do you think there is much maintenance or let's call it deferred maintenance required on the fleet that’s been out of service for some time.
The answer, yeah, we are going to see higher IT expenses related specifically to those items. You know when you have had some equipment that’s been sitting for two or three years or four years, the good news is, is now we are going deeper in the inventory because we need those assets. And we are going to experience initially here some higher spend. But once we have made that spend and a turn the next time, we will be back to really normalcy in terms of those types of cost. So if you had to line up the scenario coming out of the great recession, it's all about taking utilization from 65% back up to much higher levels. And that means that you have got to make these investments as the booking opportunities come. So that’s the first, really sign of recovery. That, a, you are getting the booking, and, b, you are spending the dollars to rotate the inventory.
And David in conjunction with that spending, we are also very actively looking for opportunities to move market pricing up and we are seeing success there. Clearly, lots of work still to do and a long way to go to get back to where we were a few years ago. But as an example, if you look at the overall fleet rental rate, it did uptick slightly in Q2 over Q1. And, again, it's more how we are operating in the field and what we are trying to achieve there and at least seeing some evidence that we can move pricing to a better clip.
Our next question comes from the line of Joe Box with KeyBanc Capital Markets. Please go ahead.
Joe Box - KeyBanc Capital Markets
I actually just wanted to follow- up on those prior questions. So the first one on the inventory cost. I guess I am just trying to understand the repair and maintenance component. I mean should we be thinking about the repair and maintenance and all the processing costs that are associated with putting these items back on rent. Should we be thinking about them as being a potential headwind until you see utilization normalized or is this more of a timings lift, where it's really just one to two quarters until you basically get these units out on rent and you collect fees from it.
You know, it's probably a little bit of both. I mean, to the extent that you did a lot of activity in a single quarter with customization work, you can have both those costs really jump just tied to customization plus the normal kind of additional cost that you are going to have to turn longer sitting inventory. So it's really this mix of how much general activity are you getting on standard products plus what's the customization mix. And like I said, we capitalize very little and almost everything gets expensed. So both of those are good guys, ultimately. And if we set for the next three or four quarters, that we are going to have similar expenses, then we ought to see a direct tie to utilization building up significantly which would be just what we want. So it's a little bit like, you know if you are seeing them that should be a good indicator of the health of the business. If you are not seeing them, if there is an, okay, well, you have got some upticks here and we are not seeing that same momentum in booking level.
So the net of that is, the more of this we can see, it should be a very good indicator. In sale you get to some point to where you have gone deep enough in your inventory and you are now getting a turn of equipment -- of other equipments you have touched previously and had those deeper expenditure costs already.
Joe Box - KeyBanc Capital Markets
You are right. And I am not arguing that it's a bad thing. I am just trying to understand how long it might persist. So when you guys specialize in a product, when you specialize a product for somebody, do you get paid on the front end for that or do those specialization costs get tied in over the life of the rental product?
Yeah. When it's a modification, typically those are amortized over the life of the lease. So those, in terms of -- we get it in rental revenue obviously, but it's typically over the life at least and they are not paying any onetime cost to us upfront to the most part. Occasionally you have that, but it's almost always spread.
Joe Box - KeyBanc Capital Markets
And Joe, one other thing I would say is, with the stronger activity levels and more activity than we had expected, at the margins, our labor in terms of having more use of contractors, working a bit more overtime. That’s a slight negative for us when we have to react to the market as quickly as we did. Over time if we are at these more elevated levels of work, there will be more opportunities to sort of manage the work a little differently in the workforce. Again, it's not a primary change to the number but it's the kind of action we can take over time as we start seeing higher levels of business activity in the inventory centers.
Joe Box - KeyBanc Capital Markets
Understood. Okay. Switching gears to the pricing side. I know we have talked extensively about the kind that would take for new rental rates to hit parity with some of the units coming off of rent. Given the more optimistic tone in the release on the mobile modular business, is that parity happening quicker than you had expected or can you maybe give us a sense of when we might actually see that happen?
Joe, it's a very good question and we are still feeling our way. What's interesting is that, what you don’t know is what's going to come back and when. So you have got that legacy equipment that’s out there and hopefully that continues to stay. And maybe we are back to normal return rates now which would be good. And as Keith mentioned earlier, we are starting to see some higher prices in products and especially as you get this demand bottleneck. And they are just not marginally higher prices, some of them are much more substantial back to normal sense. So I would just say that it's too early to tell. I mean we are still feeling our way through here. But the good news is, if you look overall and if you were to speak to the sales staff there is no question we put an emphasis on raising rates, especially when we are dealing with supplies of equipment that are in lower availability are readily available. And we tend to be getting better rates across the board. So all signs are favorable but we are very early in that transition in terms of being able to really begin to see any kind of material step upwards in the way of increasing rental rates across the entire fleet.
Joe Box - KeyBanc Capital Markets
Great. Thanks. Just a high level question for you on Adler. Obviously, we have written Adler off on the utilization curve and since it's come down and pricing sounds like it's now a little bit more competitive. How are guys viewing the supply demand balance in the market right now? I mean even though it's lower, are the returns still so attractive that you might see more fully growth from your competitors, or are we starting to see that switch that maybe the returns are a little bit less favorable now and you could start to see some of your peers back of in terms of buying new equipment.
Well, I mean to be candid, we have only really seen any kind of significant pressure on the fracking related business. I mean our other segments are all holding very steady. In fact, if you look at year-over-year rental rates on the quarter, I mean there are very close. So this is much more a fracking dynamic and the over-supply of equipment serving that market currently today. You know the rig count, the deployment of the rig count is down about what, 8% to 10% year-over-year. And there are assets that are idle in these different major shale plays and that’s where the competition is coming from. It's too much equipment chasing too little business. And of course that ebbs and flows. But know that X amount of that equipment cannot be used in the other segment because it's not clean enough. It doesn’t have a smooth wall interior. It can't be ready to state more environmental construction or industrial plant use. But we have built our product a certain way so that it's transferable between and just that it's very dynamic.
Joe Box - KeyBanc Capital Markets
Right. Okay. Thanks, that’s helpful. And just one housekeeping item, and I apologize if I missed this. What was the mobile modular rental revenue growth within California and then outside of California? I think I just heard you say bookings.
Yeah, we don’t have recorded that directly in the prepared remarks, but outside of California rents were up 13% year-over-year. In California they were down 6%. And then for the division as a whole, rents were up 2% year-over-year.
(Operator Instructions) Our next question comes from the line of Scott Schneeberger with Oppenheimer. Please go ahead.
Scott Schneeberger - Oppenheimer
I will jump around the segment but in modular, following up on the question, specifically on the pricing question, what are you seeing in the pricing environment? I just want to look a level deeper since you have nothing conclusive right here. Have through this five years of downturn, have competitors gone away? Are you one of the only sources on the way out? And obviously looking to see if there is a great potential for pricing increase is right out of [date]?
Yeah. Well, we have to kind of take it by market. Let's talk about California which was the [bell cow] state and the [bell cow] market. There are in effect are really today only if you look at educational first. So only two players of any significance. It's ourselves and Williams Scotsman. Now that’s down from three, prior to the great recession there were three. There was ModSpace, a former GE business, Williams Scotsman and ourselves. And then the classroom fleet that GE owned, they sold to Williams Scotsman. And that was right around I think the beginning of the recession or somewhere in that era. So coming out of the recession, and as we have said before, typically when there is rental opportunities in California for educational product, we are the primary beneficiary. I don’t know how else to put it, but we certainly have dominated that in terms of booking most of the business from those market segments of public and private.
And as that educational market gets healthier and healthier, it's starting to [fruit] now and there is more facility bond money, we should really benefit very favorably, from both the competitive environment, assets that are in good condition and that at a low cost basis relative to any new market entrant or anybody who would want to participate again in California. Commercially there is only three players in California, it's ourselves, it's Williams Scotsman and it's ModSpace. We are the largest of the three. And then if you look at all of our other markets, all three, I meant ourselves, Williams Scotsman and ModSpace, are in the other Texas, Florida and Mid-Atlantic markets. However, the distinction I would make is that in the Florida market and in the Mid-Atlantic markets, we have classroom products that our competitors don’t have. Those are very, very popular and we have done very well with those.
So we don’t really have -- from an educational standpoint, any kind of really typical market competition on those products. And commercially it's a different story. More competitive etcetera. But that kind of give just some sense as we come out of the recession and our opportunities. I think we are very well situated.
Scott Schneeberger - Oppenheimer
Obviously, it's been competitive, still is competitive as you mentioned on commercial and had been on education as well. Are you seeing a turn there? Kind of a question to the behavior of your competitors or just is everyone kind of in lock steps still, of trying to make their way out of it?
Well, I would just say this, let's talk about classroom sites. In California, yes, it's been very competitive for five years and it's competitive coming out of recession. Until we get to that inflection point where there is multiple 50 or 100 unit orders and you just don’t enough readily available equipment and if you are going to do it, you are going to charge more etcetera. And even in California in the commercial side now, we are seeing substantial increases in rental pricing on a single wide equipment because there is just not enough readily available asset to be able to meet market demand and that’s also in complex floors. So the commercial side is recovering much faster in California on price then the educational side. But the educational side will come as more bond money gets put in place, and if you look forward now on projects in California, we have got a lot of school projects and we have got a number of those that are going to be late 2013 and into 2014 projects. And that’s without a bond measure yet having passed.
So things are ramping. The budgetary dynamics in California are much more favorable than they have been in five to six years. So that’s a really good thing. The other item I would just mention real quickly, we never experience in our product in Florida, any really erosion in rental pricing throughout the recession. For the most part, that hybrid product, as nobody else built it, really was able to sustain its pricing level throughout the great recession.
Scott Schneeberger - Oppenheimer
Thanks, Dennis. And then just one more and then I'll move off to a different segment. You alluded to the fact your opportunity in modular and you just touched around the edges on it briefly. And I am only looking for a brief response here, but could you remind us about what you see, what makes you feel confident in the future years that you can get the lift there, particularly in education?
Well, I mean if you look at California, I mean let's just take that because that’s in the bell cow business for a long period of time in it. It took the most significant blows during the recession. And overall, let me just remind everybody, you know in 2007 we did $57 million worth of EBIT in the modular division. And this past year I think we were what, at $17 million or $18 million in EBIT. So let's just ground ourselves in how much earnings have been lost in 5 to 6 years. Now what makes us feel really good about the future is, all of our legacy rental assets. We have a very attractive cost basis. We have maintained them well. We were the leader in the industry, coming into recession I think we are all the stronger coming out in all the markets that we are in. And in California in particular, we have had tax measure pass, we have got $2 billion ahead on tax revenues, corporate and personal income tax and sales taxes are all ahead. Class size reduction is starting to go back in the correct direction now of getting those class sizes down from the austerity levels that the legislature let them have during the great recession.
So there are a number of things that really bode very well for us. And I can go down the list further in California in terms of the unemployment rate today, it's 8.5%, it was 12.6% at the peak of the recession. And if we just remember too, it was approximately 9.5% just at the end of 2012. Home prices, up 30% year-over-year, and I could go on and on. So there are a number of factual, anecdotal, pieces of information that really speak about the rise. And we are in the very early stages there. And the rest of the country, Florida, housing prices are better. The population is increasing. As I said when we are in the thick of the great recession, the reasons people live and work in states like Florida and California haven’t really changed. Those same attractive features are still there and we expect those to be very favorable for our return to health in the modular business.
Scott Schneeberger - Oppenheimer
Thanks. I appreciate that. Quickly switching to TRS. Just one question there. You were cautious this quarter. It's been the first quarter in years where you turned slightly incrementally cautious. Is that sequestration and uncertainty? Are you seeing a change because that's been a workhorse of the segment for you for a while now?
Yeah. Well, that business has done very well. We have positioned ourselves very well. You know during the five year or six year period we lost some competitors. We are really one of the two most significant players in the industry today. All good items. But with what's going on, we have seen some headwinds in general purpose equipment. We have seen project get deferred. Even though our numbers are still very favorable, we are just trying to be cautious, responsibly cautious. And we will have to see, I mean there is a new fiscal year coming up October 1. I don’t know what it holds. I am hopeful that the executive brand and the legislative branch will be able to reach some agreement on things. So it's really just borne out of, let's be responsibly cautious not because we are seeing anything so pronounced that it gives us cause but there is enough there that we would probably be not as responsible if we didn’t say something.
Scott Schneeberger - Oppenheimer
That's fair. And I know we're getting long on the call, so just swinging it to Adler now. Can you speak any quantification in differentiating pricing behavior in the 21Ks versus the other tanks and a mix of your total portfolio of 21K and non?
Well, as you know the 21K product serves multiple vertical markets. So the standard product -- so it’s kind of a mix. I think the best way to speak to it is, obviously our fracking, percentage of fracking business is down substantially from the peak. So that means we have less of that price erosion exposure. So that’s a good, Scott.
And pricing in that segment is where we have seen significant pressure in parts of the market. We have talked in the past about the Marcellus, but I would say, generally supporting fracking opportunities, the price points have gone down quite a bit from what they were a year or two years ago.
Scott Schneeberger - Oppenheimer
And, Keith, the point of that is, it's not just Marcellus but broadly and nationwide?
I would say more broadly. Again, it differs a little bit by region but there is pressure there.
Yeah, if you look at all the major shale plays, I take there is 14, the rig counts are down in 10 of the 14. So they are only up in 4. Now they are not substantially down but they are down enough where there is pressure. The other dynamic is that most companies now are not held by lease, so to speak. So we don’t have to continue drilling even when prices are not in the most favorable range. So the market has changed there. What happened in the first few years of really the boom in gas and oil shale was that there was such a limited amount of equipment that even though prices were down, companies were held by lease. They had to drill, they had to produce etcetera. And now they have kind of gone, they are in the second stage here etcetera. And even when they weren’t drilling, they kept the equipment on rent because they couldn’t be cut short. They had to have those assets available to them.
Well, that’s changed when you have an abundance of supply or higher or greater supply than demand, then they don’t have to keep that equipment on rent. They can keep it on the site but they take it off-rent. Because they know they are going to need it again the next time they are ramping. And that serves both the lessor and the lessee. But those are just some of the dynamics there of the kind of ebb and flow in the maturation process, the terrain in the different shale plays. But the way, shale business is here to stay. I mean it's likely to be 15% or 20% at this time next year but (inaudible). I mean it's a good business but it's just going through the ebbs and flows of supply/demand and market pricing.
Scott Schneeberger - Oppenheimer
I guess just to summarize that up with a question. Keith, what is the percentage now? Dennis just mentioned it could be 15% next year. What is it now? What was it one year ago, two years ago as percentage mix?
Sure. Fracking was 11% of our rental revenues in the second quarter of this year. That compares with 23% in the second quarter of 2012. And it compares with 35% of the business mix back in 2011. So, again, when we look at things that have played out differently from what we expected, we thought we bottomed out with the deterioration in the fracking portion of our rental revenue. But as Dennis said earlier in the prepared remarks, the fracking revenues that we were getting in Q2, were down 49% year-over-year and they were down 24% sequentially. So that’s not something we anticipated and it really, if you will, it eroded some of the base in our business. And even though we were growing the non-fracking quite successfully, it's very hard to make up that shortfall.
Scott Schneeberger - Oppenheimer
Understood. One last one for me. CapEx in the Adler segment. Could you give us an update on where you are and juxtapose that to past quarters and what you anticipate going forward given the dynamic?
Sure. I will just give you year-to-date numbers. So the first six months of last year we added $34 million to the fleet. First six months of this year, it's been 16. So given where utilization is at, we don’t need to add equipment at the same pace much of what we are adding is either specialty units or box units. So tanks, we have a lot of them in most of the markets. We would like to get more of them on rent. I think you will see the pace of CapEx at Adler on a slower momentum than it was a year ago, just as I have noted in the first half of this year.
Our next question comes from the line of Les Bryant with UBS Financial Services. Please go ahead.
Les Bryant - UBS
Since you're seeing more demand for used classrooms, could you give us some color on what's happening at Enviroplex division?
Enviroplex is moving along. One of the challenges they have had is without available state bond money, they had to turn to other sources of revenue generation. I would say they have actually done a very admirable job through the great recession in doing more private and charter school type work, and they build a pretty nice following there. With general demand increasing for classrooms and austerity measures being throttled back, that can only be good for Enviroplex in the long run but what they are going to need really here is this next year, ideally if there is a bond measure passed and as more money is available for new construction, which is really the bucket they have pulled from. The used market is kind of separate from their but in some respects if you are seeing higher demands in our rental assets that bode well for the other side as well. It means that there is likely smaller class sizes, increasing student population and less austerity overall.
Les Bryant - UBS
So you're not seeing much demand growth right there at present for new construction?
Well, that’s tied directly really to the state bond moneys availability. The way new school construction in California gets financed is half of it comes from the state and half comes from the district and the district does that through partial taxes, and also through special bond measures locally. That funding has been pretty healthy right through the great recession. What hasn’t been there, has been the state bond moneys availability. And that’s what Enviroplex and other manufacturers are looking for in come 2014, because the last bond measure to pass was in 2006 at a state level that allowed for funding for new construction. And they took a number of years to use that up but they pretty much had a dry bucket for some time. So if there is a bond measure in 2014, which we expect, and it passes that should be a great shot in the arm for Enviroplex and other modular classroom manufacturers in the state.
Our final question is a follow up question from the line of Joe Box with KeyBanc Capital Markets. Please go ahead.
Joe Box - KeyBanc Capital Markets
Yeah, just one quick follow-up, and I apologize if you gave this, but what was the TRS end of the quarter utilization rate?
End of quarter, 63.3%, and that was unchanged from the end of quarter number at the end of the first quarter but down when compared to the end of quarter number from a year ago which was 65.7%. So 63.3%.
Joe Box - KeyBanc Capital Markets
Is it normal for the utilization to trend down throughout the quarter?
Yeah. You know that business, you can get big returns or a lot of foot going out at once. It's really tough to gauge utilization in that business within a quarter in a time of year. Perhaps except for the fourth quarter which typically can be this ramp down towards the end of it, but otherwise it's tough to draw any conclusions within a quarter in that business.
It occurs that there are no further questions at this time. Please continue with your closing remarks.
Thank you, Lily. Well, thank you all for joining us on our Q2 call this afternoon. We greatly appreciate your continued support. The next we will be chatting with everybody will be in very early November when we report our Q3 2013 results. Thank you, again. Bye, bye.
Ladies and gentlemen this concludes the McGrath RentCorp's second quarter 2013 financial results conference call. This conference will be available for replay after 7 p.m. Eastern Standard time today through August 7, 2013 at midnight. You may the access the replay system at anytime by dialing 800-406-7325 or 303-590-3030, and entering the access code of 4527691. Thank you for your participation. You may now disconnect.
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