McGrath RentCorp (NASDAQ:MGRC) Q1 2018 Earnings Conference Call May 1, 2018 5:00 PM ET
Joe Hanna – President and Chief Executive Officer
Keith Pratt – Executive Vice President and Chief Financial Officer
Scott Schneeberger – Oppenheimer
Marc Riddick – Sidoti
Ladies and gentlemen, thank you for standing by. Welcome to the McGrath RentCorp’s First Quarter 2018 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, Tuesday, May 01, 2018.
Before we begin, note that the matters that the company management will be discussing today, that are not statements of historical facts, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our 2018 total company’s operating profit outlook as well as statements relating to the company's expectations, strategies, prospects or targets.
These forward-looking statements are not guarantees of future performance and involve significant risks and uncertainties that could cause our actual results to differ materially from those projected. Important factors that could cause actual results to differ materially from the company's expectations are disclosed under risk factors in the company's Form 10-K and other SEC filings. Forward-looking statements are made only as of the date hereof. Except as otherwise required by law, we assume no obligation to update any forward-looking statements. In addition to the press release issued today, the company also filed with the SEC the earnings release on Form 8-K and Form 10-Q. Speaking today will be Joe Hanna, Chief Executive Officer; and Keith Pratt, Chief Financial Officer.
I would now like to turn the call over to Mr. Hanna. Go ahead, sir.
Thank you, Grace. Good afternoon and thank you for joining us on today’s call. I will start off the call with some comments on our first quarter performance and then Keith will provide greater detail in his financial review and outlook comments. Our first quarter was a good start to the year as company-wide rental revenues were up 9%. The rental revenue growth reflected end market strength in each of our divisions.
Sales revenue growth was primarily in our modular business. We have put more effort into selling non-core used assets in markets or product categories, where the financial returns are less attractive. To optimize our performance, we are maintaining our enhanced operating disciplines established in 2017. We are targeting the more attractive industry segments and markets and maintaining CapEx return thresholds for investing in new fleet.
I was pleased with our 39% operating profit increase as it was achieved with only 2% increase in our total invested capital base. All of the divisions delivered improved operating income in the first quarter. We are realizing most of our revenue growth from the fleet we already own through pricing and utilization gains. Combined with cost discipline, we are seeing more of the revenue gains fall for the bottom line. Our efforts to optimize profitability and financial returns are showing positive results and we will remain focused on this challenging work.
Let’s look at each of the divisions. Mobile Modular saw continued improvement in rates with utilization up slightly, rental revenues improved by 10% and operating income by 42%. Rate improvement is a continued result of our upgraded pricing strategy that was initiated in 2017. Bookings in California and the rest of the country were healthy and we saw a broad based demand for both commercial and education projects. While sales are somewhat unpredictable and can add lumpiness to our performance on a year-over-year basis, we also saw opportunities for sales of both new and used equipment. During the quarter, our portable storage business realized a healthy 15% rental revenue growth with rental rates increasing modestly.
TRS-RenTelco saw a favorable demand for both general purpose and communications test equipment, rental revenue improved by 9% and operating income by 27%. Pricing and utilization improved slightly and average rental equipment on rent increased by 8%. On the general purpose side, we saw strength in a variety of markets as demand was healthy. We have invested in the fleet to take advantage of opportunities and will continue to tune the fleet to be the best mix of products for current market demands.
Communications demand was supported by some 4G densification projects and some initial work on infrastructure that is a precursor for 5G projects. Wireless 5G activity has not commenced yet for the test equipment we provide. We don’t anticipate that happening until 2019 at the earliest and we are still uncertain as to the specifications and amount of testing that maybe required.
At Adler, we realized improved activity on oil and gas exploration during the quarter, rental revenues improved by 8% and operating income by 40%. Upstream oil and gas rental revenues increased from 6% to 10% of the Adler total in the first quarter on stronger demand from drilling activities. Construction activity was also healthy. While utilization improved 10%, rental rates are still under pressure. We hope that with improving utilization in the industry, rental rates may stabilize.
Looking ahead market conditions continue to be highly competitive and our visibility is limited as a result of the shorter rental terms of typical Adler and TRS-RenTelco transactions. That said for the first part of the year underlying demand conditions appear promising in a majority of the markets we serve. Our businesses are well positioned and we will be working hard to build upon our favorable start to the year.
Let me turn the call over to Keith now, who will take you to our financial review.
Thank you, Joe. Total revenues increased 11% to $105.1 million for the first quarter of 2018 from $94.8 million for the same period in 2017. The company's 39% operating profit increase for the quarter was driven by a $5 million increase in gross profit from rental operations and an additional $1.3 million increase in sales gross profit. Net income increased 81% to $14.5 million from $8 million and earnings per diluted share increased to $0.59 from $0.33.
The first quarter of 2018 includes a net income benefit associated with the Tax Cuts and Jobs Act or the Tax Act that was enacted in December 2017. The Tax Act reduced the U.S. federal corporate statutory rate from 35% to 21%, which contributed $0.11 to earnings per diluted share in the first quarter 2018.
Now let’s review rental division performance compared to the first quarter of 2017. Mobile Modular total revenues increased $5.5 million or 11% to $53.9 million on higher rental and sales revenues. Rental revenues for the quarter increased 10% from a year ago primarily driven by 9% improvement in average rental rates. Sales revenues increased $1.6 million or 55% on higher used equipment sales. Rental revenue growth continued to be healthy across our commercial and education markets as well as in our portable storage business.
Rental margins increased to 58% from 55%. The combined result was a 15% increase in gross profit on rents. We continued to invest selectively in new modular rental equipment primarily in regions outside California and for our portable storage business. As a result average modular rental equipment for the quarter was $746 million, an increase of $1 million. Average fleet utilization for the first quarter increased to 77.3% from 76.8%. TRS-RenTelco total revenues increased $2.7 million, or 11%, to $28 million on higher rental and sales revenues.
Rental revenues for the quarter increased 9% primarily driven by 7% higher average rental equipment and improved utilization. Rental margins increased to 44% from 42%. The combined result was a 14% increase in gross profit on rents. Test equipment rental revenues for general purpose and communications increased by 10% and 5% respectively. We continue to invest in general purpose test equipment for growth opportunities. Finally, average electronics rental equipment for the quarter was $264 million, which was an increase of $18 million. Average utilization for the first quarter increased slightly to 62.7% from 62.2%.
Adler Tank Rentals total revenues increased $0.7 million or 4% to $21.2 million on higher rental and sales revenues partly offset by lower rental related services revenues. Rental revenues for the quarter increased 8% primarily driven by 10% higher average utilization, partly offset by 3% lower average rental rates. Rental margins increased to 59% from 57%. The combined result was a 13% increase in gross profit on rents.
Adler's rental revenue growth was driven by improved general construction and industrial activity and an improved upstream oil and gas environment. With these favorable market conditions, upstream oil and natural gas rental revenues increased from 6% to 10% of total rental revenues at Adler. While our average fleet size was up only 1% year-over-year, we continued to focus on better utilization of the existing fleet. Finally, average equipment on rent increased 11% and average utilization increased to 57.6% from 52.3%.
With our division review complete the remainder of my comments will be on a total company basis. Selling and administrative expenses increased slightly from $27.8 million to $28.1 million, primarily due to increased salaries and employee benefit costs. On a consolidated basis, interest expense for the first quarter of 2018 increased $0.2 million or 7% to $2.9 million. Higher net average interest rates were partly offset by lower average debt levels. The first quarter 2018 provision for income taxes was based on an effective tax rate of 23.9% in 2018, compared to 39.9% in 2017. As discussed earlier, the primary driver of the decrease was the passage of the Federal Tax Act.
Turning now to review our 2018 cash flow highlights, net cash provided by operating activities was $31.2 million, an increase of $5.3 million compared to 2017. The 21% increase was primarily attributable to improved income from operations, more significant decreases in accounts receivable and other balance sheet changes. We invested $24.2 million for rental equipment purchases, compared to $15.9 million for the same period in 2017, primarily due to higher purchases at TRS-RenTelco.
Property, plant and equipment purchases decreased $3.2 million to $2.7 million in 2018. Net borrowings decreased $2.8 million from $303.4 million at the end of 2017 to $300.6 million at the end of the first quarter of 2018. Dividend payments to shareholders were $6.3 million.
At quarter end, the company had capacity to borrow an additional $251.4 million under its lines of credit. And the ratio of funded debt to the last 12 months actual adjusted EBITDA was 1.63:1. First quarter 2018 adjusted EBITDA increased 18% to $42.8 million, compared to the same period in 2017. Consolidated adjusted EBITDA margin was 41% and 38% in the first quarters of 2018 and 2017 respectively. Our definition of adjusted EBITDA and a reconciliation of adjusted EBITDA to net income are included in our press release for the quarter.
Finally, turning to our 2018 financial outlook, based upon the Company's year-to-date results and current outlook for the remainder of the year, we are raising the financial outlook and expect 2018 total company operating profit to increase 11% to 15% above 2017, compared to our prior expectation of an 8% to 12% increase.
That concludes the prepared remarks on our quarterly results. Grace you may now open the lines for questions.
Thank you. [Operator Instructions] And our first question comes from Scott Schneeberger with Oppenheimer, your line is now open.
Thanks, good afternoon. I guess if we could please start talking in Mobile Modular. Keith, you said that investing outside of California and in portables, all sounds logical to me. Just wondering if you could give us an update on the dynamic in California right now, and just – this is early in the year. Remind us of the seasonality and any consideration you're giving to perhaps increasing your investment – capital investment in the modular business over the balance of the year? Thanks.
Yes, Scott, you're absolutely right with the comments. We've been investing around the country. I would say looking in the rear view mirror, we had some extra fleet in the California market. And were looking forward to improve business conditions to utilize more of that fleet. We've made a lot of progress in those efforts, particularly in northern California but also seen nice improvement in the Southern California as well. So we're well positioned, and if there is incrementally more robust demand in the California market, we can apply some capital, if we see opportunities to get our target returns. And we're prepared and happy to do that.
Thanks. And just kind of following-up on that portables, how broad are you now? Could you address perhaps geographies? And your expansion, are you padding your locations where you are? Or you're actually geographically expanding?
Sure. We're located with our Portable Storage business in the markets that we serve with our modular business plus a few extra ones, and that would be Chicago and the New Jersey, New York area. But the rest of the markets are overlaps at this point. And we are actually really concentrated and focused on growing our current footprint prior to expanding geographically.
And Joe, how would you say the capital investment is in portables this year relative to a year ago relative to the year prior that? Thanks.
It’s similar. We’re investing. Utilization is fairly good right now. And so the demand is there, and we've been buying equipment, and we'll continue to do that.
Alright, thanks. And then one from me, I’m going to move over to Adler, and still negative. I'm just curious about that dynamic because a very nice pick up in utilization, and obviously, with oil price lifts, you addressed oil and gas and now that's improving. I'm just kind of curious, are you seeing stabilization perhaps out of the oil patch or is it still the contagion impact of the past. And is it just a specific kind of tank versus others? If you could just provide a little bit more granularity on what assets are getting what pricing, and if you think we're going to get to an inflection point soon because it seems to be the trend. Thanks.
Yes, I think with utilization improving across the industry, and if you've been looking at our competitors and us, I mean it has been going up. And so our hope is that pricing will stabilize at least and begin to turn around. We'd very much like to see that. There are specialty equipment that we have, which is more or less the run-of-the-mill tank. There's special pieces of equipment, and pricing has been pretty good with those pieces of equipment. But in the general, 21K tank line, that's where we've continued to see most of the pressure. And I think that's really the area that – once better utilization comes further around for everyone, I think we'll see a change there. We're hoping for that.
Scott, I would also add, and I think you know this. When we publish rental rate for the fleet of each of our operating segments, that is an aggregate fleet statistic. And in the case of Adler, if you look into the detail, that rate factor can get impacted by the mix between how many tanks are on rent versus boxes, and then as Joe mentioned, certain categories of specialty equipment. So while that published rate factor was down by 3% in the first quarter, in the individual product categories, I would say, more of the pricing was flattish in recent periods. But mix issues were a factor in lowering the published rate.
Thanks guys. That’s a helpful color. I will turn it over.
Thank you. Our next question comes from Marc Riddick with Sidoti. Your line is now open.
Hi good afternoon.
I was wondering if you could touch a little bit about the classroom market that you're seeing around the country. I think one of the things that – when we last spoke, I guess, the things seemed to be pretty strong across the board. I think you did mention that maybe it was almost too strong in Texas because some folks were actually buying as opposed to renting. So I was wondering if you could just give us an update on the classroom market there?
Sure, I'll just focus on the Texas. And last year was an interesting year for us, and we did have more folks that were buying than normal. It wasn't alarming, but some of the folks that we typically transact with decided to purchase. Actually, this year, the pipeline is stronger, and we are seeing better opportunities for rental transactions in Texas. And we're very encouraged by that. So I think we should have a better year in Texas for education bookings.
Okay, great. And then one of the things I guess maybe I should circle back on you. You'd covered several things with the prior questions on Portable Storage. One thing I was just curious about is whether you can sort of bring us just a general up-to-date overview as to general view on pricing kind of where you see that. I know you mentioned the strength in California in general, but how are you sort of feeling about the pricing dynamic in – specific to Portable Storage?
Yes it’s actually improved, but slightly. That's about all there is to say on that. We are actually stronger.
I think we've had more success from a pricing point of view in the modular classroom and office side of the business, which is the vast majority of what we do in the modular segment.
Ladies and gentlemen, that appears to be the last question. Let me turn the call back over to Mr. Hanna for any closing remarks.
Alright. Thank you very much, Grace. I'd like to thank everybody for joining us on our call today and for your continued interest in the company. We look forward to speaking with you again in late July to review our second quarter results.
Ladies and gentlemen thank you. This concludes today’s program. You may all disconnect.