McGrath RentCorp's (MGRC) CEO Joe Hanna on Q2 2018 Results - Earnings Call Transcript

McGrath RentCorp (NASDAQ:MGRC) Q2 2018 Earnings Conference Call July 31, 2018 5:00 PM ET

Executives

Joe Hanna – Chief Executive Officer

Keith Pratt – Chief Financial Officer

Analysts

Scott Schneeberger – Oppenheimer

Marc Riddick – Sidoti

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the McGrath RentCorp Second Quarter 2018 Conference Call. At this time all participants are in a listen-only mode. Later we will conduct the question-and-answer [Operator Instructions] This conference is being recorded today, Tuesday, July 31, 2018.

Before we begin, note that the matters that company management will be discussing today that are not statements of the 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 operating profit 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 the project – 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 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 Form 8-K and the Form 10-Q for the quarter.

Speaking today will be Joe Hanna, Chief Executive Officer; and Keith Pratt, Chief Financial Officer. I will now turn the call over to Mr. Hanna. Go ahead, sir.

Joe Hanna

Thank you, Valerie. Good afternoon, and thank you for joining us on today’s call. I will start off the call with some comments on our second quarter performance, and then Keith will provide greater detail in his financial review and outlook comments. Our second quarter is what sets the pace for the year, and the quarter’s results were encouraging. Our most important driver is rental revenue, and company-wide, we realized a 10% increase. Operating profit grew 12% through a $3.7 million increase in gross profit on rental revenues and a $1 million increase in gross profit on sales.

I’d like to highlight the strong rental revenue performance from all of our businesses this quarter. We benefited from good conditions in most of the market verticals we operate in, providing a healthy demand picture. In addition, we had strong sales and operational execution, with each of our businesses positioned well to capitalize on opportunities. We provide rental-ready products on time to required specifications with exceptional service. Our disciplined focus on performance improvement continues. Our objective is to get a better return from our current capital base and to carefully allocate growth capital to deliver stronger returns as we responsibly grow the business. We have enhanced our information systems to assist in these decisions, and the leadership teams across the enterprise are becoming better business operators as a result. I could not be more pleased.

Now let’s look at each of the divisions. Mobile Modular’s 9% rental revenue increase was primarily driven by pricing, with improvements in all geographies. Operating income was up 4% as cost to prepare equipment for summer installations increased compared to a year ago. Our rental bookings were very healthy for the first half of 2018, driven by robust funding for both education and commercial projects. Our work to increase rental rates continues to yield success, and we will be working hard to make further improvements in both rate and utilization.

In our Portable Storage business, rental revenues increased 14% on strong demand in all regions. TRS-RenTelco rental revenue grew by 12% and operating income by 19%. Communications demand was supported by continued needs for bandwidth with fiber installations and other preparations for 5G rollout. In the general purpose segment, we saw strength in a variety of end markets as R&D activity was robust. We achieved strong financial returns in this business and have been actively deepening our rental pool due to the demand environment while achieving operating leverage.

At Adler, we were pleased to see rates improved along with utilization. Rental rates increased 2%, rental revenues increased 12% and operating income increased 34%. Construction activity was the primary contributor to our improved rental revenue growth, followed by environmental services. Additionally, June was a record high for oil and gas production in the U.S., helping to drive demand in this segment. Despite very competitive market conditions, the division is implementing performance-improvement initiatives by focusing on higher-return industries and customers and raising rates when appropriate. We are encouraged by the early successes we are realizing.

Looking ahead, we feel good about our first half of the year and where the business is headed. Business conditions are good, and funding is available for projects. Rental revenue growth is strong, and we are focused on our initiatives to deliver improved returns. In closing, I would like to thank all of our employees for their ongoing hard work and dedication as execution is so important to our customers.

Let me turn the call over to Keith now, who will take you through our financial review.

Keith Pratt

Thank you, Joe. Total revenues increased 7% to $117 million for the second quarter of 2018 from $109.6 million for the same period in 2017. The company’s 12% operating profit increase for the quarter was driven by a $3.7 million increase in gross profit from rental revenues and an additional $1 million increase in sales gross profit.

Net income increased 39% to $15.9 million from $11.5 million, and earnings per diluted share increased to $0.65 from $0.48. The second quarter of 2018 included 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 $0.12 to earnings per diluted share in the second quarter 2018.

Now let’s review rental division performance compared to the second quarter of 2017. Mobile Modular total revenues increased $3.2 million or 6% to $59.9 million on higher rental and rental-related services revenues. Rental revenues for the quarter increased 9% from a year ago, primarily driven by an 8% improvement in average rental rates. Sales revenues decreased $0.5 million or 6% on lower new equipment sales. Rental revenue growth continued to be healthy across our commercial and education markets as well as in our Portable Storage business.

Equipment preparation cost or direct cost of rental operations, other, increased $2.2 million or 22% to $12.5 million. The higher costs were primarily driven by higher production volumes to meet healthy market demand that Joe mentioned earlier and to a lesser extent were caused by higher material costs. As a result, rental margins decreased to 54% from 56%. The combined result of higher rental revenue but lower rental margin was a 5% increase in gross profit on rents. Average modular rental equipment for the quarter was $747 million, an increase of $2 million. Average fleet utilization for the second quarter increased to 77.1% from 76.5%.

TRS-RenTelco total revenues increased $3.8 million or 14% to $30.4 million on higher rental and sales revenues. Rental revenues for the quarter increased 12%, primarily driven by 11% higher average rental equipment and improved utilization. Rental margins increased to 44% from 43%. The combined result was a 14% increase in gross profit on rents. Test equipment rental revenues for general purpose and communications increased by 16% and 3%, respectively. We continued to invest in general purpose test equipment for growth opportunities.

Average electronics rental equipment for the quarter was $274 million, which was an increase of $26 million. Average utilization for the first quarter increased to 63.2% from 62.4%. Adler Tank Rentals total revenues increased $0.8 million or 4% to $23 million on higher rental revenues, partly offset by lower sales and rental-related services revenues. Rental revenues for the quarter increased 12%, primarily driven by 9% higher average utilization and 2% higher average rental rates. Rental margins increased to 60% from 57%. The combined result was an 18% increase in gross profit on rents.

Adler’s rental revenue growth was driven by improved general construction and industrial service activity and an improved upstream oil and gas environment. With these favorable market conditions, upstream oil and natural gas rental revenues increased from 9% 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. Average equipment on rent increased 9%., and average utilization increased to 59.1% from 54.4%.

Now with this division review complete, the remainder of my comments will be on a total company basis. Selling and administrative expenses increased $2.1 million or 8% to $29.5 million, primarily due to increased employee headcount, salaries and employee benefit costs. On a consolidated basis, interest expense for the second quarter 2018 increased $0.1 million or 2% to $3 million. Higher net average interest rates were partly offset by lower average debt levels. The second quarter 2018 provision for income taxes was based on an effective tax rate of 24.6% in 2018 compared to 39.4% in 2017. As discussed earlier, the primary driver of the decrease was the passage of the tax act.

Next, a review of our 2018 year-to-date cash flow highlights. Net cash provided by operating activities was $53.8 million, an increase of $4.4 million compared to 2017. The 9% increase was primarily attributable to improved income from operations, partly offset by a higher increase in prepaid expenses and other assets. We invested $58.7 million for rental equipment purchases compared to $46.1 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 $6.4 million in 2018. Net borrowings increased $11.5 million from $303.4 million at the end of 2017 to $314.9 million at the end of the second quarter 2018. Dividend payments to shareholders were $14.5 million. As highlighted in our press release, this is a 31% increase year-over-year. At quarter-end, the company had capacity to borrow an additional $217.1 million under its lines of credit, and the ratio of funded debt to the last 12-months’ actual adjusted EBITDA was 1.67:1.

Second quarter 2018 adjusted EBITDA increased 8% to $45.4 million compared to the same period in 2017. Consolidated adjusted EBITDA margin was 39% and 38% in the second 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. The company reconfirms its expectation that total company operating profit will increase 11% to 15% above 2017 results.

That concludes the prepared remarks on our quarterly results. Valerie, you may now open the lines for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from Scott Schneeberger of Oppenheimer. Your line is open. Sir, your line is open.

Scott Schneeberger

I’m sorry, can you hear me?

Keith Pratt

Yes, Scott.

Joe Hanna

Yes, now we can.

Scott Schneeberger

Good. I’m going to start with Adler. The rental rates increased 2% in the quarter. How is visibility there? Obviously, the momentum looks good. But how would you gauge visibility? And what do you see for that in future quarters? Thanks.

Joe Hanna

Scott – I’ll assume, Scott, that you’re talking about pricing there. I mean, it’s – our rental transactions in that business, I think as you know, are very short, and so visibility is very limited in that business. But as utilization goes up in the industry and it continues to go up within our business, I think the pricing picture will get better for us. And so our immediate outlook is that pricing should continue to improve modestly.

Keith Pratt

Yes, and the caveat, Scott, is always with mix issues. Our reported rental rate sometimes can be impacted between the mix between tanks and boxes. But we’ve seen good trends, and we were pleased with the 2% uptick in the second quarter.

Scott Schneeberger

All right. And then I’m going to turn it to TRS-RenTelco and, basically, the same question. Looks like some momentum is building there. Could you talk a little bit about the end markets? And what you see on a go-forward basis?

Joe Hanna

Sure. First, I’ll start with communications. I think as you listened to Keith’s comments, we had a more modest rental revenue increase from communications part of the business, and then a more significant one from the general purpose side. The communications section of the business is benefiting from the wired work that’s going in, the backhaul work that is supporting 5G future rollout. So we haven’t hit any of the towers yet for the wireless piece, but the fiber work and the wired portion is driving a little bit of demand there. And we anticipate that continuing in the next quarters ahead.

On the general purpose side, pretty good R&D environment right now. Semiconductor and aerospace and defense are good businesses for us right now. And we are seeing just nice activity there with high-end products that we have in our rental pool. So we believe that also as long as government doesn’t shut down and we have any adverse issues there, that should continue also into the foreseeable future.

Scott Schneeberger

All right. I’ll leave Modular for someone else. I was curious, SG&A was a little bit more elevated expense than we had anticipated. It may be how we modeled our quarters, but I’m curious, is that going to be a little bit more elevated than you expected? And just how you think about that trending through the balance for the year?

Keith Pratt

Yes, Scott, just to give you a little bit of context, you’re absolutely right. SG&A was up $2.1 million or 8% in the second quarter compared to a year earlier. The vast majority of that increase was people-related. And we have our customary merit increases, higher health care costs and the like, that was a portion of it. We also have done a little bit of hiring, some of which is backfill and just a very few selective new positions in the company, both in divisional leadership and some of our support services at corporate.

And then we have a little bit of extra performance-related compensation that we’re accruing as well. So three real primary reasons behind most of the increase, which is, again, all people-related costs. I would say looking forward, we were just over $29 million in the second quarter. I think we’ll have a number in that neighborhood for the remaining quarters of this year, in that neighborhood based on what we know today.

Scott Schneeberger

All right, thanks, Keith. That’s very helpful. I will turn it over guys. Thank you.

Keith Pratt

Thank you.

Operator

Thank you. Our next question comes from Marc Riddick of Sidoti. Your line is open.

Marc Riddick

Hi, good afternoon.

Keith Pratt

Hi, Marc

Marc Riddick

Well, since the opening was given so, so generously, we might as well delve a bit into Portable Storage. I think you mentioned it being up about 14%. I was wondering if you could give some greater details around, first of all, I guess what percentage of revenue are we up to now. We’re approaching 10%? And sort of what are the driving forces of that performance?

Keith Pratt

Yes, 9%, Marc. Portable Storage is 9% of total McGrath core rental – or revenues, total revenues.

Joe Hanna

Sure, Marc. I mean, we’re – as we’re seeing in the Modular part of the business, and we’re co-located in many of the markets that we operate in, construction demand is strong. In May, I know new construction starts were up – that are above $20 million in size were up 9% on a year-over-year basis. So in this – in these months here that we’ve seen, there has been just real healthy activity there, and that business is benefiting from it.

Marc Riddick

Okay, great. Now I wanted just – if you could delve a little bit into what you were talking about as far as some of the success you’ve had on working on rate and maybe some of the pushback that you may or may not be getting. Obviously, that’s a slug that takes some time. But I was wondering if you could give a little bit greater detail on some of the areas that you think have legs going forward on rate increases.

Joe Hanna

Sure. As part of our performance-improvement initiative and to increase the performance of the company, rate increase has been a very big factor and a very big focus area for us. We have implemented higher rates, particularly in Mobile Modular, over the last year at least to 18 months, and we’ve seen very good success. Initially, some of our customers had questioned some of the rates and were, obviously, wondering why we’re increasing rates and what the rationale is? And our teams were very well equipped with talking points to discuss that with our customers. And at the end of the day and rolling the clock forward, we have had very good success.

What we’re seeing is that rates are increasing in construction for virtually all of the services that are being provided in the field right now. Stick-built construction, site services, permitting, everything is more expensive now. So our rate increases and the products that we provide for our customers in those projects are really not a very big part of the project. And so for us to come in and ask for more higher rates was something that we had success in. So we’ve actually kind of built off that success in our other businesses. We’re doing more of that in Portable Storage now. We’re doing more of that in Adler. And our sales teams are becoming more confident and – in their ability to raise rates on our customers and, in many cases, are accepting them. And we’re going to continue to do that.

Keith Pratt

And I think, Marc, just from a commercial point of view, I think when we’ve managed to raise rates, we’re providing a lot of value to the customer, both in terms of equipment quality and level of service. And when we’re having those conversations, I think it’s a vote of confidence that we can still win a lot of business and do it at these higher rates.

Marc Riddick

Okay, great. Just two more things for me. One, I wanted to get your thoughts on tariffs. If – what your thoughts were there? And where any impacts may lie that – how you’re thinking about that for the remainder of the year? And not just, I guess, maybe from your own thoughts, but whether – how much of that has been entering conversations with new customers?

Keith Pratt

Yes, I think the potential main impact can be on some of the material costs in our business. And I would say primarily in our Enviroplex manufacturing business, we’ve seen cost increases in that arena. And obviously, if tariffs become more significant and more extensive, there’s some risk there. We try to protect ourselves as best as we can with how we price and write contracts. And then the other area is just the overall maintenance of our modular fleet. The line item I mentioned in the prepared remarks, our inventory preparation costs in our inventory centers, those costs were up year-over-year.

And part of that increase was related to higher material costs. We’re seeing that in a number of commodity areas, not all of which may be impacted by tariffs. But there’s – I think we really see some of that starting to bleed through into the marketplace. And we, like all the companies, are working with our suppliers, trying to minimize the impact, but there is impact. And so we would certainly want to be watchful going forward. And if prices continue to edge up, we’ll have to look again with our customers and see if we can pass some of that through.

Marc Riddick

Okay, great. And then one last piece for me. Wondering if you could give us a bit of an update on regional strength and activity, particularly in the education market. I think you mentioned in the past that region looks pretty good. Though if I remember correctly, a couple of states seem to be doing more buying than renting. So wondering if you could give an update on that.

Joe Hanna

Sure. I believe what we referred to was, last year, the Texas central region was doing a little bit more buying. And that varies from year to year, and we’re not necessarily seeing that change overall. And we believe that the rental demand is still very good for us. Just in all the regions that we’re operating in, I really can’t think of one of them from an education perspective that is really lacking funding at this point. And so money is available right now, either through local bonds or state bonds or tax referendums for modernization projects in the markets that we serve right now. And so we’re very happy about that, and we’re positioned to take advantage of that.

Marc Riddick

Okay, sounds good. I appreciate. Thank you gentlemen.

Keith Pratt

Thank you.

Joe Hanna

Thank you.

Operator

Thank you. [Operator Instructions] Ladies and gentlemen, that appears to be the last question. Let me turn the call back over to Mr. Hanna for any closing remarks.

Joe Hanna

All right. Thank you, everyone, for joining the call today and for your continuing interest in our company. We look forward to speaking with you again in late October to review our third quarter results.

Operator

Thank you. Ladies and gentlemen, that does conclude today’s conference. Thank you for your participation, and have a wonderful day. You may all disconnect.