McGrath RentCorp (MGRC) 2003 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the McGrath Rentcorp second quarter, 2003, conference call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. If anyone needs assistance at any time during the conference, please press the star followed by the zero. As a reminder, this conference is being recorded on Thursday, July 31st of 2003.

I would now like to turn the conference over to Mr. Jeffrey Busher [ph] of SCG Investor Relations. Please go ahead, sir.

Thank you, operator. Good afternoon. I'm the investor relations advisor to McGrath Rentcorp and will be acting as moderator of the conference call today. On the call from McGrath Rentcorp are Dennis Kakures, President and CEO, and Tom Sauer, Vice President and CFO. Please note that this call is being recorded and will be available for replay for up to 48 hours by dialing 1-800-405-2236 for domestic callers and 1-303-590-3000 for international callers. The passcode for the replay is 542168 and then the pound symbol. This call is also being Webcast live over the Internet and will be available for replay. We encourage you to visit the investor relations section of the company's Web site at MGRC.com.

A press release was sent out this afternoon at 4:05 Eastern Daylight Time or 1:05 Pacific Time. If you did not receive a copy but would like one, it is available on-line in the investor relations section of our Web site, or you may call 1-206-652-9704 and one will be sent to you.

Before getting started, let me remind everyone that the matters we will be discussing today that are not truly historical are forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, including statements regarding McGrath Rentcorp's expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements are based upon information currently available to McGrath Rentcorp, and McGrath Rentcorp assumes no obligation to update any such forward-looking statements. Forward-looking statements involve risks and uncertainties, which could cause actual results to differ materially from those projected. These and other risks 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 10K and Form 10Q.

I would now like to turn the call over to Dennis Kakures.

Good afternoon, everyone, and welcome to our second quarter, 2003, conference call. From a call format standpoint, I'm going to turn the call over to Tom Sauer, our CFO, in just moment, to speak to everyone on the numbers and then I will follow up with color and insight regarding our business units and market activity.

But first, I wanted to ground everyone in the fact that we are having an absolutely terrific year in classroom rental bookings, one of our strongest ever. However, I also know that when you look at our second quarter results coupled with our earnings guidance reduction announcement earlier this month, these are very mixed messages. I wanted to get this in front of everyone first this afternoon until I can provide more detail in my comments a little bit later. I'll do my very best at that time and in our Q&A session to break everything down and have it make sense. Thank you.

I'd now like to turn the meeting over to Tom Sauer, our Chief Financial Officer.

Thank you, Dennis. In addition to the press release issued today which discusses the second quarter, 2003, results, the company also filed with the SEC the press release on Form 8K and its Form 10Q for the three months ended June 30th, 2003.

For the second quarter, 2003, net income was $4.7m or 39 cents per share as compared to a net loss of $1.2m or a 10-cent loss per share in the second quarter, 2002. For comparability, as indicated in the press release, excluding the impairment charge and expenses related to the terminated Tyco merger, second quarter net income would have decreased 24 percent from $6.2m in 2002 to $4.7m in 2003 with earnings per share decreasing 20 percent from 49 cents per share in 2002 to 39 cents per share in 2003.

For Mobile Modular, rents declined 9 percent in Q2, 2003, to $15.2m as compared to Q2, 2002, primarily due to lower average rental rates and, to a lesser extent, lower utilization. Average modular utilization for Q2 declined from 85.8 percent in 2002 to 82.8 percent in 2003, however utilization trended up to 83.6 percent at quarter end. Sales in Q2, 2003, decreased 2 percent to $4.6m as compared to Q2, 2002. Sales for the first six months of 2003 decreased 11 percent from 2002 levels, primarily due to a significant sale of equipment occurring in the first six months of 2002.

For Mobile Modular, pre-tax income declined 25 percent from $9.6m in Q2, 2002, to $7.2m in Q2, 2003, and represents 91 percent of the company's pre-tax income for the quarter.

For RenTelco, our electronics business continues to be challenged as a result of the weakness in the telecommunications industry. Rental revenues for the quarter increased 11 percent on a sequential basis to $3m from $2.7m in the first quarter, 2003. Electronics utilization is below our target range of 50 to 55 percent, however utilization continues to trend up, ending the quarter at 45.1 percent. Pre-tax income for Q2, 2003, was $421,000 with the sale of under utilized equipment positively impacting pre-tax earnings for the quarter. Even with nominal pre-tax earnings, the electronics business generated EBITDA for the second quarter of $2m.

The company continues to generate very strong cash flows to operate our business and return value to our shareholders. For the first six months of 2003, cash generated was used to purchase $12.2m of rental equipment, repurchase $10.2m of the company's common stock and pay $4.7m in dividends, with debt only increasing by $2.7m.

For the first six months of 2003, EBITDA, adjusted for non-cash impairment and compensation expenses, declined 19 percent from $30.6m in 2002 to $24.6m in 2003, primarily due to the company's lower revenues. Consolidated EBITDA margin declined from 44.8 percent in 2002 to 41.7 percent in 2003. The company declared a second quarter dividend of 20 cents per share, 2 cents per share higher than second quarter, 2002, dividend. On an annualized basis, this dividend represents a 2.9 percent yield based on the July 30th, 2003, close price of $27.13 per share.

With respect to earnings guidance for 2003, recently our 2003 full-year earnings guidance was revised to be in a range of $1.75 to $1.85 per diluted share, a reduction from our earlier full-year guidance range of $2.12 to $2.17 cents per diluted share. This revision was primarily due to lower than expected modular sales order activity as opposed to rental order activity.

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

Thank you, Tom. I'd like to jump right to our second quarter results and press release comments for our modular rental business. In particular, we indicated that Mobile Modular experienced a 9 percent decline in rental revenues for the second quarter, 2003, compared to second quarter, 2002. This is also the third consecutive quarterly decline in rental revenues for Mobile Modular. However, we have also had an exceptional year in classroom rental order activity and the impact from these bookings will be reflected in rental revenue levels beginning in the third quarter this year and more so in 2004.

Before discussing more market and booking activity for 2003 to date, I first want to spend a few minutes creating a better understanding with the listening audience on the factors leading to the decline in rental revenues over the past few quarters. In our press release, I spoke to two components. One, a reduction in the average rental rate of utilized equipment, and, two, lower overall utilization. In analyzing average rental rates of utilized equipment, we can break this down into two contributing factors. First, with the economy in California continuing to be sluggish, there has been downward pressure on rental rates, especially the commercial construction sector. Equipment rentals put out during more favorable economic periods, when recycled and put back in rent, are experiencing a more competitive environment and thus lower rental rates.

The second contributing factor impacting average rental rates of utilized equipment is the mix of equipment returned over the past few quarters. We have experienced a higher number of larger square footage buildings with higher absolute rental rates as compared to smaller square footage, single-wide buildings that carry lower absolute rates. Thus, the mix of utilized equipment reflects an overall lower average absolute rate per floor.

Finally, lower utilization has also impacted rental revenue levels. This is primarily due to the coincidental return of an increased number of classroom rentals for finished school modernization projects and some larger commercial complex buildings related to the completion of permanent building space. However, as Tom mentioned earlier, although average [inaudible] utilization for Q2, 2003, dropped to 82.8 percent, by the end of the quarter utilization had increased to 83.6 percent. It has continued to rise steadily during the month of July. More to that point a little bit later.

If we were to stand back from the items mentioned earlier that have contributed to lower rental revenues and ask ourselves what conclusions or insights can be drawn, I believe there are two. First, although the modular product can be counter cyclical in nature, it is not immune to some downward pressure on rates during a down cycle of the economy. And second, with an increasing mix of classroom rentals associated with school modernization projects, we will see this product cycle back through our inventory centers more frequently going forward.

Now, with respect to booking levels for classroom rental orders, we've had a truly outstanding year to date. In fact, the internal booking goals we established for our sales teams for the first half of 2003 were met and surpassed at over 150 percent of goal. The vast majority of the equipment returns that led to the lower utilization levels discussed earlier have now been committed for the new school year. Additionally, our new equipment purchases for classroom buildings will be the highest they have been in many years. The unutilized and new equipment began shipping out to school districts in large quantities towards the end of June. In fact, July has been our highest shipping month for classroom orders in the company's history.

Keep in mind that the majority of these orders are shipping in mid to late summer, as is typical of most school years. Therefore, from a rental revenue standpoint, although there will be an impact to third quarter rental revenues, the fourth quarter of this year will be the first quarter in which a full three months of rent will be reflected in our financials for the great majority of this order activity. Many of these projects coming on line in 2003 will also provide a full year's rental revenue flow in 2004.

Earlier in my comments I touched on Modular's utilization having up ticked at quarter end to 83.6 percent from the quarterly average of 82.8 percent. We would expect utilization to be significantly higher at the end of the third quarter.

When we began the year, we set our sights at maximizing the opportunity presented by passage of the November, 2002, bond measure, and in particular monies allocated for school modernization work in California. Our internal goals were to increase both rental revenue booking levels and our base of school district customers. The initiative in front of these goals was to enhance even further our market leadership position in renting educational facilities in California and more specifically our expertise in serving the modernization and reconstruction project needs of school districts. Without question, we hit on all cylinders.

Finally, let's address our earnings guidance reduction earlier this month to make sense in light of our exceptionally strong success in classroom rental bookings thus far in 2003. Simply stated, the primary contributing factors to our earnings guidance reduction for the entire year were the lower volume of one-time building sales and site-related services opportunities thus far in 2003. When we develop our financial plan at the beginning of each year, we estimate a certain level of sales and site-related services for Mobile Modular. This includes building sales of used equipment from inventory, equipment on rent, and new equipment and site-related work associated with building installations, including items like grading, electrical, plumbing, landscape and so on.

We've been very consistent historically in stating that sales of our modular product can vary greatly based upon customer demand and funding as compared to the consistency of a recurring revenue rental business. Even though we established building sales and site-related service levels for this year's financial plan in a fairly tight range to last year, neither the quantity of projects nor revenue volume to date has closely approximated what we had built into our plan. Remember, these transactions are one-time events. They do not create longer-term cash flow and income streams like those associated with our core modular rental business.

On the modular side of the business, let's examine Enviroplex, our classroom manufacturing subsidiary. Sales revenues for the first half of 2003 decreased slightly to $4.1m from $4.3m a year ago. However, our backlog of orders as of June 30th, 2003, was $9.5m compared to $6.7m a year earlier. Passage of the November, 2002, bond measure has also impacted Enviroplex positively, however greater complexity associated with more customized building projects and receipt of final design and regulatory approvals could push income for certain 2003 order activity into 2004.

Now, let me turn our attention to RenTelco and their results for the quarter. In our press release, we indicated that RenTelco increased quarterly revenues 11 percent on a sequential basis to $3m from $10.7m in the first quarter of 2003. This was the first sequential quarterly increase in rental revenues since first quarter, 2001. RenTelco contributed nominal pre-tax earnings, however these earnings were primarily due to selling under utilized equipment. As our pool of under utilized equipment declined, we expect profit on sales to reduce in the quarters ahead.

The good news in this is that we've done a very good job of having the marketplace absorb our under utilized inventory, increase favorable profit on sale levels over the past year. However, it also means that rentals will need to make up this difference going forward. While we can look at the sequential quarterly increase in rental revenues very favorably, we caution that the improvement in rental revenues may not be reflective of improving fundamentals, given the challenges that still exist throughout the telecommunications industry.

Utilization has increased to 45.1 percent in Q2, 2003, from 44.2 percent in Q1. This is a result of both sales of under utilized equipment, and, to a lesser degree, recent improvement in rental bookings. There is no doubt that our efforts this year in increasing our number of customer touches and our dedication to excellence and thoroughness on each sales opportunity are beginning to pay off. More and more, it appears that being able to execute very, very well on the basic blocking and tackling of the business will have the greatest impact in producing sustainable growth over time.

In closing, I think it would be beneficial to summarize what we believe are the key take-aways for our shareholders from today's call. Hopefully, we've provided greater insight and understanding regarding our businesses and their dynamics. In a few minutes, we'll begin our Q&A and field questions in order to provide further insight into today's comments and our recent press release, but first, to summarize.

One, we have had an exceptionally strong year in orders for modular classroom rentals. Classroom rentals are at the core of our success and provide a recurring income stream for future financial reporting periods. They will continue to do so in the years to come. Two, utilization of our modular rental product began up ticking at the end of the second quarter. We expect this trend to continue very strongly through the end of the third quarter due to the significant number of classroom rental orders booked and scheduled to ship over the next few months.

Three, to the extent that classroom rentals for school modernization projects become a larger portion of the mix of educational rentals, we will see our classroom rental fleet recycle more frequently through our inventory centers. Four, the earnings guidance reduction is not a reflection of the health of our core rental business. Rather, it is a result of the quantity and size of one-time sale orders and site-related services not materializing as we had anticipated.

Five, over time, it has been our modular rental business that has provided the great majority of the operating cash flow to both grow our businesses and to pay out increasing annual dividends. Point six, we are the leader in educational rentals in California and are looking to continue to expand our customer base in building offerings to grow this business even more so in the future. And lastly, for RenTelco, incrementally our test equipment rental business can add nicely to our [inaudible] modular rental business with limited downside exposure.

Finally, on the industrial relations front, I want to let everyone know that Tom Sauer and I will be presenting at the upcoming Deutschebank Securities Global Services Conference in New York City on September 22nd and 23rd. We will have information posted on the company's Web site on the investor relations section as soon as more details are available.

And now, Tom Sauer and I are pleased to take any of your questions.

[operator instructions]

Our first question comes from Mr. Cliff Walsh with Sidoti. Please go ahead with your question.

Hi, guys.

Hi, Cliff.

Hey, Cliff.

The first question I had was with respect to the budget delay in California. I realize - I know the budget has been approved. But with the delay, is there going to be any delay in schools getting the operating funds that they need for, you know, class size reduction?

Not that I'm aware of.

OK. So how does that work when - I mean the budget's been approved but it hasn't been signed off on and changes can still be made. So how do schools go about, you know, budgeting, and, you know, paying their bills and that sort of thing when they're relying on some of those funds for, you know, some of their class size reduction programs and whatnot?

Well, my understanding - at this point right now, both the Senate and the Assembly have passed the budget and the governor is waiting to sign it. Now, whether that took place today or not, I'm not sure. But as of the time of this call, the governor still needs to sign it. He has indicated he will. My understanding is, at least from an operating standpoint, is that there were various mechanisms in place to kind of bridge the gaps here. But I don't have any reason to believe that there are going to be any operating issues with respect - you were speaking specifically to class size reduction and funding for that and other classroom related funding issues that I'm aware of.

OK. Now as for the November, 2002, bond issue, is there any word out there as to how much money has been given out already and how that's going to flow out? You know, like maybe percentage-wise how much is the in school district's hands right now and how much are they saving for, you know, future years?

With respect - I can't speak to the modernization component of what was in the November, 2002, bond measure. There was roughly $3.3b allocated for modernization work. My latest information is that roughly $3b of the $3.3b has been allocated. Now, we have to remember that monies that are allocated - the projects that they relate to can be in all different sorts of stages. They can be in the very early stages of where they're doing initial design work on the reconstructions of schools and so forth. They can be at a point to where they've already let a contract and now they're trying to set up the interim facilities, and so on.

So they can be at all - various stages. The good news is that the state utilizes those monies right out of the gate. Even in December of last year they had started allocating significant chunks of those funds. And we certainly have benefited nicely this year by having seen how quickly those funds flowed into being able to be put to work in terms of projects.

OK. Any idea, you know, when polling data will start coming out about the March, '04, bond issue?

I'm not aware of any timing on polling data. I don't have any specific information on that.

OK. I just - I mean I just remember, you know, with the November issue, you know, a couple months before, we started hearing about, you know, what the voters were saying. I didn't know if there was specific data as to when that started...

If there is data out there, I'm not aware of that at this point.

I haven't seen any data. I was just wondering if there was a timeframe as to when, you know, it might start, just so we could keep our eyes open for it. OK. Did you mention how many shares you bought back during the quarter?

This is Tom Sauer. We bought no shares during the quarter nor through July 31st, 2003.

OK. OK, that's all I've got. Thank you very much.

Cliff, thank you very much.

[operator instructions] Our next question comes from Ms. Lauren Romeo [ph] with Daltan Grainer [ph]. Please go ahead with your question.

Hi.

Hey, Lauren, how are you?

Hi, Lauren.

Good, how are you?

Good.

Can you - is there a way that you can quantify the amount of - you talked to the level of classroom rentals that you have orders for - I guess for - I'm not phrasing it correctly. But is there a way that you can quantify what that could mean to you in terms of future revenue streams, given that you now have that visibility once you sign those rental agreements?

I think the way I'd like to address that is I'm going to have Tom just make a comment with respect to cap ex to give you a sense of - I can tell you now that what we've had come back in off rent - virtually all of that is being utilized. Of course you always have a mix of different types of classrooms. But, Tom - I'd like to have him just speak for a moment to cap ex to give you a sense of how we are adding to our asset base to support the demand.

Yes, this is Tom. As you're aware, we tend to focus on net balance sheet additions as the pool of rental assets that we draw from. Through the first six months of 2003, the net rental additions on the balance sheet for modulars has been about $7m. We would expect that number to be better than $20m by year end, and that's compared, if you look back to last year, of less than $5m of net ads for 2002.

And any sense of - what type of expected yield could we apply on that? What kind of yield on those assets would you expect based on what you have in the pipeline now?

Predominantly, those assets are classroom product which carries a lower overall yield, however the good thing about that particular product is it's a low-touch product and our margin is very good on that.

And it's also a longer term income stream by transaction product versus others.

OK. Is there any thing that you could talk about in terms of - on the sale side? Since the end of the quarter, have you seen anything come in that maybe you had expected to come in on the first half of the year?

There really isn't anything new to report there in terms of any really substantive up tick in sale opportunities.

OK. And what has been your expectation for sales for the year on the Mobile Modular side and what are they going forward?

We've really not broken the revenue components out.

Can you just talk about maybe how your expectations have changed though for at least the back half of the year, given the first half did not come in? I mean just getting to your guidance, the new guidance, what kind of assumptions do you have in there? Are you - you know, what are you assuming in terms of sales implicit in this new guidance? You know, are you assuming you will get some Mobile Modular sales?

There are definitely sales dollars built in there. It's just that we've obviously had to reduce back what our expectation was when we started the year. That's the reason for revising the guidance numbers.

But you still are - I mean how did you come to - you know, given the unpredictability of it, how did you get to a level that you feel - you know, why do you feel comfortable with the level of sales that you're predicting that's implied in the new guidance? I mean is there anything you can talk about, what assumptions you might have used that went into that?

Well, we had to make certain assumptions about levels of market activity and I think we put on a more conservative hat with respect to what we thought could occur in light of what we had seen in the first six months. That's a very difficult area to predict, just because, you know, individual customer usage situations can dictate that, you know, all of a sudden they want to buy buildings off rent or there's a new project that comes along that has a very nice large package of site-related services that are a one-time impact item for the current year. But we really just had to sit down and make some new assessments and judgments about what might be in the pipeline.

Is it assumed to increase relative to last year?

No.

OK. And in terms of the recall of the governor, are there implications that could have on you in terms of maybe extended decision making by some of the customers that you're speaking with on, you know, classroom rentals or anything?

Well, at least to date in terms of any decisions being deferred or reconsidered, I'm not aware of any decisions that are being - if I'm answering your question, any decisions being deferred out or anything related at all to the recall, potential recall, in terms of school districts moving forward with projects.

OK, thanks very much.

Gentlemen, there are no further questions at this time. Please continue.

I'd like to thank everybody for joining us on today's call. We are looking forward to our next upcoming call for Q3. And for those of you that will be on the East Coast on September 22nd and 23rd, we'd love to have you attend our conference with Deutschebank. And again, we'll have more information on that on our Web site in the next couple of weeks. Thank you all very much.

Ladies and gentlemen, this concludes the McGrath Rentcorp second quarter, 2003, earnings conference call. If you would like to listen to a replay of today's conference, please call 303-590-3000 or 800-405-2236 followed by access number 542168. Thank you for your participation in today's conference, and have a great evening.