McGrath RentCorp (MGRC) 2003 Q3 法說會逐字稿

Good afternoon ladies and gentlemen and welcome to the McGrath RentCorp Quarter Three 2003 Earnings 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 "*" followed by "0" on your touchtone phone. And as a reminder, this conference is being recorded is being recorded today, Thursday, October 30, 2003. I would like to turn the conference over to Mr. Jeffery Busher (ph.). Please go ahead sir.

Thank you operator, good afternoon. I'm the Investor Relations Advisor for McGrath RentCorp and will be acting as a 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 1800-405-2236 for domestic callers and 1303-590-3000 for international callers. Pass code for the call replay is 554966 followed by the "#" sign. The 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 website at mgrc.com. A press release was sent out this afternoon at approximately 4:05 Eastern 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 1206-652-9704 and one will be sent to you.

Before getting started, let me remind everyone that the matters we'll 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 on information currently available to McGrath RentCorp, and McGrath RentCorp assumes no obligation to update any such forward-looking statements. The forward-looking statements involve risks and uncertainties, which could cause actual results to differ materially from those projected. These and another risks relating to McGrath RentCorp's business are set forth in the documents filed on 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 Dennis Kakures.

Thank you Jeffery. As most of you are aware, we announced earlier this month that Tom Sauer will be stepping into a newly creative role as Vice President of Financial Planning and Analysis and that we would be hiring a new Chief Financial Officer. We've been working towards increasing our officer and senior management level bandwidth over the past year to serve key needs of the Company. Thomas' migration to his new role would serve us greatly in dedicating more resources to financial planning and analysis in order to support our strategic growth planning and execution efforts. Needless to say, Tom is immensely qualified to serve in this key position. I'm very excited about the contributions that Tom would be making in his new role. Congratulations Tom.

Thanks.

The Company has initiated a search for a new CFO and Tom will continue to serve as CFO until such time we've filled the position. I'd now like to turn things over to Tom; I'll be addressing everyone again later in the call.

Thank you Dennis. In addition to the press release issued today which discusses the third quarter 2003 results, the Company also filed with the SEC the press release on Form 8-K and as Form 10-Q for the 3 months ended September 30th 2003. For the third quarter 2003, net income was 6.1m or 50 cents per share as compared to 8.5m or 68 cents per share in the third quarter 2002. For comparability, as indicated in the press release excluding the expense reimbursement related to the terminated Tyco agreement, third quarter net income would have decreased 21% from $7.7m in 2002 to $6.1m in 2003 with earnings per share decreasing from 62 cents per share in 2002 to 50 cents per share in 2003.

For Mobile Modular, rents declined 3% in Q3 2003 to $16.2m as compared to Q3 2002 primarily due to lower average rental rates and to a lesser extent, lower utilization. However, on a sequential basis rental revenues were up 6% from Q2 2003. During the quarter, other direct class of rental operations increased 27% to $4.7m primarily due to the preparation of equipment for shipment during the quarter. These increased expenses impact the gross margin on rents for the quarter, which declined from 68% in Q3 2002 to 59% in Q3 2003. Average modular utilization for Q3 declined from 86.1% in 2002 to 85.1% in 2003; however, utilization trended up to 85.8% at quarter end.

Sales in Q3 2003 decreased 11% to $5.8m as compared to Q3 2002. Sales for the first 9 months of 2003 decreased 11% from 2002 levels, primarily due to a significant sale of equipment purchased off rent occurring in the first 9 months of 2002. For mobile modular, pre-tax income declined 23% from $10.8m in Q3 2002 to $8.4m in Q3 2003 and represents 82% of the Company's pretax income for the quarter.

While RenTelco, our electronics business continues to be challenged as a result of the weakness in the telecommunications industry. Rental revenues for the quarter increased 14% on a sequential basis to $3.4m from $3.0m in the second quarter of 2003. Electronics utilization below our target range of 50-55%; however, utilization continued to trend up ending the quarter at 48.6%.

Pre-tax income for Q3 2003 was $1.2m with the sale of unutilized equipment positively impacting pre-tax earnings for the quarter. The Company continues to generate very strong cash flows to operate our business and return value to shareholders. For the first 9 months of 2003, cash generated was used to purchase $27.2m of rental equipment; we purchased $10.2m of the company's common stock and paid $7.1m in dividends with debt only increasing a $0.5m.

For the first 9 months of 2003, EBITDA adjusted for non-cash impairment and compensation expenses declined 21% from $49.6m in 2002 to $39.2m in 2003, primarily due to the Company's lower revenues. Consolidated EBITDA margin percentage declined from 45% in 2002 to 42% in 2003.

The Company declared a third quarter dividend of 20 cents per share, 2 cents per share higher than the third quarter 2002 dividend and on an annualized basis, this dividend represents a 2.7% yield based on the October 29, 2003 close price of $29.76 per share.

With respect to earnings guidance for 2003, we continue to believe earnings per share for the full year 2003 will be in the previously provided guidance range of $1.75-1.85 per share. At this point, I would like to turn the call back over to Dennis.

Thank you Tom. Let's jump right to our third quarter results for our modular rental business. In the third quarter 2003, rental revenues increased to $16.2m from $15.2m in the second quarter. This reverse is a trend of three consecutive quarterly declines in rental revenues for mobile modular. We've had an exceptionally strong year in classroom rental bookings as monies from passage of the November 2002 bond measure were allocated to school districts for modernization projects. Although we've had a very good year in classroom rental bookings, we have experienced unexpected project delays by customers, lower average rental rates, and an increased number of equipment returns. These factors have offset some of our strong order activity. The net out, depending how the very favorable year in classroom rental bookings coupled with these offsetting factors has lowered the expected sequential rental revenue growth in the third quarter. Despite these offsetting factors we still expect our highest ever fourth quarter rental revenues. We will also benefit from this increased run rate heading into 2004.

I'd now like to take a few minutes to speak more specifically to the factors that have helped back rental revenue grow in 2003 in spite of a very, very strong classroom booking here. Let me preface my comments by stating it is my goal to provide our investor base with as much transparency as possible into the dynamics of our businesses. I can think of no area of modular rental business more important than create a deeper understanding that factors impacting rental revenue growth. Keep in mind that when we utilize the phrase "net out" in terms of rental revenues, we are speaking in a broader sense to anticipated rental revenue levels taking in to account new rental orders coming on-line, equipment coming off-rent and other factors.

In both our press release as well as in my earlier comments, I spoke to three factors that have challenged growth levels thus far in 2003. Item one, unexpected project delays by customers. The majority of our new classroom rentals for 2003 are serving school modernization projects. These are very large school construction projects that have a high degree of complexity and a great many elements that have to be in place before interim facilities get shift and installed for occupancy by students displaced during the constructional window. Everything from designing, engineering issues to general contractor selection to agency approval problems can create unexpected projects delays. We've had a number of school projects committed to in 2003 that have experienced project delays for these varied reasons. The good news in all of this is that we booked the business and the rental stream should commence in 2004.

Item 2, lower average rental rates. When 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 with the commercial construction sector. Rates for our classroom rental products have also been impacted by tighter school budgets due to the state budget deficit. Equivalent rentals put out during more favorable economic period, when re-sampled the system back on rent during 2003 had experienced a more competitive environment in this lower rental rates. The second contributing factor in packing average rental rates of utilized equipment is the mix of the equivalent return over the past few quarters. We've experienced a higher number of larger square footage building with higher absolute rental rates as compared to smaller square footage single-wise building that carry lower absolute rates. Thus the mix of utilized equipment reflects an over a lower averaged asset rate per building.

And item 3, equivalent returns. Increased numbers of returning classroom rentals for completed school modernization projects and some larger commercial complex buildings related to the completion of permanent building space has slowed growth. It's very important to remember that unlike classroom rentals for growth or class size reductions that can stay for extended time periods, modernization projects have a beginning and an end. As stated earlier, classroom rentals for modernization projects have been the largest component by far of new classroom rental orders in 2003. Typically these buildings are on rent anywhere from 12 to 36 months. This type of classroom rental equipment will turnover more frequently than other classroom rental needs. Equipment returns are a reality of the business.

Looking forward, assuming a higher mix of modernization project rentals, in order for us to continue to grow our classroom rental business at favorable levels, we will need to paddle faster in the future to quickly re-deploy returning classroom equipment and continue investing in new equipment. Although we've had a very strong increase in average fleet utilization levels sequentially from Q 2003 at 82.8% to Q3 2003 at 85.1%. Without the higher equipment return levels experienced in the third quarter, average utilization would have been noticeably higher. If there are any questions or any additional clarity that's required regarding any of the factors impacting rental revenue growth levels, we'll be pleased to address them during our Q&A session following shortly.

Finally, for Mobile Modular, in 2003 we set internals goals to increase both school 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 renting educational facilities in California and more specifically our expertise in serving the modernization and reconstruction project needs of school districts. Although absolute growth was less than what we would have liked to see in the third quarter for the reasons stated earlier, this should not attract in the long-term benefits of this year significant booking levels, including the increased levels of recurring rental revenues, broadening our school customer base, and greatly solidifying our leadership position in classroom rentals in California. We have a truly outstanding year in generating new classroom rental business that would benefit the company greatly going forward. Finally, I can't say enough about the quality and ability of our people to execute the goals established to drive our initiatives. They did a truly remarkable job.

Staying with the modular side of the business, let's examine Enviroplex, our classroom manufacturing subsidiary. Sales revenues for the first nine months of 2003 decreased to $7.1m from $11.3m a year ago; however, our backlog of orders as of 9/30/3 was $7.1m as compared to $2.8m a year earlier. The backlog increased to $4.3m compared to last year at this time includes $3.7m of projects in process during the third quarter but not complete at quarter end. Although passage of the November 2002 bond measure has been favorable for Enviroplex, greater complexity associated with more customized building projects and receipt of final design or regulatory approvals will push income recognition for various 2003 quarter activity into the fourth quarter and early 2004.

Now, let me turn our attention to RenTelco and their results for the third quarter. Our communications and test equipment business experienced a second sequential quarterly increase in rental revenues in the second quarter -- in the third quarter of 2003. This was the first time that this occurred since the first quarter of 2001. RenTelco contributed pretax earnings of $1.2m and EBITDA of $2.7m or a $2.25m multiple of pretax earnings for the quarter. Average utilization is increased to 47.1% in Q3 from 45.4% in the second quarter of 2003. Sales of equipment continue to be the largest contributor to the pretax profit and higher utilization in rents. However, the relative contribution of rent increased for the quarter. Finally, we are continuing to purchase the latest technology equipments to serve growing marketplace demand in key sectors.

I think it is important to calibrate expectation for the businesses as we hit into the fourth quarter. Historically, Q4 has had lower business activity levels than other quarters due to seasonal factors. Said another way it should not be surprising to see fourth quarter rental revenues coming lower than third quarter rentals due to these seasonal factors for RenTelco. Although we are cautious in our enthusiasm, we are seeing the beginnings of a broader number of product area showing signs of improvement. We fully expect the business to continue its road back to better health in 2004.

In closing, I think it would be beneficial to summarize what we believe are the key takeaways for our shareholders from today's call. Hopefully, we 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.

First to summarize, classroom rentals are the core of our success and provide a recurring income stream for future financial reporting periods. We have had an exceptionally strong year in orders for modular classroom rentals. The majority of these orders came on line during the third quarter, probably the fourth quarter will be the first quarter in which we recognize a full three months of rental revenues.

Although, we had a very strong year in classroom rental bookings, we have also experienced unexpected project delays by customer, lower average rental rates and an increased number of equipment returns. These factors have offset some of our strong order activity. The net out of having had a very favorable year in classroom bookings coupled with the offsetting factors have lowered sequential rental revenue growth in the third quarter. Despite these offsetting factors, we still expect our highest ever fourth quarter rental revenues. We'll also benefit from the increased run rates heading into 2004.

To the extent that classroom rentals to school modernization projects become an increasing percentage of the mix of our educational rental business, we will see this portion of our classroom rental portfolio turn over more frequently. Looking forward, assuming a higher mix of modernization project rentals, in order for us to continue to grow our classroom rentals business at favorable levels we will need to paddle faster and quickly redeploy returning classroom equipment and continue investing in new equipment.

RenTelco rental revenues increased 14% over the second quarter; hopefully, we are seeing early signs of a turnaround for our communications and test equipment business. We shouldn't be surprised if there are lower rental revenues during the fourth quarter due to seasonal factors. We fully expect the business to continue its recovery in 2004.

Both of our rental business models generate significant amounts of cash flow. We utilize this cash to reinvest in rental assets to grow the business further and to pay out increasing annual dividends even during difficult economic and market environments.

Finally, we are reconfirming guidance in a range of $1.75 to $1.85 for a year 2003.

And now Thomas and I are pleased to take any of your questions.

Thank you sir. Ladies and gentlemen at this time we will begin the Q&A session. (Caller Instructions) Our first question comes from Cliff Walsh with Sidoti. Please go ahead with your question.

Hi guys.

Hi Cliff how are you?

Good. My first question is about the change in Governor. I know that Arnold is pro-education and I think he is pro-, the March 2004, bond issue. My question is you know, do you think there will be a change in the Allocation Board and if so what kind of effect do you think that would have on your business?

I don't have any insight as to what changes may occur on the State Allocation Board and further any impact that we have on the business. My sense is, and you really spoke to it a moment ago when you said he is pro-education -- my sense is that we are probably going to see things to be fairly consistent going forward with respect to budget for schools and what's been outlined. I think it will be difficult for the Governor-elect to make some changes there that would be unpopular.

Okay. I was just curious from a, you know, a timing standpoint in funding. You know, if a change could possible delay some funds you know, being passed out to schools?

No I am not aware of any. I know that with respect to the November 2002 bond issue, those monies have really been allocated for the most part.

Okay.

So the next part of money, so to speak, would be from the March 2004 bond measure soon to pass.

Okay so we've got some time before it, you know if those changes would be made. Okay. In terms of strategic planning you guys have been working internally on a lot of different things, can you share anything with us in terms of what you've come up with?

What I can't share is that we have been involved in an extremely rigorous process, our entire senior management group actually -- we term it the Strategic Planning Council. And we have been working very hard at looking at a number of different opportunities for the Company. We actually, more recently have chartered 4 different areas to look at in which we've actually created internal teams that are doing much deeper dives in those areas. I can't speak publicly about what those are, but know that we are hard at work at looking at where future growth will come from for the Company and turning it back to earnings.

Okay is there a timeframe as to when you would share that with us?

I can't give you a timeframe right now; there'll be an appropriate time in the future, that's all I could say at this time.

Okay great, thanks very much.

Thank you our next question comes from Ross Demount (ph.) with Midwood (ph.) Capital; please go ahead with your question.

Hi guys few questions for you. As I've looked at your company and your placements of classrooms are generally divided, those classrooms into sort of two different baskets. One where a district needs some space because they're going to go through a modernization project, and two where a district basically has a capital budget problem and needs to create an operating budget solution, so they bring in a classroom for -- it could be one year, it could be 3-4 years. Now that all these dollars have flowed to school's capital budgets and we're getting sort of essentially more stick bill classroom space out there, it seems like that's pushing or its creating a les of a need for that second bucket. And you mentioned that basically modern and improving towards more products in modernization, does that concern you; I mean, to me that seems like a lower quality placement of product, it turns more quickly, it doesn't have the stickiness that the other type of placement had. I mean, do you see this as problematic?

Well first of all, from where I sit in and you think in our classroom market, I would take as much modernization business that we can get our hands on. It's still a very profitable piece of business without question. Is it as profitable as a long-term rental that it goes after growth and you know, stays for 6-7 years? No, its not. However it's still very favorable and I think when you started your question with comment with respect to capital budget and so forth, we still see plenty of opportunities and even this year that we put out product for general growth needs that are rentals. It's still the least expensive alternative for districts. California has struggled historically to catch up with its capital budget needs for permanent schools. I don't see much of a change in that area.

Okay so may be let me come at it just from a little different way and that certainly answers part of my question. But, if the average turn of on-lease products for your inventory and everyone else's is basically getting shorter, let's say it was 3 years or a couple of years ago when it's moving towards a year and a half down and I don't know that those numbers but does that -- wouldn't that double the effective inventory of classrooms available for lease and won't that sort of create a sustained pressure on rates?

Well it's all a function of what the demand is and where the demand is coming from. And although products are turning faster and the reason they turn faster is modernization of products as I said in my remarks, or prepared remarks, is that there is a beginning in the end of those projects. The Standard Committee [inaudible] lot of dollars to rehabilitating existing facilities; and I don't see that lessening going forward. So it's a function of us as we did this year, really stepping up and taking additional market share to continue. If that's where most of the opportunity is going to come from then we need to grow our market share in that area.

Okay, fair enough.

I do want to emphasize that there is still plenty of rentals that go after general growth needs.

Okay, thanks guys.

Thank you. Ladies and gentlemen if there are any additional please press the "*" followed by the "1" at this time. As a remainder if you are using speaker equipment, you will need to lift the handset before pressing the numbers. Our next question comes from Rob DeLong (ph.) with Gray & Gene Capital (ph.). Please go ahead with your question.

I like to just delve into this average of rental rate decrease a little bit more. Is there -- I mean you are getting a lot of product coming back in that you are trying to send back out again on these. Is there competition that's affecting rental rates or is there an elasticity of demand issue -- I mean why can't you hold the rates firm in this environment?

The best way to describe it is that and we can take -- lets take the commercial section and then do with the educational sector. The commercial sector is more competitive; from a standpoint of commercial construction that's been a very competitive arena for rentals and that's the utilization issue for dealers such as ourselves. There is less commercial construction going on in California in particular, therefore people have more underutilized equipment and as a result rates are lower to compete for a limited amount of commercial business. On the educational side, what we have seen is school districts are watching every penny and this new dynamic with respect to more modernization business, many school districts now in order to even spend the modernization monies that they have in order to spend them they actually are required through the bond issue to hire construction management company to oversee various elements of the project as well as go out and procure the interim space. So what we are seeing is increased scrutiny on pricing, maybe less typical just, give me your standard piggy bag and we'll use that, but there is a greater consciousness with as difficult as the budget times are in the state to maximizing dollars spent.

And are you able to hold your market share by decreasing rates or is that not sort of what the strategy is?

Well, this year our goal was to grow at an increased market share and I don't think there is any doubt in our mind that we accomplish that and we are extremely successful. Now, as a part of that we are -- there is business that is set one rate versus another rate, so some where we have to much more competitive to get it, and other business can be more based upon more standard rates. And surely a mix there but we - there is no question in my mind that we will increase market share in 2003.

And is this a typical cycle that you would see in terms of rates where when the economy is soft, or the state economy is soft that rates go down and then you are able to raise rates coming out of that or it's a sort of an unprecedented rate structure we are in now?

I would -- this is new, we never had a $35b state deficit and so that certainly is contributing and I would put a lasting effect that it's modernization work. You've got a lot more shopping on equipment and that's tied to trying to really maximize the dollars that are just available for these projects.

In terms of the fourth quarter guidance, are you seeing some of these trends abate or is it pretty much, you know, you just are going to repeat the performance that has occurred in the third quarter into the fourth quarter?

Just to make sure what you refer to when you are talking of the fourth quarter guidance that you referring to --

Well, the full year --

Rental revenues?

Well, just overall the full year guidance in terms of earnings per share and then what that implies for the fourth quarter? Does that mean the fourth quarter is going to look pretty much like the third quarter in terms of all of these trends or are you seeing some trends getting better and others getting worse?

We will benefit in the fourth quarter from -- there is much of school activity that occurs after September. Most everything ships in the second and third quarters but the big benefit in the fourth quarter is the fact that we'll three months worth of billing for equipment that is already out. We've got a lot of lot of equipment that shipped in August and September. And now they got a month and a half to may be, you know, a half-month's worth of income. So we benefit in Q4; we benefit greatly from that. We also benefit from the fact that all expenses that we incurred in the third quarter to prepare product to put it out that went down pretty significantly. But in terms of the market, and the dynamics of the market place, that's probably still consistent with what we experienced during this year. But the benefit I spoke to in Q4 are tangible.

Right, okay. Just one more question, in terms of cash flow it looks as if and I guess there wasn't a complete balance sheet that came out with the press release, but it looks as if your debt level has actually gone up a little bit this year despite the cash flow. Is that because of just the investment in the business or because you bought back some stock or what was the dynamics?

It is a combination factor and I'll let Tom speak to it.

Right it is a combination of factors. We did buy $10.2m of stock in the first quarter of this year; we've also purchase about $27m worth of rental equipment this year as well and paid out dividend. The trend in Q4 because we've gone through the major part of the year where rental equipment is purchased, last few years we have reduced that and we will see that trend continuing in Q4 2003.

Okay, great. Thanks very much.

You're welcome

Thank you gentlemen there are no further questions at this time, please continue.

I'd like to thanks everybody for joining us this afternoon and we will look forward to chatting with everyone again on our Q4 call in early 2004. Thank you again.

Thank you. Ladies and gentlemen this concludes the McGrath's RentCorp Q3 2003 earnings conference call. You may now disconnect and thanks for using AT&T Teleconferencing.