McGrath RentCorp (MGRC) 2004 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the McGrath RentCorp Second Quarter 2004 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 today's conference, please press the star followed by the zero.

As a reminder, this conference is being recorded today, Thursday, August 5, 2004.

I would now like to turn the conference over to Mr. Jeff Butcher from SBG Investor Relations. Please go ahead.

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 pass code for the call replay is 11002616.

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 website at mgrc.com.

Our press release was sent out this afternoon at approximately 4:05 Eastern or 1:05 Pacific. If you did not receive a copy but would like one, it is available online in the Investor Relations section of our website, or you may call 1-206-652-9704 and one will be sent to you.

Before getting started, let me remind everyone that the matters we will be discussing today that are not truly historical are forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, including statements regarding McGrath RentCorp's expectations, release 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 relating 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 Tom Sauer.

Thank you, Jeff.

In addition to the press release issued today, which discusses the second quarter 2004 results, the company also filed with the SEC an amended Form 8K related to the TRS acquisition, the Earnings Release on Form 8K, and its Form 10Q for the three months ended June 30, 2004.

The Company completed its acquisition of TRS for 120.6m, including related expenses on June 2, 2004. TRS is a similar rental business to our electronics business, RenTelco, with an international component. The acquisition was accounted for using the purchase method of accounting, with the purchase price allocated to the assets acquired and liabilities assumed based on their respective fair values. Based on the preliminary valuation that was completed in conjunction with an independent valuation firm, 107.6m was allocated to the rental assets acquired with most of the remaining purchase price allocated to receivables. The transaction has no goodwill.

Since June 2, the electronics business has operated as TRS-RenTelco, and the 2004 results for the quarter and six months include TRS's results since that date. In other words, one month of activity from TRS is in the numbers.

To finance the transaction, the Company used proceeds from the issuance of 60 million at 5.08% Senior Notes, and an advance under its 130m revolving line of credit. As of June 30, 2004 the Company had a notes payable to equity ratio of 1.11:1, and capacity to borrow an additional 26.5m under its existing lines of credit. To date, as the Company's rental assets have grown, the Company has been able to obtain increases in the borrowing limits under its revolving lines of credit that are consistent with its increased rental asset base. We expect this to continue in the future.

For the second quarter, revenues increased 29%, from 31.6m in 2003 to 40.8m in 2004. And net income increased by 30%, from 4.9m, or $0.39 per share in 2003 to 6.1m, or $0.49 per share in 2004. The Company's improved quarter-over-quarter revenues and net income resulted from record rental revenues from Mobile Modular and the contributing revenues and income related to the TRS assets acquired.

Included in the second quarter 2004 results are non-recurring expenses of 561,000 related to the pre-payment of debt, and 880,000 in severance costs related to the consolidation of the Company's RenTelco and TRS operations. These non-recurring expenses decreased net income by 900,000, or $0.07 per share.

For Mobile Modular, rental revenues increased 12% in Q2 of 2004 to 17.1m as compared to Q2 2003, primarily due to the higher equipment levels on rent. Average modular utilization improved from 82.8% in Q2 2003 to 85.4% in Q2 2004, with modular utilization at June 30, 2004, trending up to 86.4%.

For modulars, rental-related services increased 58% to 5.6m, primarily resulting from the addition of new leases to the portfolio over the last 12 months. As you may recall, most of these revenues are associated with the one-time service revenues like delivery, installation, return delivery, and dismantle, negotiated with the original lease, and are recognized over the term of the negotiated lease.

Sales in Q2 2004 increased 19% to 5.5m compared to Q2 2003 and resulted in a gross profit increase of 289,000, or 23%.

For Mobile Modular, pre-tax income increased 27% from 7.1m in Q2 2003 to 9.1m in Q2 2004 and represents 90% of the Company's pre-tax income for the quarter.

For TRS-RenTelco, as I mentioned earlier, TRS's results are included since June 2 and was the primary driver of the improved reported results for the electronics business.

Rental revenues increased 5.5m or 181% in Q2 2004 to 8.5m compared to 3m in Q2 2003. TRS accounted for 5.1m of this increase. Average electronics utilization for Q2 improved from 44.1% in 2003 to 55.5% in 2004. Electronics utilization at June 30, 2004 was 66.1% and is a direct result of the TRS acquisition.

Pre-tax income for Q2 2004 increased from 421,000 in 2003 to 1.2m in 2004, which includes a severance charge of 880,000.

As mentioned earlier, the Company put in place financing to facilitate the acquisition of TRS. Additionally, the Company continues to generate strong cash flows to operate our business and return value to our shareholders. For the first six months of 2004, the primary uses of cash were to purchase the TRS assets for 118.4m, to purchase rental equipment of 26.2m, which was primarily modular equipment, and the payment of 5.1m in dividends to the Company's shareholders. As a result of this activity, total debt increased by only 121.2m.

For the first six months of 2004, EBITDA increased 29%, from 24.6m in 2003 to 31.7m in 2004, primarily due to the Company's higher earnings. Consolidated EBITDA margin percentage improved from 42% in 2003 to 45% in 2004. The Company declared a second quarter dividend of $0.22 per share, $0.02 per share higher than second quarter 2003. On an annualized basis, this dividend represents a 2.8% yield based on the August 4, 2004, close price of $31.33 per share.

With respect to earnings guidance for 2004, at this time as a result of the purchase of TRS on June 2, 2004 and recent operating trends in the business, we estimate the 2004 full-year earnings per share to be in a range of $2.30 to $2.40 per diluted share.

At this point, I'd like to turn the call over to our CEO, Dennis Kakures.

Thanks, Tom.

Let's jump right to our second quarter results for our modular rental business. As Tom mentioned earlier, rental revenues for the second quarter of 2004 increased 12% over the comparative 2003 period, and broke through the $17m level for the first time ever. This is a result of the impact of strong 2003 third and fourth quarter rental classroom shipments, coupled with fewer returns during the first and second quarters of 2004 as compared to a year earlier.

Also impacting the increase in rental revenues was an increase in the average monthly rental rate. We continue to benefit from providing a low-cost solution to California school districts to meet their in-term housing needs to serve local and state bond-funded modernization and reconstruction projects.

As mentioned during our Q1 conference call, we launched operations in Florida during the first quarter of 2004, and are quite pleased with our progress to date. Our Florida initiative is strictly an educational rental-based model. This allows us to create a lower overhead cost structure by avoiding significant inventory center expenditures associated with building customization and more frequent inventory turnover, which are customary with commercial rentals.

During the second quarter, we had favorable booking levels in Florida. However, we will not begin recognizing rental revenues for these transactions until the third quarter.

Looking forward, our modular division has experienced very strong classroom rental bookings during the first six months of 2004 that should help to drive higher revenues in the third quarter.

Average utilization of the quarter increased to 85.4% from 82.8% a year earlier. This is reflective of fewer returns during the first half of 2004, the improvements in rentals of buildings serving the construction and commercial markets, and our continuing focus on use of existing inventory versus making new inventory purchases.

Looking forward, we anticipate an uptick in average utilization in the third quarter, as the majority of our 2004 classroom orders are shipped and installed for both the California and Florida markets.

We noted in our press release that Mobile Modular is in the process of completing a $9m sales project to provide classroom products manufactured by Enviroplex and site-related improvements to a California school district. This project is scheduled for completion by the end of Q3.

Beyond the sales revenue and margin contributions that this project is anticipated to bring, there are other dynamics related to the project that the Company will look to benefit from going forward. These items include an increase in acceptance by California school districts to create permanent campus infrastructure from modular building technology that is indistinguishable from stick-built construction in terms of aesthetics and the quality of educational environment for fewer dollars, and in many cases one-half the timeframe of conventional construction, and also, leveraging the Mobile Modular sales force and creating more opportunities for this type of project, and in turn increasing utilization of Enviroplex's plant facilities and fixed-cost structure.

Let's now switch to our electronic test rental business, TRS-RenTelco. In our Q1 conference call and in various press releases to date, we have spoken to the strategic significance of the acquisition, including the new combined business platform, leveraging synergies in product knowledge, business development, and so on, and various operational efficiencies that could be realized. This being said, there is little doubt in our minds that we will achieve the great majority, if not all of these benefits. However, I'd like to take just a moment to speak to some of the compelling math of the transaction and the business that has made the acquisition accretive to earnings in month one.

First, purchase price; the purchase price paid for the TRS rental assets in the amount of 107.6m represents approximately $0.56 on the dollar of their original acquisition cost.

Rental revenues; total TRS-RenTelco rental revenues for the month of June were 6.2m. The TRS rental revenue contribution for June was approximately 5m. This represents a multiple, or pay-back window of approximately 22 months when dividing into our prior cost of the rental assets of 107.6m. Of course, this assumes continuing favorable rental revenue levels.

Utilization; combined TRS-RenTelco utilization as of June 30, 2004, was 56.1%. The entire percentage relates to 2 dynamics. First, TRS has a much higher percentage of general-purpose test equipment in their asset pool that typically has longer average rental terms, and thus fewer turns back in inventory as compared to communications test equipment.

And also, as compared to TRS, due to RenTelco's much smaller inventory levels on various products, RenTelco must carry a higher percentage of available equipment in order to be in a position to respond to market requests for immediate product delivery.

And our last item, consolidation economies; with our decision to consolidate all TRS-RenTelco operations at TRS's Dallas facility, we believe that we will realize operating expense savings in a range of 15% to 20% of the original combined businesses.

Key to TRS-RenTelco's success are continuing favorable integration efforts. Our integration leadership team that is made up of employees from both companies continues to work diligently on integration-related work for everything from the makeup of the sales organization to product and service offerings to website consolidation. We expect a significant amount of our integration work to be completed by the end of October.

Also, key to the success of the new enterprise going forward will be our ability to keep our focus on those initiatives that maturely support rental revenue growth, skillfully managing the technology life cycle of our rental assets, maximizing the consolidation economy's opportunity, and providing a value proposition to new customers that creates long-term loyalty.

In the time that I've spent at the TRS facility over the past three months, I have come to realize even more so than before the acquisition how tremendously successful TRS has been at creating enduring customer relationships, strong OEM partnerships, and their prowess at product management. This has all been made possible by an exceptionally talented employee base. Just as with our RenTelco employees, they have great pride in the execution of their daily responsibilities and in getting it right the first time. We can talk all we want to about the great value McGrath RentCorp realized in the assets, customer base, and income stream acquired, but it couldn't be clearer that the greatest value over the long run will be the dedicated employees of both companies who will make the business run at such a high level every day.

And finally, to our RenTelco employees who will not be transitioning into the new enterprise, thank you so very much for your dedicated service, sacrifice, and having made RenTelco such a success over the years. I also want to thank each of you for how you've conducted yourselves since the announcement of the merger. You have gone about the business of the Company and in transferring customer loyalty to TRS-RenTelco in the most professional manner imaginable. Thank you all for finishing so very strong.

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

Thank you, sir.

Ladies and gentlemen, at this point, we will begin the question-and-answer session. If you have a question, please press the star followed by the 1 on your pushbutton phone. If you would like to decline from the polling process, please press the star followed by the 2. You will hear a three-tone prompt acknowledging your selection, and your questions will be polled in the order they are received.

If you are using speaker equipment, you will need to lift the handset before pressing the numbers.

Our first question comes from Cliff Walsh from Sidoti & Company.

Hi, Dennis; hi, Tom.

Hi, Cliff.

Hey, Cliff, how are you?

Good, good. Looking at the 8K on RenTelco -- on TRS, I'm sorry -- about a $60m a year business, can you give me an idea as to what the seasonality is in the business, if it's any different than RenTelco?

This is Dennis Kakures. You say seasonality, that business has historically had trends with it where perhaps things wind down towards the end of the year. And that's consistent with both businesses, that business can be less robust towards the end of the fourth quarter. But in terms of seasonality, very different than our modular business. So it's a very steady business over time,; and the differences between them are that they have a greater percentage of general-purpose business than we do in terms of percentage of assets.

Okay. Are you expecting any additional costs from the acquisition?

I'm sorry, Cliff, we didn't hear your question.

I'm sorry. Are you expecting any additional like integration costs from the acquisition going forward?

We don't expect anything of any significance going forward at this point.

Okay. Can you touch on a little bit of the Florida business and where you stand there?

Well, the Florida business to date, we are very pleased with our progress. We started a little bit later in 2004 than ideally we would have liked to, but we've had good success. We've been able to hire some good-quality folks, and we seem to be accomplishing what we had set out to. And at the same time, we're very humble about what it takes to really be successful in the long run, but if I were to assess our first six months of effort, I would say we're very pleased.

Okay, great. Now in terms of the utilization rate in TRS-RenTelco, seems to be a little bit higher than, you know, what you stated in the past as being optimal. Does the TRS acquisition change your comfort level, or do you think you'll be adding equipment there?

Well, it just -- if you're talking in terms of the range that we've spoken to of 50% to 55%?

Correct.

The fact -- because they're so much larger and they carry so much more in terms of quantity of various products, as I mentioned in my opening remarks, they can run at a higher utilization level and still be able to respond to immediacy in the market. So that business can run at a higher utilization level than a smaller test equipment business, such as RenTelco.

Okay. So do you have a comfort level that you can share with us?

Well, I would say, you know, anything in the 65% to 70% range is very manageable. It could even go higher than that and still be in a comfortable range. So no issues there.

Okay. Now can you explain the spiking cost of sales compared to Q1? It looks like TRS's cost of sales is a little bit higher than your previous margin there, so is that the main driver there?

You mean on sales of equipment?

Yes.

As part of the valuation process, the equipment that was sold during the month of June was valued at the sales price of the equipment sold. So there was no margin recognized on the equipment sold that was acquired.

Okay, so you would expect that to, you know, kind of run rate going forward would be where you were last quarter rather than this quarter on a percentage basis?

We would expect the margins to improve on a go-forward basis.

Okay. Now, where do you think you'll be in terms of run rate in terms of interest expense on a quarterly basis? Just trying to figure out what point you took on the debt and how much it will increase going forward.

The blended rate, weighted average interest rate is just below 4% --

Okay.

-- on the debt level.

Okay. Now are there any sorts of restrictions on repayments or anything like that?

On the fixed portion, on the $60m private placement, there are pre-pay fees associated with those. The $60m is interest only for the first three years, and then there’s five equal principal payments from 2007 to 2011, and there’s no restrictions on pre-paying the revolving line of credit.

Okay, nothing on the revolver, okay, great.

Last question, given the acquisition, can you give us some help in terms of figuring out where SG&A is going to be on a normalized basis?

Cliff, where we are at this point is that as we continue to work our integration process and really understand better the various business metrics and the platform for the business going forward, that will come much more into focus for us and we just continue to work through the process. And we're going to have a very good feel for things by the start of the fourth quarter in terms of SG&A and so forth, but we continue to work every day on that.

Okay, and the severance and debt costs, they were in, in SG&A?

That's correct. The severance, the $880,000 charge was in Q2.

Okay, great. Thanks so much. I appreciate the help.

Thanks, Cliff.

Thank you. Our next question comes from John [Givens] with [Oden] Partners. Please go ahead.

Hi, Dennis and Tom. How are you?

Fine, John, how are you?

Good quarter.

Thank you.

Can I just ask you, you were going through this pretty quickly, and I thought I heard you say there is a 22-month payback on the TRS deal. I look at it -- it looks like you've got about roughly a couple of million dollars a quarter of pre-tax operating income. So I'm not sure where you get the 22-months. It looks like a 22-month payback on revenues, but that's not income.

Yeah, we're not taking income. We're just talking in terms of cash, just taking the current month's rental revenue contribution and dividing it into the asset base.

That's not how you normally make your investments though.

I know, it just speaks to the kind of cash it generates or the amount of cash put out for the assets.

Okay. My other question too is, did TRS go through the same sort of swoon, over the 18 months, let's say, ended this June that RenTelco did? In other words, did their business, the $60m of revenue [indiscernible] $100m revenue business?

Are you saying were they impacted negatively by the downturn?

Yeah, did they have the same sort of difficulties you all had when --?

Yeah, there's no question they experienced a similar impact to their business, maybe a little less so because they have a greater concentration of general-purpose equipment.

Right.

And we had a greater concentration of com equipment, which got hit hard.

So to the extent that both economies can use a pickup, you've still got both companies now leveraging upward. Is that correct?

Yeah, and I feel good, very good, about the general-purpose arena as well as com. I think we're well positioned.

That's fabulous.

My last question just goes to Mobile Modular. Could you just explain to me what's the sort of secret behind the fewer returns this year?

You know, it's -- that's really project based. In 2003, in the first couple of quarters, we got back a number of modernization products that were just at the end of their cycle. And the first six months of this year, we just had more that did not return.

That's great.

It's very school-project driven.

So the business, the tone out there is very strong in California still. That's great.

What's very strong -- what's made that -- continues to make that possible are the bond monies, both locally and on a state-wide basis that are available for this work.

Great, keep up the good work, guys.

Thank you, John.

Nice talking to you.

Thank you. Ladies and gentlemen, if you have an additional question, please press the star followed by the 1 on your pushbutton phone. If you would like to decline from the polling process, please press the star followed by the 2. You will hear the three-tone prompt acknowledging your selection, and if you are using speaker equipment, you will need to lift the handset before pressing the numbers.

Our next question comes from David Cohen with Midwood Capital.

Hey, gentlemen, good quarter.

Thank you, David.

Two questions, one on Florida. Are you able to find the same adequate sources of supply, and if so, from where to find buildings that meet code there? I mean, a pretty rigorous code I think, with respect to the section against hurricane-force winds. Were you able to find an adequate source of supply, and who are they, especially compared to say California where you've been buying for years and years.

Well, first of all we're building everything to the latest -- as you said, much stricter state code, and we have been able to develop some very strong partnerships with various manufacturers to support us. So we're very comfortable with the supply chain.

Are these manufacturers you guys have used in the past in California? Are these guys like national players that have capacity both in markets you've already been in so you have a relationship as well as in Florida?

To the best of my knowledge, these are strictly Florida-based manufacturers.

Okay, and in California is there anything this go around with the monies from the bond financing that sort of are affecting your business or are geared towards more modernization and reconstruction as opposed to, say, new builds such that, you know, rental is more attractive than purchase of these buildings? Is there any of those different demand profiles out there?

Is this for Florida [multiple speakers] California?

No, this is just in California compared to historically in California.

Well, historically in California, when we first started in the rental business, it was -- more was driven by growth in school population. And that's continued, but to a greater degree over the last three or four years, modernization has been the majority of the type of rental business that we do. And that's because of the availability of funding and the state's population growth rate has slowed some.

And does that lend itself more towards -- because we all know that there's a lot of dollars out there. I guess the question is how do they get spent and do they benefit a rental company more than, say, a company that just is selling units?

Well, you have to look at how the monies and the bond issues are distributed or what the mix is. And if there's money set aside for modernization work, which there is on a statewide level and, you know, many, many local bond issues, then those support rental of units to provide in-term states during those types of projects. But there’s also bond monies that are set aside to provide additional classroom states, and which can be purchased modulars, or a version of a modular product that's more permanent onsite, as I mentioned earlier on the part of the school project that we have.

Right, all right, thanks a lot.

Thank you very much.

Thank you. Our next question comes from Charles [Bureher] with [Bureher] Associates. Please go ahead.

Good afternoon.

Hey, Charlie.

Could you give me an estimate of your capital expenditures for calendar '04 broken down roughly between the modular component and TRS-RenTelco?

Well, I can tell you to date, for the first six months we had net rental additions of 18.3m in modulars and roughly 107m in electronics. At this point, we're not for the remainder of the year going to give guidance on CapEx. We will say, however, that we'll continue to buy as demand warrants it.

Well, the figures in the modular division are dramatically higher than they were through the first six months of last year, right?

Absolutely, there's no question.

Okay, so you can assume that there will be a fairly robust trend there while not quantified at this point.

Charlie, let me put it this way. We don't find -- the asset maybe speaks to itself in the fact that we buy assets if the market demand is there. So we'd rather not speculate further on revenues for the rest of 2004.

No, I was just trying to make a generic observation because it appears that the demand forces are quite strong at the present time. And there is obviously a lead and lag. Another question regarding --

That's correct, and the other thing that drives those purchases are going to be what returns in the last six months of the year --

Right.

-- what inventory is available to redeploy.

Okay.

Secondly, in the RenTelco division, Tom, I don't know whether you covered it when you were making your remarks, but could you establish what the utilization rate was for traditional RenTelco at the end of the second quarter versus what it was at either the second quarter last year or the first quarter this year? Was there a modest uptick?

The stand-alone RenTelco utilization was right at about 51%, and that was compared to last year's utilization, period-end utilization, of 45.1%. So there was about a 6 point pickup in utilization.

Okay, and then just finally one question about Florida. If I remember correctly, some time ago the Florida Legislature was toying with the idea of decreasing class sizes. Has that occurred, or am I wrong?

And secondly, if so do they have the finances for it?

Well, the class size initiative that was passed, actually voted on and passed by a slim majority is still in place. To the best of our knowledge, districts are continuing to implement it, and there has been some talk because of -- from a financial standpoint trying to reel that in and maybe they don't have the money to support it. But our latest information is the fact that it's continuing on, and the earliest that anything would be looked at in terms of that would be in 2005 or 2006. But it's a popular program, and schools are continuing to implement it.

Okay, thank you very much.

Thank you. Ladies and gentlemen, if you have an additional question, please press the star followed by the 1.

At this time we have no further questions. I would like to turn the conference back over for any concluding comments.

Well, this is Dennis Kakures speaking. I would like to thank everybody for joining us today, and we'll look forward to speaking to you again on our Q3 conference call in a few months.

Thanks so much.

Ladies and gentlemen, this concludes the McGrath RentCorp Second Quarter 2004 Earnings Conference Call.

If you would like to listen to the replay of today's conference, you may dial 303-590-3000, or 1-800-405-2236, and you will need to enter the access code of 11002616 followed by the pound sign.

Once again, thank you for participating in today's conference. At this time, you may now disconnect.