McGrath RentCorp (MGRC) 2004 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen and welcome to the McGrath Rent Corp. fourth quarter 2004 earnings conference call. At this time all participants are in listen-only mode. [OPERATOR INSTRUCTIONS] As a reminder, this call is being recorded today, Thursday, February 24th, 2005. I'd now like to turn the conference over to Jeffrey Busher of SDG Investor Relations.

Thank you operator. Good afternoon. I'm the Investor Relations advisor to McGrath Rent Corp., and will be acting as moderator of the conference call today. On the call from McGrath Rent Corp. are Dennis Kakures, President and CEO, and Tom Sauer, Vice President and CFO.

Please note 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. Passcode for the call replay is 11019909. That's 11019909. This call is also being webcast live over the internet in the Investor Relations section of our website, and will be available there 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 ET 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 21-E 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. 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 10-K and form 10-Q.

I would now like to turn the call over to Tom Sauer.

Thank you Jeffrey. In addition to the press release issued today which discusses the fourth quarter 2004 results, the Company also filed with the SEC the press release on form 8-K. As most of you have seen in the press release today, the Company announced a 2-for-1 stock split. Our comments today are pre-split, unless otherwise stated.

For the fourth quarter 2004, total revenues increased from 37.1 million in 2003 to 59.3 million in 2004. And net income increased from 7 million or $0.57 per share in 2003 to 8.8 million or $0.70 per share in 2004. Most of the Company's improved quarter-over-quarter revenues and net income resulted from the contribution of the acquired TRS assets and operations. Also as a result of the acquired TRS operations, the fourth quarter effective tax rate was reduced from 39.9 percent, to 35 percent due to recording a cumulative true-up adjustment for the state income tax accrual rate. The tax adjustment increased net income by 0.7 million, or $0.05 per diluted share.

Looking forward, we estimate the effective tax rate to be approximately 39.25 percent in 2005, compared to 38.5 percent in 2004. Reviewing the fourth quarter results from all modular, revenues increased 13 percent in 2004 to a record 19.1 million as compared to Q4 2003, driven by educational rentals. Average modular utilization for Q4 improved from 85.1 percent in 2003, to 86.3 percent in 2004, with quarter end utilization of 86.1 percent. Modular rental related services increased 17 percent to 5.9 million, primarily from the additions of new leases to the portfolio over the last 12 months. Most of these revenues are associated with one-time service revenue like delivery, installation, return delivery & dismantle, negotiated with the original lease. These revenues and the associated costs are recognized over the term of the negotiated lease.

Although quarter-over-quarter total revenues increased 11 percent, pretax income declined 2 percent to 9.8 million in Q4 2004, representing 73 percent of the Company's pretax income for the quarter. Mobile modular's 2 percent decline in pretax income, was primarily due to increases in maintenance expenses s to pre-prep unutilized equipment, as well as higher allocated overhead and interest expenses.

For TRS-RenTelco , our combined electronics group, the improved quarter-over-quarter results for the electronics business was primarily due to the impact of the acquired assets and operations of TRS. Mind you, Q4 2003 represents RenTelco 's standalone results pre-acquisition. Rental revenues increased 15 million, to 18.5 million in Q4 2004's compared to 3.6 million in Q4 2003. Average electronics utilization for the fourth quarter improved from 46.6 percent in 2003 to 63.9 percent in 2004 with quarter-end utilization of 61.6 percent.

Pretax income for Q4 2004 increased from 1.1 million in 2003, to 3.9 million in 2004, and represented 29 percent of the Company's pretax income for the quarter as compared to 9 percent in 2003.

The Company continues to generate very strong cash flows to operate our business, and return value to our shareholders. For 2004 net cash flow from operations increased 15 million over 2003, a 31 percent increase to 63 million and resulted primarily from the higher revenues and earnings contribution of the TRS acquisition.

Net cash used in investing activities amounted to $160 million for the year, and included $120 million for the TRS acquisition, 67 million for rental equipment purchases, 1 million for purchase of other fixed assets, with 27 million in proceeds from used equipment sales reducing the cash requirements of our investing activities. Dividend payments to shareholders amounted to 10.5 million and stock option proceeds were 2.8 million. As a result of the above, and the strong operating cash flows of the business, net borrowings only increased 105 million during 2004.

For 2004 EBITDA adjusted for non-cash compensation expense increased 60 percent from 56 million in 2003 to 89 million in 2004 primarily due to the impact of the TRS acquisition. Consolidated EBITDA margin percentage improved during 2004 from 42 percent in 2003 to 44 percent in 2004.

With respect to earnings guidance for 2004, at this time adjusting for the announced 2-for-1 stock split, the company expects its 2005 full year earnings per share guidance to be in a range of $1.45 to $1.55 per diluted share. This guidance range excludes the impact of expensing stock options which will be implemented as required in the third quarter of 2005. We expect the retrospective impact of the non-cash compensation expense to reduce 2005 diluted earnings per share by approximately $0.05 per share.

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

Thank you, Tom. Let's jump to our fourth quarter and year end results. Mobile modular had an outstanding year in rental revenue growth. Not only was the fourth quarter our highest rental revenue quarter ever at 19.1 million, but rental revenues for the full year also reached a record level at 71.5 million which is over an 11 percent increase from 2003.

These record rental revenue levels are the result of the exceptionally strong year in California classroom rental orders that we spoke to during conference calls in 2004. With the passage of the March 2004 statewide facility bond measure,as well as other local funding vehicles, there are increased levels of money available for school monetization and reconstruction projects. When you couple the payroll funding environment with our leadership position providing classroom facilities to California school districts, to meet their interim housing needs, the results speak for themselves.

Also as I mentioned in our Q3 2004 conference call, we focused our sales professionals on expanding our base of educational rental customers in California in 2004, and those efforts are also reflected in our strong results. We should benefit nicely in 2005 from the recurring rental revenue stream that came on-line in the third and fourth quarters of 2004, related to the strong year in new educational rental business. With respect to our Florida board of Education rental initiative that was launched in early 2004, we are very pleased with what we have been able to accomplish and in establishing ourselves in the marketplace in such a short time frame.

Order activity in 2004 was ahead of our initial financial plan modeling, and we continue to be enthusiastic about the opportunity to create a meaningful educational rental business in Florida. Average modular utilization increased in 2004 to 85.6 percent, from 84.2 percent in 2003 with ending year utilization in 2004 at 86.1 percent. This is reflective of fewer returns during 2004 than a year ago. The impact of an increased amount of new classroom equipment purchases and utilization of those assets, and improvement in building rentals, serving the construction and commercial markets.

Now let me turn our attention to TRS-RenTelco and their results for the fourth quarter in 2004. Fourth quarter rental revenues were relatively flat at 18.5 million as compared to 18.7 million in the third quarter of 2004, which which was the initial full quarter of combined TRS-RenTelco operations. Looking at activity levels in the first quarter 2005 to date, have been slower than what we'd like to see however our quotation activity has been favorable with the understanding that many customers are in their early year process of establishing budgets for projects coming online throughout 2005. Although we experienced favorable improvement in our test equipment rental business in 2004 it's important to note that the industry as a whole in still some ways to go in recovery, particularly in various communications test equipment markets.

As a result we may experience some unevenness quarter-over-quarter in business activity levels, as the industry continues to recover. We continue our work on key integration projects during the quarter. We accomplished a great deal in 2004 including right-sizing the workforce, combining websites, implementing an integrated go-to-market approach for our sales and marketing teams, restructuring our channel management program, and integrating systems for financial and business activity reporting.

Although we believe we've set the combined businesses up for success going forward, just how successful TRS-RenTelco can become will rest greatly on our ability to be disciplined in our execution of key strategies surrounding customer touches and management of equipment utilization and depreciation levels. Said another way, organizationally having everyone aligned in the day-to-day fundamentals in these key areas,will go a long way towards realizing its potential.

In closing I'd like to take a few moments and review some high points of 2004 and their impact going forward. Early in the year we launched modular operations in the state of Florida under an educational rental market structure. We exceeded our first full year projected rental booking levels in the first six months of business operations. We are highly optimistic that we can make Florida a significant contributor to earnings in the years ahead. Modular rental revenues reached record levels for both the year at 71 million, and an exceeding 19 million in the quarter in the first first time in Q4.

In June we acquired TRS, a test equipment rental business approximately 5 times the size of RenTelco . This created the largest test equipment rental company in North America as measured by rental revenues. The Company generated EBITDA of 89 million for the year. Following the acquisition of TRS, the last six months of 2004 produced EBITDA of 57 million. Approximately an 85 percent increase over the second half of 2003. Net income grew to 30 million, an EPS to $2.42 per share, which represented a 31 percent increase over 2003 EPS.

We announced a 27 percent increase in the first quarter 2005 dividend as a one-time step-up in the dividend pay off, related to the TRS acquisition that reflected the increased amount of cash flow that TRS is providing.

Looking forward, we expect any future dividend increases beyond 2005 to generally reflect increases in our underlying growth rates. In our view, we create value for shareholders employing free cash flow and available debt capacity on strategic growth opportunities, that we believe may result in increased earnings and distributing excess cash flow in the form of dividends. Both the launch in Florida and the TRS acquisition with the direct result of a tremendous amount of work over the past few years by the Company's management and understanding our strategic course, and then pursuing opportunities that will align with those capabilities.

Having a sound strategic growth framework serves as an important filter so that we are pursuing only those opportunities that we believe can have a high degree of success. As it is with all enduring successful companies, strategic planning is a continuum for McGrath Rentcorp. In 2005 you can expect for us to continue our idea generation and exploration efforts in seeking out and assessing opportunities for additional growth engines.

However, the greatest nearer-term impact to growing earnings, will come from management spending all of the time necessary working closely on optimizing what we took on in 2004. We can and will do both, but our first priority lies with providing TRS/RenTelco and Florida every opportunity to optimize the earnings contributions, sooner rather than later.

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

Ladies and gentlemen at this time we will begin the question and answer session. [OPERATOR INSTRUCTIONS] Our first question comes from Cliff Walsh with Sidoti & Company.

Hi Dennis, hi Tom.

Hey, Cliff, how are you?

Good. Can you quantify the TRS' integration costs in the quarter?

We have not broken those out separately for disclosure. We did incur expenses during the quarter for the integration and as we spoke to on our last call, those payroll expenses came out during the quarter. Q1 '05 will be our first quarter without those expenses.

Can you perhaps comment as to whether or not it is larger than the tax benefit that you got from TRS?

The tax benefit that we recorded in the fourth quarter related to revenues and assets being generated in states with lower tax rates. The total dollar impact was just under 0.7 million, and it was attributed for the most part to the TRS-RenTelco operations. We have some -- we do have assets on the modular side of the business that are in other states that are in lower rates, but what really grows that tax benefit was the TRS assets and revenues.

I'm sorry, Tom. Actually, my question was whether or not the integration costs were larger than the tax benefit?

Cliff, this is Dennis Kakures. Let me try to get clarity. You're talking about the costs of putting the businesses together, and there being separate expenses associated with that?

Yeah. I'm just trying to get a sense as to, you know, what the kind of the on-going operations would look like, if you stripped out integration costs and the tax benefit that you got. We know the tax benefit was $0.05. I'm just trying to get a sense of what the integration costs were.

The on going related to the tax benefit there's an ongoing tax benefit through a lower effective tax rate.

Okay.

In 2004 we were providing at 39.9 percent in our tax rate, in 2005 would be reduced to 39.25 percent.

Okay. In terms of other integration costs, I mean, really what's happened is there's been a fairly significant reduction from day 1 in headcount, and also salary expense, so obviously there's been effort to put the businesses together in various areas, but that's mainly management time, and some other expenses associated with various items, but not significant.

Okay. In terms of the maintenance expenses you had at mobile modular and getting things ready for, you know, you talked about the 2005, can you comment as to how much larger than normal they were?

The dollar amount it was just under $1 million in additional expenses quarter to quarter. 2004 over 2003. The bulk of that -- those expenses related to our inventory center operations, materials and labor.

Okay. Now, how often do costs like that come up?

Maybe I can best explain that or answer that, Cliff, by saying that what we found was transitioning from 2003 into 2004, that demand was greater than what we had anticipated last year, and we needed to get further ahead of the curve this year as demand has increased, and we've had very favorable market conditions.

It's very important in the fourth quarter of 2004 that we started our pre-prep process as we call it , preparing equipment in order to meet the demand that we are experiencing in 2005 thus far, and believe will continue throughout the year. So this was strictly an effort to get as far ahead of the wave as we can in terms of demand.

So would you say it was more of a shift in expenses from maybe like the first quarter of last year to, you know, if we were looking at a year-over-year basis, is that why that was such an increase, because you normally do it in a different quarter?

What we did is this year we accelerated our effort there just to try to get ahead of the pre-prep rather than running into the same situation next year, so we actually kept on more staff, added more contractors to try to prepare equipment, so I guess you can say some of that would have maybe normally occurred in Q1 but it's all driven by higher demand, which is a good thing.

Okay. Fair enough. Thanks very much, guys.

Our next question comes from Jeff Goldberger with RS Investments. Go ahead.

It's actually Bill Wolton, and I'm here with Jeff. I'm just trying to get my hands around this maintenance expense that Cliff was just talking about. I mean, are you guys preparing for a big ramp in Florida, and that's why you decided to do this, or I'm just trying to get a little bit better handle on it. It hasn't been explained very well.

Thanks for your question. This is not related to Florida. This is strictly related to predominantly California operations versus Texas. Florida we're still in a mode of buying new equipment from manufacturers and putting that it out in rent , and in California because because of the large size of our rental fleet, we turned that equipment to our inventory centers, and put it back out on rent, so it's expenses related to the labor and material associated with maintaining the product and putting it back out, so the net of it is, is we're trying to get ahead of the wave here, I think it speaks fairly favorably to the type of demand that we expect in 2005.

Okay. Can you also explain maybe there's some one-time stuff in there, I would guess, just from the acquisitions, but we're looking at the cost, total direct cost of rental operations last year was about 42 percent of sales in this quarter, in the fourth quarter, and this year was 53 percent. It looks like the big delta was on depreciation. Can you just talk to where that should be on an on-going basis looking out over the next several years?

Are you looking at direct cost of rental operations including depreciation, you said?

Yeah.

The huge delta between Q4 of last year and Q4 of this year is the depreciation associated with the TRS equipment. The increase in depreciation -- hold on one second here. The depreciation on the RenTelco equipment -- or TRS-RenTelco equipment last year was 1.3 million, and the depreciation this year is 9.5 million for the quarter-to-quarter comparison.

No, I understand that, but so should we be looking at this acquisition then from an EBITDA standpoint, or did you just dilute your operating margins by a 1000 basis points?

You should -- there's a huge EBITDA benefit because of the depreciation with the TRS assets.

Right. So is the on-going operating margin profile business different now because of the depreciation, or is this just a one-time catch up on the depreciation in an ongoing basis, you'll be back to the normalized level. I guess I'm asking if this telco business is that much different from an operating earnings perspective than the modular business is, it certainly appears that way, looking at this one quarter, anyways

This is Dennis Kakures. I don't think you can judge the TRS acquisition on one quarter. We have a dynamic where -- from a utilization standpoint. By the way, one of the key measurements of the business that can be looked at, is looking at depreciation as a percentage of rent. That's a pretty good calibrator. We are currently probably in about a 48 to 50 percent range, a much more attractive range that we are striving to reach as the industry recovers, and as we target various models for higher utilization levels would be in the low 40s to high 30s. That's where we -- that business ideally should be able to get to, so if you're looking for metrics to calibrate performance, that is definitely one that should be looked at.

Okay. And then the press release also talks about higher allocated overhead, and it indicated that that was on the modular side, so I would assume that had nothing to do with the acquisition. What was that?

We had both SG&A related to indirect folks, whether it's the accounting group, outside consultants, accounting legals get pooled in an expensed pool and are allocated based on revenues, just as interest expense also is an allocated expense that is allocated based on assets. Allocations between years that went to mobile modular increased and a lot of that had to do with personnel costs and outside consultants in our effort to comply with SOX 404.

Okay. So should I read sort of one-time issue there? In other words the SG&A gets back into say the mid 15 percent range, instead of the 17.5 percent it was this quarter?

17 percent, as a percent of what?

Sales.

I -- we -- SG&A we look at as a percentage generally of rent, rather than total revenue, because the sales transactions will come in and out, and fluctuate based on customer requirements. At this time we're still looking to trim expenses and focus on expenses going forward, so we're not prepared to give an outlook as to what that will run on an on-going basis in 2005.

Okay. If we heard you correctly, the tax rate at 35 percent, that was a one-time thing. Your guidance assumes 39.25 for the entire year of '05?

That's correct. The Q4 effective tax rate was 35 percent, and that was a cumulative adjustment, where we had to re-price our deferred taxes, because of a lower state rate. For the entire 2004 the effective tax rate was 38.5 percent, and where we set the guidance is with a tax rate, an assumed tax rate during 2005 of 39.25 percent.

Okay. And then lastly, just on the guidance, I'm assuming that this quarter was kind of a funky quarter with margins, and one-time expenses and also maybe offset by a one-time tax benefit, but if I simplistically take $0.70 and multiply it by 4 just to get a run rate, your guidance comes anywhere from 7 to 14 percent above that, and it seems quite low to me, given the opportunities in Florida combined with still a couple more quarters of extremely good compares from the acquisition. Can you just talk about sort of the assumptions that went behind the guidance, please?

This is Dennis Kakures speaking. I appreciate your optimism. We certainly share a great deal of that optimism for 2005, and when we sit down and we do earnings guidance, we have to make certain decisions about different parts of the business and 2005 we expect to be a very strong year and we've tried to give it our best outlook here. There's obviously variables out there that could impact things up or down, but that's really the extent of really detail that we would give behind guidance annually. As we progress next year on each quarterly conference call, we will certainly share more color on how the year is developing and how in line we are with the guidance that we're giving on this call.

Thanks a lot.

Thank you.

[OPERATOR INSTRUCTIONS] And our next question comes from Charles Berger with Berger and Associates. Please go ahead.

Good afternoon. I have a question relative to RenTelco and TRS. Looking at midyear '04 to the end of the year, have you experienced any improvement in your basic rental structure, or have the rates been substantially unchanged? And then secondly, could you give us an idea of what Sarbanes-Oxley might have added to your expenses this year? I know in the case of some relatively small companies, or companies such as yourself in terms of scale, they have been significant.

Charlie, this is Dennis Kakures. I'll address the rates question. The rates have been fairly stable in the different product groups for the test equipment business since we acquired TRS in June of 2004, so it's been fairly stable.

Okay.

Related to the SOX issue, no question our expenses have gone up and we've applied a lot of internal resources to that. We've also applied external resources and -- or obtained external resources in the form of consultants. We are pretty much through our SOX audit, but the expenses are just at or near $1 million in the extra costs.

Okay. Thank you very much.

Thanks, Charlie.

And our next question comes from Les Bryant with UBS Financial Services. Please go ahead.

Could you give a little outlook on the interest rate raises and how they affect the company? Are we -- do we have floating rate loans with the school districts, et cetera? Or is it fixed and do we get squeezed a little as interest rates go up?

This is Tom Sauer. At the end of the year we adjusted about $152 million in debt. We do have a $60 million fixed amount that the private placement, that carries a coupon rate of 5.08 percent, and then the balance of our debt is a floating revolver, floating line of credit that carries LIBOR based pricing currently it's matrix pricing but currently it's at LIBOR plus 1. Blended rate for Q4 was just over 4 percent is what we were incurring.

And, Les, our transactions with school districts are really straight operating leases there's not an interest dynamic to the customer, like on a finance sale transaction.

Is that a floating rate with the schools?

There's no -- interest is not a criteria. This is a true operating rental.

It's a rental. That can be adjusted.

Yes. As equipment returns or gets beyond term on a contract still in rent, the rates can be adjusted, that's right.

Okay. By the way I went through your southern California facility, and I can see, saw first hand what you guys are talking about, in the refurbishing of the classrooms. I think you do a great job. Throughout the company.

Thank you, Les. We'll keep trying.

Very good.

Ladies and gentlemen, if there are any additional questions, please press the star followed by the 1 at this time. As a reminder if you're using speaker equipment today it will be necessary to lift the handset before pressing the numbers.

Management, we have no further questions at this time. Please continue.

I'd like to thank everyone for joining us on today's call. We appreciate your interest in the Company and we'll look forward to chatting with you again on our Q1 2005 call. Thanks so much.

Ladies and gentlemen, this concludes the McGrath Rentcorp fourth quarter 2004 earnings conference call. You may now disconnect and thank you for using ACT Teleconferencing.