McGrath RentCorp (MGRC) 2005 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to McGrath RentCorp second quarter 2005 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. [Operator instructions.] As a reminder, this conference is being recorded today, Thursday, August 4th, 2005. I would now like to turn the conference over to Jeffrey Busher, Investor Relations advisor. 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 this call is being recorded and will be available for replay for up to 48 hours by dialing 1-800-405-2236, and 1-303-590-3000 for international callers. The pass code for the call replay is 11034471. This call is also being broadcast live via 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 at approximately 4:05 p.m. Eastern time or 1:05 p.m., Pacific time today. 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 matters we will be discussing today that are not truly historical are forward-looking statements within 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 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 documents filed by McGrath RentCorp with the Securities & 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, Jeff. In addition to the press release issued today, the Company also filed with the SEC the earnings release on Form 8-K and its current quarterly report on Form 10-Q. For the quarter, total revenues increased from 40.8 million in Q2 '04 to 63.9 million in Q2 '05, a net income increase from 6.1 million, or $0.25 per diluted share, in Q2 '04 to 9.5 million, or $0.38 per diluted share in Q2 '05. Most of the Company's improved quarter-over-quarter revenues in net income were driven by the continued demand for modular classrooms and the impact of the June 2004 acquisition of TRS.

It's important it note that Q2 '05 results include three months of the acquired TRS business, as compared to Q2 '04 , which only had one month. Looking forward, quarter-over-quarter comparisons will be more meaningful, especially for the TRS-RenTelco segment, as both quarters will have the acquired TRS business for a full three-month period.

For mobile modular, total revenues increased 8.5 million, or 30%, to 36.7 million in Q2 '05, primarily from higher rental and sales revenues associated with educational markets we serve. Pre-tax income increased 15%, from 9.1 million in Q2 '04 to 10.5 million in Q2 '05, and represented 69% of the Company's pre-tax income for the quarter. Rental revenues increased 15%, to 19.6 million in Q2 '05, primarily due to having over $29 million more of equipment on rent as compared to Q2 '04, with the related gross profit increasing 12%, to 12.2 million. Average modular utilization improved from 85.4% in Q2 '04 to 85.6% in Q2 '05, with quarter end utilization reaching 85.9%.

Sales revenues increased 104% to 11.2 million in Q2 '05 over Q2 '04, with related gross profit increasing 0.9 million to 2.4 million. Sales margin declined from 28% in Q2 '04 to 22% in Q2 '05, due to a higher percentage of new equipment sold during the quarter. Sales revenues and gross profit are less predictable in the modular business and will tend to fluctuate each reporting period depending on customer requirements, equipment availability and funding.

For TRS-RenTelco, quarter-over-quarter revenue and pre-tax income increases were driven by the effect of the TRS acquisition in June 2004. Total revenues increased 13.1 million to 25.3 million in Q2 '05 from 12.2 million in Q2 '04. Pre-tax income increased from 1.2 million in Q2 '04 to 4.7 million in Q2 '05, and represented 31% of the Company's pre-tax income for the quarter.

Rental revenues increased from 8.5 million in Q2 '04 to 17.2 million in Q2 '05 on much higher equipment levels related to the acquired TRS equipment, with related gross profit increasing 2.7 million to 6.4 million in Q2 '05. Gross margin on rents was 37% in Q2 '05 compared to 44% in Q2 '04, primarily due to depreciation expense representing a higher percentage of rental revenues.

Average electronics utilization for Q2 '05 was 64.3% with quarter end utilization reaching 66.5%. Gross profit on sales increased 1.5 million over Q2 '04 to 2.2 million on sales volume of 7.1 million with a 31% gross margin. Sales of electronics equipment are an essential part of the electronics rental inventory management, however, as with the modular business, sales revenues and gross profit are less predictable and tend to fluctuate each reporting period.

EBITDA for Q2 '05 increased 10.6 million to 28.5 million from 17.9 million in Q2 '04 to 28.5 million in Q2 '05, with consolidated EBITDA margin percentage improving from 44% in Q2 '04 to 45% in Q2 '05. The Company declared a dividend of $0.14 per share in Q2 '05, a 27% increase over Q2 '04. On an annualized basis, this dividend represents a 2.2% yield on the August 3, 2005, close price of $25.86 per share.

On July 11, 2005, the Company amended its existing lines of credit to increase the Company's borrowing capacity from 135 million to 195 million and extended the expiration date one year to June 30, 2008, increasing our capacity to borrow up to an additional $89 million beyond the $106 million then outstanding. These lines of credit are in addition to the $60 million in senior notes we have at the Company.

With respect to earnings guidance for 2005, at this time, based on our results through Q2 '05 and our outlook for the remainder of the year, we are re-confirming our 2005 full-year earnings per share guidance to be in a range of $1.45 to $1.55 per diluted share. At this point, I would like to turn the call over to Dennis.

Thank you, Tom. Let's go right to our second quarter results beginning with our modular rental business. In our press release, we spoke to this being our highest second quarter pre-tax income level ever for our modular rental division at 10.5 million, with gross profit on rent increasing 12% over second quarter 2004 to 12.2 million.

The increase in rental profitability was driven primarily by our increase in rental revenues of approximately 15%, to 19.6 million. We benefited nicely from the recurring rental stream from classrooms going on rent in the latter half of 2004 from both the California and Florida markets, as well as new rental activity coming on-line in the first half of 2005 in all markets.

In California, we have benefited from the need to modernize schools, and the bond measure funding available to do so. Of the 2.3 billion available for modernization projects from the March 2004 statewide school facilities bond measure, approximately one-half, or 1.2 billion, remain that either have not been apportioned or released to school districts to date. At this time, it appears unlikely that there will be another statewide facilities bond measure in 2006 to further support the modernization and reconstruction of public schools.

We anticipate the remaining bond monies to support the apportionment of monies necessary for new projects being applied for through 2006. Additionally, we are in the process of assessing future modernization and reconstruction rental opportunity by seeking a better understanding of the monies apportioned or released to date from past state and local bond measures, and the status of related projects.

In Florida, we are providing classrooms to support strong student growth, implementation of class size reduction and the phasing out of older model code portable classrooms. We continue to experience very favorable booking levels, and by (ph) all measures are having a very strong year. In just a little over 15 months in the Florida market, we have captured either rental or sale business with approximately one quarter of the public school districts. We are also focused on developing business in other educational markets in Florida, including private schools, colleges, and universities.

During our first quarter conference call I mentioned that we were moving ahead this year with purchasing land in Florida in order to establish an inventory center in 2006. We've made good progress over the last few months in this effort, and are focusing in on a few select properties in central Florida. We continue to work hard in differentiating ourselves from our competitors in Florida in terms of our product offerings and our logistical and execution capabilities.

On our first quarter conference call I spoke to one of our efforts of differentiation with the development of our hybrid modular classroom product. This first-to-market product continues to see very favorable demand with school districts in Florida. By fire-rating the sidewalls, the new product allows for significantly more efficient land utilization by school districts by allowing them to place buildings directly next to one another versus having to create a 20-foot separation between classrooms. This is a very important benefit for many school districts in saving valuable land resources for other uses.

Additionally, due to its low profile design the new product eliminates the need for a separate ramp and stair system to be installed, thus saving school districts these costs and logistical efforts. The aesthetics of the new product are also a big improvement over today's standard product.

Also contributing to mobile modular's record pre-tax income for the second quarter was strong equipment sales. Gross margin on sales increased 57% to 2.4 million in the second quarter from 1.5 million a year ago, primarily due to two large school scale projects. We always like to caution that sales, different than rentals, can fluctuate greatly quarter to quarter based on customer demand and funding.

Now let’s take a closer look at TRS-RenTelco, our test equipment rental division. Due to the fact that the acquisition of TRS occurred in June of 2004, and we don't have full quarter-over-quarter results of the combined TRS-RenTelco business, I will discuss the second quarter financial performance on sequential basis, as compared to the first quarter 2005. We feel this provides the most valuable information at this time. Beginning with our third quarter 2005 results, we will be in a position to give meaningful comparisons and color on a quarter-over-quarter basis.

TRS-RenTelco's pre-tax profit in the second quarter increased 2.8 million, or 144%, to 4.7 million over Q1 2005. Gross margin percentage on rent improved from 28% in the first quarter to 37% in the second quarter. This was our most profitable quarter to date for the newly combined TRS-RenTelco business. A modest increase in rental revenues, significant reductions in depreciation and operating expenses, and strong sales of used equipment led to the increase.

Now I'd like to go into more depth on the component that led to the strong increase in profitability. Let's start with the increase in rental revenues. Rental revenues increased by 0.3 million to 17.2 million over first quarter 2005 results. Although the increase was modest over the first quarter, what's especially positive within the quarter is that rental revenues increased sequentially each month; that trend continued for the month of July.

During the second quarter, we saw increased business activity in many of our core test equipment product groups, however, there are still key market segments for higher dollar communications rental products that remain only marginally improved from the low levels in 2003. Market conditions as a whole appear to be improving at this time and our outlook is quite positive for improving rental activity in the third quarter.

Now let's take a closer look at depreciation expense. Test equipment depreciation expense declined by 0.9 million, or approximately 9% to 8.5 million over first quarter 2005 results. The decline was attributable to the extension of useful life of two test equipment models at 0.6 million, the sale of underutilized equipment 0.4 million, and the drop-off of depreciation expense for equipment that became fully depreciated during the quarter at 0.2 million. Depreciation expense for the month of June was just under 2.8 million.

Focusing in on test equipment sales, gross margin sales increased by 0.7 million, or approximately 47%, to 2.2 million over first quarter 2005 results. The increase was due to a very targeted focus by our sales teams and product management group on selectively selling underutilized equipment. This equipment was sold to both end users and to test equipment brokers. These efforts at selling underutilized equipment are continuing in the third quarter.

During our first quarter conference call we spoke to depreciation as a percentage of rent as a key metric that we utilize to measure the health of our test equipment rental business and our need to reduce this percentage. For the first quarter, depreciation as a percentage of rents stood at 56%, with our strong quarter end sales of underutilized equipment and other depreciation expense reductions noted earlier, coupled with the modest increase in rental revenues, we were able to reduce depreciation as percentage of rent to 49.6% for the quarter.

More importantly, for June, the last month in the quarter, we were at 47.3%. We are now targeting depreciation expense as a percentage of rent to fall into the 47% to 50% range for all of 2005, with further improvement in 2006. Ideally, we would like to see the business run in the high 30% to low 40% range.

Now let's take a closer look at operating expenses for the quarter. Operating expenses decreased by 0.9 million, or approximately 13%, to 6.3 million, as compared to first quarter 2005 results. The largest contributing factors to this decline were lower equipment repair and calibration expenses, and lower general office and marketing expenses.

With our strong quarter end sales of underutilized equipment, and with growth and rental revenues, average utilization to the second quarter improved to 64.3%, as compared to 61.6% in the first quarter. At June month-end, utilization hit 66.5%, our highest month-end level since the acquisition.

Although I've spoken numerous times today regarding our sales of underutilized equipment, we continue to purchase the latest technology test equipment to support rental revenue growth. The redeployment of capital from the sale of underutilized equipment into newer technology test equipment that is more highly utilized helps to lower depreciation expense as a percentage of rent. For TRS-RenTelco our efforts at reducing depreciation expense and operating costs are with a focus on setting the stage for sustainable earnings growth in the quarters ahead as top line rental revenues improve.

And now for a few closing comments. As many of you already know, we announced Tom Sauer's retiring from McGrath RentCorp effective at the end of January 2006. We have retained Korn/Ferry International as a recruiting firm to head up the search process for a new CFO. Thus far we have interviewed a number of candidates, and are actively working the evaluation process. Our goal is to have the new CFO aboard by early fall so that there is adequate overlap for knowledge transfer before Tom's departure in early 2006.

With respect to our full-year guidance range of $1.45 to $1.55 per share, as Tom mentioned earlier, we are re-confirming this range. And now, Tom Sauer and I are please to address any of your questions.

Thank you, sir. Ladies and gentlemen, at this time we will begin the question-and-answer session. [Operator instructions.]

And our first question comes from Cliff Walsh with Sidoti and Company. Please go ahead.

Hi, Dennis and Tom.

Hi Cliff.

Can you tell us what the utilization in TRS-RenTelco was at the end of July?

I -- hold on just a moment. We're trying to pull that now. Cliff, we don't have it in front of us.

Okay.

At this time. But I can tell you that we've had very good rental activity and it's actually -- it's improved.

Okay. Can you just discuss quickly, the recent quote activity in that business?

Well, the second quarter has certainly been stronger than the first quarter. And, I'm very pleased with the amount of quote activity and also on the booking side of what we're capturing. So, some very favorable items going on there. Still, there are some pockets there that, again, as I mentioned in my prepared comments, on the -- some of the higher-end communication products that are slowly recovering and I'd love to see those gain strength in the quarters ahead.

Okay. Would you say that's kind of the major reason why you didn't see a major jump over Q1, and why that business was a little bit lighter than what you saw in Q3 and Q4 of last year?

Q1 was a very slow window. Q2 has come back and ramped up very nicely. And as I mentioned earlier, the ramp, and we've had increasing rental revenues every month since February. So, and it got stronger throughout the quarter in Q2. So, what you're seeing is that there's really more horsepower towards the end of the second quarter in rental revenue growth than there was in the first part. So you're not capturing as much in Q2.

Okay.

So I expect Q3 to -- no question, be higher than Q2, and hopefully more than the increase over Q1.

Okay. And in terms -- so would you say that in Q2 TRS performed up to your expectations?

I was very pleased with the breadth of rental activity in the different areas. And like I said, it got stronger as the quarter moved along. So, that's a good sign. And then with July also following in that same regard, that's very positive.

Okay. Now, you've had the acquisition -- TRS acquisition for a year now. Can you talk about how far you've come in taking cost out of the business and what you think you can do going forward?

Well, I think operationally, -- well, as you know, we made a reduction in force towards the end of last year. Obviously, there was further refinement that we were doing in the first six months of the year with operations. And even in the second quarter, just the way in which we're handling the repair and calibration of equipment, running a much larger operation. We've gotten more efficient and smarter in how we do things.

I think at this point we probably, operationally, are there, although I do believe we can -- we have more efficiency to come. I think the most significant operational fine-tuning has occurred. And we certainly have areas that we can improve in though, so -

Okay. Can you comment on whether or not Florida -- the Florida business was profitable and if you still expect that to be profitable for the full year?

Florida is definitely profitable. It's on a very good track. I don't think the management could be more pleased with the results of those operations to date.

Okay. And maybe you could just comment quickly on, kind of, TRS and international expansion, if that's a possibility at some point in the future and kind of a time frame as to what you might look for.

That's certainly a very likely item in the future. But [know] we currently do international business to date with -- in various South American countries, and a very small amount in Asia that is done out of our base in Dallas. So we do x-amount of international business today. In terms of setting up operations internationally -- and by the way, I include Canada as really a domestic operation when we're speaking of it, because obviously we're based in Canada and a large provider of test equipment there for rental.

But those are items that the strategic planning group will have to work on more closely in the future, and it's something that's certainly on our list. Right now we're trying to focus in getting the domestic operation in great shape. There's plenty of opportunity here domestically, getting our cost structure aligned, which we did a very good job in Q2 with depreciation and operating expenses, and then also optimizing the opportunities that we see every day, increasing our close ratios with our applications engineers and generating more business opportunity through more efficient productivity of our various marketing groups. So, a lot of opportunity domestically. We certainly are also interested in growing internationally, and that will come in due time.

Okay. And final question. Can you just comment a little bit on the bond measure that you mentioned? You don't expect something to occur in 2006. I'm assuming you meant that on a statewide basis.

That is correct.

Can you just talk about how much your business relies on that versus maybe local funding for renovations and that sort of thing?

Well, first of all, the way bond measures work, and I'll give a little background for all of our listeners, is that statewide facility bond measures are passed -- are put on a ballot typically, only in even years, so 2004, 2006, 2008. And the way those facility bond measures work for modernization and reconstruction is that school districts that are looking at doing modernization work receive -- can get up to 60% of the project cost covered from the state, based upon the facility funding that's available. And then the district comes up with 40% on their own. Typically, they come up with their funding on local bond measures that they've passed within their own districts. So that's really how the structure works.

The dynamic here is that there's still $1.2 billion worth of modernization monies to be allocated among school districts, which is a good thing. And our best information at this time, is that's anticipated to fund those new projects coming on-line through 2006. The dynamic is, is that in 2006, if there isn't a bond measure on the ballot for modernization reconstruction, that in 2007 there could be some weakness potentially in opportunities in modernization and reconstruction work until another bond measure comes on-line in 2008. This is quite a ways out but what we wanted to do publicly was share the information that we were aware of at this time, but it's still a very strong and robust market in terms of modernization reconstruction work and we're having a very strong year because of it.

So, Cliff, did that give you some insight?

Yes, definitely, maybe you could just touch on how much you have been relying on that business recently and maybe, how much you think you can make up in other areas, perhaps Florida, a couple years out?

Well, I would say that Florida is certainly contributing nicely and it will become increasingly more significant in the course ahead. So that's a very nice item that we have going for us. The majority of our -- in the last couple years, modernization reconstruction has certainly been a contributor to growth. And it will be going forward. Because there are, I think over 70% of California schools are better than 35-years old, and obviously, they're in need of asbestos abatement, seismic retrofitting and various items like that. So the -- from a demand side, it's not going to go away, it's just how the state on a timing basis, funds it.

The silver lining in there not being a facilities bond measure in 2006, or at least our best information at this time is telling us, is that there will be no new monies allocated for permanent construction, either. Because they really are tied together. In which case, that could mean that there's an increased rental demand post-2006 to serve school districts that are growing and that need to build new schools, etc. So bond measures are always a little bit of a mixed bag.

Okay, thanks very much, guys.

And our next question comes from [Shareen Carardi] with Pilot Advisors, please go ahead.

Thanks. I'm sorry if you already made this point, but could you clarify the rationale for why there wouldn't be one in '06, another bond measure?

Actually, we didn't clarify that at this time. The reason is, the thinking is right now because there is still, oh, roughly 4.7 or 4.8 billion available in permanent funding to build schools at this point in time that it would be difficult to build momentum on a campaign in 2005 to put another facilities measure on the ballot in 2006.

Gotcha. So would your school -- would your sale -- sales benefit at all as a result of that, or it has nothing to do with that?

I wouldn't say we're directly impacted sale-wise. We can be, but as you know, our main focus is rental.

Gotcha. Okay

Okay.

[Operator Instructions.] Our next question comes from John Gibbons with Oden Partners. Please go ahead.

Hi, guys, nice quarter.

Thanks, John.

Can I just understand, Tom, the thinking behind the change in depreciation in the two lines in TRS? I just -- that business is so jumbled. Is this something that came out of the acquisition or it’s something from the old business? You extended the lines -- extended the lives out on two lines.

There were two communications products that are highly popular that we are very highly utilized on, that we continue to buy to serve the marketplace, that information, coupled with knowing from the manufacturers that newer model numbers that were expected to come out to, in effect, replace those are not going to be coming out as quickly as we had anticipated.

Okay.

So that led to that decision which we think is a very sound one.

It seems counter intuitive for everything we know about technology, that's all.

And this equipment was part of the TRS acquired equipment.

It was. Okay. Great. Thank you, guys. Keep up the good work.

Thanks, John.

[Operator Instructions.] At this time we have no further questions. I would like to turn the conference back to management for any concluding comments, please go ahead.

I'd like to thank everybody for joining us today and we look forward to your further participation in our Q3 conference call in early November. Thanks so much.

Ladies and gentlemen, that does conclude the McGrath RentCorp second quarter 2005 earnings conference. Once again, if you would like to listen to a replay of today's conference, you may dial 1-800-405-2236, or 303-590-3000, The pass code for the replay will be 11034471, pound. Thank you again for your participation in today's conference and you may now disconnect.