McGrath RentCorp (MGRC) 2005 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to the McGrath Rentcorp Q3 2005 earnings conference call. [Operator Instructions] I would now like to turn the conference over to Mr. Geoffrey Buscher of SBG Investor Relations. Please go ahead.

Thank you, operator. Good afternoon. I'm the investor relations adviser to McGrath Rentcorp and will be acting as moderator of the conference call today. On the call today, from McGrath Rentcorp, we have 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 telephone replay for up to 48 hours following the call by dialing1-800-405-2236 for domestic callers and 1-303-590-3000 for international callers.

The pass code for the call replay is 11041135. 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 Web site at mgrc.com.

A press release was sent out today at approximately 4:05 Eastern Time or 1:06 p.m. Pacific. If you did not receive a copy but would like one, it is available online in the investor relations section of our Web site, or you may call 1-206-652-9704 and one will be sent to you.

Before getting started, let me remind everyone that matters we will be discussing today that are not truly historical are forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934 including statements regarding McGrath Rentcorp's expectations, beliefs, intentions or strategies regarding the future.

All forward-looking statements are based upon information currently available to McGrath Rentcorp, and McGrath Rentcorp assumes no obligation to update 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 the McGrath Rentcorp's business are set forth in the documents filed by McGrath Rentcorp with the Securities and Exchange Commission including the company's most recent Form 10K and Form 10Q. I would now like to turn the call over to Dennis Kakures.

Thank you, Geoffrey. Before we get started with our discussion of our results for the third quarter, I wanted to make a few comments regarding some recent events. On Friday, October 14, the NASDAQ honored McGrath Rentcorp and Bob McGrath for its 20 years on NASDAQ and past financial success by having Bob ring the opening bell at NASDAQ's Time Square location. It was a great event and a wonderful acknowledgement for the company and for Bob.

I also wanted to mention that in October we had an additional firm, Stephen's Inc, out of Little Rock, Arkansas, pick up coverage on McGrath Rentcorp. We welcome them to our call today.

The last item I wanted to mention was that we are continuing to interview candidates to replace Tom Sauer who will be retiring as CFO of the company in early 2006. We've interviewed a number of candidates to date and hope to begin narrowing the field of applicants over the next few weeks. And now I would like to turn the call over to Tom Sauer to take us through our third quarter numbers. Tom?

Thank you, Dennis. In addition to the press release issued today, the company also filed with the SEC the earnings release on Form 8K and its current quarterly report on Form 10Q. For the quarter, total revenues increased from $72.5 million in Q3 '04 to $77.8 million in Q3 '05, and net income increased from $9.4 million or $0.38 per diluted share in Q3 '04 to $12.1 million or $0.48 per diluted share in 'Q3 05, a 26% increase. Most of the company's improved quarter-over-quarter revenues and net income were driven by the continued demand for modular classrooms. It's also important to note that when reviewing 2004 year-to-date results, that TRS was acquired in June 2004 and that the 2004 year-to-date amounts only include four months of TRS' results from June to September.

For Mobile Modular in the quarter, total revenues increased $9.1 million or 23% to $48.7 million, primarily driven from high rental and sale revenues associated with the educational markets we serve. Pre-tax income increased 29% from $10.5 million in Q3 '04 to $13.6 million in Q3 '05 and represented 69% of the company's pre-tax income for the quarter. Rental revenues increased 13% to $20.9 million in Q3 '05 primarily due to having over $30 million more dollars of equipment on rent as compared to Q3 '04 with related gross profit increasing 22% to $13.3 million. Average modular utilization declined from 86.3% in Q3 '04 to 84.7% in Q3 '05 with quarter end utilization of 84.1%. Sales revenues increased 42% to $20.1 million in Q3 '05 over Q3 '04 with related gross profit increasing $2 million to $4.9 million. Sales revenues and related gross profit are less predictable than the rental portion of the business and will tend to fluctuate each reporting period depending on customer requirements, equipment availability and funding.

For TRS-RenTelco in the quarter, pre-tax income increased $4.5 million in Q3 '05 to $5.1 million in Q3 '05 and represented 26% of the company's pre-tax income for the quarter even though total revenues decreased $1.9 million to $24.9 million from $26.8 million in Q3 '04. Rental revenues decreased from $18.7 million in Q3 '04 to $18.4 million in Q3 '05 with the related gross profit increasing $0.7 million to $7.9 million in Q3 '05.

Gross margin on rents improved from 39% in Q3 '04 o 43% in Q3 '05 primarily due to depreciation expense representing a lower percentage of rental revenues. Average electronics utilization improved from 65% in Q3 '04 to 68.3% in Q3 '05 with quarter and utilization reaching 70.9%. Gross profit on sales increased $0.2 million over Q3 '04 to $1.7 million on sales volume of $5.8 million with a 30% 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 than the rental portion of the business and tend to fluctuate each reporting period.

The company's consolidated EBITDA for Q3 '05 increased $3.8 million to $33.2 million from $29.4 million in Q3 '04 with consolidated EBITDA margin percentage improving from 41% in Q3 '04 to 43% in Q3 '05. The company declared a dividend of $0.14 per share in Q3 '05, a 27% increase over Q3 '04. On an annualized basis, this dividend represents a 2% yield based on the November 2, 2005, closed price of $20.18 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 to June 30, 2008. As of September 30, 2005, the company, under its existing lines of credit, had capacity to borrow an additional $100 million.

With respect to earnings guidance for 2005, at this time based on our results through Q3 '05 and our outlook for the remainder of the year, we are increasing our 2005 full-year earnings-per-share guidance to be in a range of $1.57 to $1.62 per share. At this point, I'd like turn the call back over to Dennis.

Thank you, Tom. Let's go right to our third quarter results beginning with our modular rental business. This was the highest ever quarter for rental revenues at $20.9 million in rental gross profit at $13.3 million. These levels represent increases of 13% and 23% respectively for rental revenues and rental gross profit over last year's third quarter results.

We benefited nicely in the third quarter from new classroom rentals coming on-line throughout 2005 in all of our classroom rental markets. We also benefited from lower inventory center expenses during the quarter relative to a year ago due to a larger percentage of factory direct classroom shipments versus shipments that's inventory center readied equipment. In California, during the third quarter, we experienced higher than normal classroom returns related to the completion of various public school modernization projects. Over the next 12 months, we anticipate redeployment of the great majority of this equipment. In Florida, we continue to provide classrooms to support strong student growth, implementation of class size reduction and the fazing out of older-model portable classrooms.

We've experienced favorable booking levels through the first three quarters of 2005 which have contributed nicely to rental revenue growth. Equally as important is the benefit we'll receive in 2006 when we realize a full 12 months of rental revenues on the great majority of this equipment. In just a little over 18 months in the Florida market, we have placed either rental or sale business with over one quarter of the public school districts. We're also focused on developing business in other educational markets in Florida including child care, private schools, colleges and universities. Our hybrid classroom product continues to be received very favorably in the Florida marketplace and we are continuing to improve and enhance the product with each production run.

On prior conference calls this year, we spoke to our efforts to purchase land in Florida in 2005 in order to establish inventory center operations in 2006. Subsequent to quarter end, we closed escrow on a property in central Florida between Orlando and Tampa Bay. In 2006 we will begin the development of this property to serve our future needs. We continue to work hard at differentiating ourselves from our competitors in Florida in terms of our product offerings and our logistical and execution capabilities. We're adding to our service and operations staffs in order to proactively address issues surrounding the growth we've experienced. We realize the importance of creating great customer experiences and the value that serves towards growing market share. Although getting things right the first time is what we strive for and have built a reputation on, we also recognize that how we respond to, take ownership of and solve normal growing pains has much more to say about who we are and what our customers can expect from us going forward. Finally, in speaking to our Florida operations, I want to publicly thank Tom Wagner (ph), our senior Florida manager, and his entire staff for the exceptional work they have done in 2005. They, along with our senior modular division management, have done a remarkable job at managing the opportunity flow in the Florida market. Well done, everyone. Our quarter-over-quarter results reflect a fairly sizable increase in sales revenues. We commented in our press release on three large sale projects that helped lead to this increase. It's important to emphasize that we view these types of large sale projects as unique opportunities and generally would not expect sales projects of a similar size to occur on a regular basis. We also noted in our press release that $5.8 million of the quarterly sales revenue increase was related to building infrastructure needs resulting from recent hurricanes in the southeastern U.S. In addition, as of September 30, 2005, we have a backlog of $8.5 million in sale revenues related to the recent hurricanes that will be recognized during the fourth quarter 2005. Looking forward, we continue to be selective on the opportunities that we pursue related to the recent hurricanes and believe that we will see additional rental and sale business, although the extent and duration remains uncertain.

Now let's take a closer look at TRS-RenTelco, our test equipment rental division. The third quarter 2005 represents our first quarter-over-quarter results for the combined TRS-RenTelco business. Third quarter pre-tax income rose to $5.1 million from $4.5 million or 13% from a year ago and grew sequentially from $4.7 million in the second quarter of 2005, a 9% increase. This was our most profitable quarter to date for TRS-RenTelco. Our vigilance at closely managing our rental inventory by selling underutilized assets and continuing to purchase the latest technology test equipment that typically is more highly utilized has enabled us to move average utilization for the quarter to 68.3% as compared to 65% a year ago. In turn, we have lowered depreciation expense as a percentage of rental revenues to 45% for the third quarter from 51% a year ago. We have our sights set on seeing this percentage lowered to around 40% as we continue to refine the makeup of our inventory and with improved top-line rental revenue results.

Our lower depreciation expense as a percentage of rents helped drive our gross margins on rent percentage to 43% from 39% a year ago. We are targeting gross margin in rents to increase to a 50% level with increased business activity in the future.

Now, I'd like to give a little additional color on a few areas of results for TRS-RenTelco. Let's start with the slight decline in rental revenues from $18.7 million in the third quarter of 2004 to $18.4 million in 2005. There is still some bumpiness in top-line growth as the test equipment industry continues to recover. Although rental revenues were lower compared to third quarter 2004, what's particularly positive is that rental revenues have grown in consecutive quarters in 2005 from a low of $16.9 million in the first quarter to $17.2 million in the second quarter to $18.4 million in the third quarter.

During the third quarter, we continued to see increasing business activity in many of our core test equipment product groups and some slight improvement in various higher end communications rental products. At this time, our outlook is for continued favorable business levels early in the fourth quarter with slower business activity in the latter part of the quarter due to the historical seasonality of various test equipment, rental products and customer segments.

Now let's take a closer look at depreciation expense. Test equipment depreciation expense declined by $1.1 million or approximately 12% to $8.3 million over third quarter 2004 results. The decline was attributable to the extension of useful life of two test equipment models at approximately $0.6 million beginning in the second quarter of 2005 and $0.5 million from the net impact of selling underutilized equipment and rental equipment becoming fully depreciated, offset by new equipment purchases.

We continue to focus our sales teams and product management group on selectively selling underutilized equipment. With our strong quarter and rental revenue growth comparably to the second quarter of 2005, and continuing sales of underutilized equipment, equipment utilization at quarter end stood at 70.9%. We've made very favorable progress in reducing both depreciation expense and operations costs since the acquisition. We feel very good about the refinement of TRS-RenTelco's overall cost structures since the merger, it's strong operations know-how and best in the industry workforce. We believe that our electronics rental business is set up nicely for greater earnings growth in the quarters ahead as additional product markets recover more fully and top-line rental revenues improve.

And now for a few closing comments. Over the past few quarters, we have been heavily engaged in planning for new ERP systems to support the company's growth. We have entered into an agreement with Rental Result (ph), a rental software application provider to support transitioning our modular business and certain aspects of our electronics business and accounting systems to their platform and other supporting applications.

During the third quarter we began incurring more significant consulting and hardware expenses associated with this migration. At this time, we anticipate that the project scope will take approximately 18 to 24 months to complete. These information system upgrades are essential to serve and support a strategically growing McGrath Rentcorp.

Over the last 12 to 18 months we've worked hard to digest our 2004 growth initiatives, the merger of TRS-RenTelco and our modular's launching in Florida. Although we have ongoing process and productivity improvement efforts in place for each of these initiatives, our integration and operations development work is largely behind us. Assuming favorable market conditions going forward, we believe both initiatives are well positioned to achieve more significant earnings growth in their respective futures. And we are excited about this potential.

As a result, in the third quarter our strategic planning council increased its focus on potential new opportunities for growth of our core rental businesses and adjacencies to those businesses. We are now beginning our process of creating charters for a select number of potential growth opportunities and assigning them the sub-teams of the council for greater exploration. Know that the management of the company is highly focused on utilizing the strength of our low-leverage balance sheet to seek out new income growth opportunities in order to create greater value for our shareholders.

And finally, with respect to guidance, as Tom mentioned earlier, based upon our most recent results and anticipated fourth quarter business levels, we are electing to raise our full-year guidance range for 2005 to $1.57 to $1.62 per share. And now, Tom Sauer and I are pleased to address any of your questions.

Thank you, sir. [Operator Instructions] The first question comes from Cliff Walsh with Sidoti and Company. Please go ahead.

Hi, Tom. Hi, Dennis.

Hello.

Hello

Dennis, I am assuming that the land - that purchase that you mentioned will eventually become the inventory center and, I guess, possibly another sales office.

It will be a combination inventory center and sales and operations center. That's correct.

At what point do you really expect to start to see classrooms coming back off rent where you need to have this inventory center up and running?

Well, although a great majority of the classroom products, we would believe at this time, would stay out (ph) for multiple-year terms, you can always have recycling of product that occurs for whatever reason. So we could have some equipment come back as early as next year. However, because of the rapid growth rate that we've had since we launched, we felt it prudent to go ahead and get set up sooner rather than later. And by the way, the development of the inventory center we will do in phases, so to speak, as the growth of the business supports that. So we won't do everything on day one. We will do what is appropriate for various windows and then expand from there. So we're trying to manage that in that fashion.

Okay. I would like to touch on the hurricane situation a little bit if I could. Can you comment on how much demand you saw or you think you saw in RenTelco on the hurricane side?

At this point in time, we've seen some opportunity with the RenTelco business, but nothing that is significant. There has been some infrastructure damage, but we don't have anything in the way of quantifying that impact to date. We may see more of that type of activity going forward, but I would say at this point there's nothing significant in the way of impact from any of the hurricanes with respect to that business to date.

Okay. Any of the classrooms that you sold or rented to the hurricane-affected regions, I mean, they were all for from Florida or Texas, right? Nothing from California?

In terms of product that we deployed?

Yes.

Yes. Nothing from California.

Okay. And any insight as to what access is like to the modular manufacturers. I mean, some of them are seemingly running close to full capacity -- in anticipation in response to orders from Texas and Louisiana? So what is your availability of product like?

We feel that because of our past practices of partnering with manufacturers in the way we have, that we're very well positioned for production line space to support opportunities.

Okay, great. Thanks very much, everyone.

Thank you, Cliff.

Our next question comes from Joe Chumbler with Stephens, Inc. Please go ahead.

Thanks. Great quarter, guys.

Thank you, Joe.

Let me start on the T&M (ph) segment. It sounds like the higher-dollar communications equipment demand is kind of showing signs of improvement. Can you JUST talk about where you're seeing that and what's missing in terms of demand in that market?

We're starting to see some spottiness and higher adoptical(ph) network opportunities. I won't get anymore specific than that for competitiveness reasons on the call. But that's what we're starting to see. There are some renewed signs of life in that sector which is a good thing. But that's -- I want to caveat things by saying that it's a little bit of an uptick. It isn't anything of any substantive nature at this point.

Okay. And what about just booking trends in general in that segment for the quarter?

Bookings have been very solid in the quarter and actually continued in October to be a very solid month from a booking standpoint.

Okay. And then switching to modular, can you just talk about how you plan to redeploy the returns in California, how challenging will that be to get it done over a 12-month period?

Well, the dynamic that exists today is that there's still a significant amount of educational classroom business that's out there and when you line up the fact that there is about roughly $3.7 billion in application backlog for modernization work, and that information comes from the Office of Public School Construction in California, that's a very positive sign. And just in general, our sense of what we're hearing from customers and so forth. And we've had periods previously where we've had this kind of return activity. In fact, in late 2003 and the first two quarters of 2004, we actually had a dip in utilization related to the normal return of modernization products and we did a very, very good job of turning that equipment around and actually adding to the asset base going forward. So from a demand standpoint, I mean our comments are made tied to that, plus backlog in school projects that we're hearing from the state.

Okay. And I guess, maybe - I'm wondering if you were happy with your equipment acquisition in the quarter, maybe in each segment? Can you just give us an idea of your overall activity of acquisition and if it was in line with your needs?

I would say that our historical behavior is such that we buy equipment based upon market demand. And we continued to do that, so we stayed right to our historical game plan. So I'm very pleased that we're executing as we need to.

Okay. And then the timeframe for the growth initiatives that you mentioned, have you got one in mind?

We don't at this point. We're still in an exploration stage. And typically, we would be fairly closed on the subject matter until we went ahead and took our action or made our strike on something. So - and we'd love to share more information at a later date on whatever we may select once it's appropriate.

All right. Thank you.

Thank you very much, Joe.

[Operator Instructions] Our next question comes from Bill Wolfenden from RS Investments. Please go ahead.

Good afternoon, gentlemen.

Hi Bill.

Hey Bill.

Just a quick question - a couple of questions on the gross margin. Just a comment you made, gross margins on the rental of the equipment, I assume, or is it the Telco portion target was 50%? Is that right?

We're moving in that direction. We have improved from 39% Q3 '04 to 43% this quarter and we would expect over the next several quarters to move in the direction of 50%.

In Telco?

In Telco. That's correct.

Based on - and in your comment was based on improved business activity. Is that -- are you starting to see that improved business activity which is what gives you the confidence over the next several quarters you can get back to that 50%?

From looking at the rental revenue trend for 2005 from 16.9% to 18.3%, even though fourth quarter historically can be a little soft, and what I'm seeing in the way of opportunity potential in 2006, we feel pretty good about top-line growth. And also probably more tightly managing the depreciation side of things. So those -- the combination of those two items we feel can get us considerably higher than where we're at today.

Okay, great. And then later in the call, you were talking about just the efficiencies and such that had sort of been put in over the next couple of years along with the acquisition and that that was mostly behind you. I think the comment was something to the extent that you are well positioned to achieve more significant earnings growth going forward. Does that imply that the rate of change in earnings growth might accelerate from the level that it's been over the last few quarters?

Well, everything is really tied to how quickly the top line grows. And that's -- as we saw Q3 of last year over Q3 this year, there's just -- the industry is still recovering. It's very hard to kind of get your finger on that although I do think things are starting to get on a more consistent track. But that's what will make the biggest difference. If that's, really -- if we see significant growth on the top line then you could see an acceleration. At the same time, I'm not predicting that at this point. I'll stay very conservative and look at the future in that fashion.

Fair enough. And just for my edification then, were those comments based on the Telco business or the company overall?

I think it was Telco we were just speaking to at that point.

Okay. And then sort of the growth initiatives that the previous caller focused on where you talked about using the balance sheet to potentially grow the company. I assume that's through some new products or maybe M&A-type activity. I mean, can you give just kind of give us a sense of what types of things you're talking about without tipping your hat?

It could be concentrated focus in particular markets. It could be acquisition candidates. It could be international business growth. It could be ancillary products to our existing rental products -- any one or all of those types of items.

Okay. And I assume you've factored in the expense from the new ERP system in with the guidance. Should that be something that we should be thinking about over the next 18 to 24 months that could potentially put pressure on operating margins or is that not that significant of an expense?

Relative to the business as a whole, it's not that significant of an expense.

Great. Thanks very much. Nice quarter.

Thank you very much, Bill.

Our next question is a follow-up from Joe Chumbler with Stephens, Incorporated. Please go ahead.

I just wanted to follow on the ERP expense. Tom, was the $1 million sequential increase in SG&A part of that?

There was some of that there, roughly a couple of hundred thousand of SG&A expense is attributable to the ERP system in the Q3.

Is that what we should expect going forward or a little bit higher?

Well, the total project over the next couple of years, and if you look at it on a five-year time line, is probably a magnitude of in the neighborhood of $5 to $7 million, a cost that will come through the PNL over a five-year period.

Equally distributed?

Not necessarily equally distributed. There's probably a little bit more on the front end related to the ERP. But for our purposes or discussion today, it's more or less even.

Okay. All right. Thanks.

Thank you, Joe.

At this time, there are no further questions. I'd like to turn the conference back over to management for any closing comments.

Well, I'd like to thank everyone for joining us this afternoon for the call. We appreciate all your support and we look forward to chatting with you again on our Q4 2005 call early next year. Thanks so much.

Ladies and gentlemen, this now concludes the McGrath Rentcorp Q3 2005 earnings conference. Thank you again for your participation. You may now disconnect.