McGrath RentCorp (MGRC) 2006 Q3 法說會逐字稿

Good afternoon and welcome to the McGrath RentCorp Third Quarter 2006 Earnings Conference Call. At this time, all participants are in listen only mode. [OPERATOR INSTRUCTIONS] As a reminder this conference is being recorded today, Thursday, November 2, 2006. I would now like to turn the conference over to Geoffrey Buscher with SBG Investor Relations. Please go ahead, sir.

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 are Dennis Kakures, President and CEO, and Keith Pratt, Vice President and CFO. Please note that this call is being recorded and will be available for replay for up to 48 hours following the call 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 11071763.

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. Our press release was sent out this afternoon at approximately 4:05 Eastern or 1:05 Pacific Standard Time today. If you did not receive a copy but would like one, it is available on line 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 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 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 Dennis Kakures.

Thank you, Geoffrey. Before turning the call over to Keith to review our third quarter results with you, I have a brief comment. I wanted all of our shareholders to know that in October McGrath RentCorp was recognized on Forbes Magazine's Top 200 Small Public Companies List for 2006. This was our sixth time making the grade. The list is based upon a company's performance on various key metrics including return on equity and earnings per share growth over a five year period.

Our listing says a great deal about the company's ability to make intelligent rental asset investments and to operate our businesses with increasing precision. This is all possible due to the quality of our people and their ownership of what they do daily in producing consistently strong results. My great thanks to all of our employees. Now, I'd like to turn things over to Keith to go over our third quarter numbers and then I'll be back later to give some added color to our results.

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 third quarter 2006 Form 10-Q. For the third quarter 2006, total revenues increased slightly from $77.8 million in 2005 to $77.9 million in 2006. And net income increased 5% from $12.1 million, or $0.48 per diluted share in 2005, to $12.7 million or $0.50 per diluted share in 2006.

Third quarter 2006 results included $.8 million of non cash stock compensation expense required under FAS 123R, reducing earnings by $0.02 per diluted share. Reviewing the third quarter results for the company's Mobile Modular division, Mobile Modular total revenues decreased $4.4 million or 9% to $44.3 million over the same period in 2005, due to $8.6 million lower sales revenue, offset by higher rental and rental related services revenues during the quarter.

Gross profit on rents increased $1.7 million or 13% to $15 million from $13.3 million in 2005, primarily due to higher rental revenues. Rental revenues increased $3 million or 14% over 2005, while rental margins decreased slightly to 63% in 2006, compared to 64% in 2005.

Selling and administrative expenses increased $.6 million or 11% to $6.3 million from $5.7 million in the same period in 2005, primarily due to $.5 million of non cash stock compensation expense related to the adoption of FAS 123R. The combined effect of the revenue decrease, increased selling and administrative expenses, and higher allocated interest expense, was a decrease in pretax income of $.7 million or 5% to $12.9 million for the third quarter 2006, from $13.6 million for the same period in 2005.

Finally, average Modular rental equipment for the quarter was $393 million, an increase of $45 million from the third quarter of 2005. Average utilization for the third quarter declined from 84.7% in 2005, to 83.7% in 2006. For the company's TRS RenTelco Division, total revenues increased $1.7 million or 7%, to $26.6 million, compared to the same period in 2005, due to higher rental revenues.

Gross profit on rents increased $1.1 million or 14% to $9 million as compared to the same period in 2005. Rental revenues increased $1.7 million or 9% as compared to 2005, and rental margins increased to 45% in 2006 from 43% in 2005. Pretax income increased $.8 million or 16% to $5.9 million for the third quarter 2006 from $5.1 million for the same period in 2005, primarily due to higher gross profit on rental revenues.

Finally, average electronics rental equipment at original cost for the quarter was $176 million, an increase of $25 million from the third quarter of 2005. Average utilization for the third quarter improved from 68.3% in 2005 to 70% in 2006.

On a consolidated basis, interest expense for the third quarter 2006 increased 41% to $3 million from $2.1 million for the same period in 2005 as a result of the company's higher average interest rates and higher average debt levels.

The third quarter provision for income taxes was based on an effective tax rate of 39%, compared with 38% during the same period in 2005. The company's estimated effective tax rate of 39% is based on the 2006 expected revenue distribution by state.

Next, I'd like to review our year to date 2006 cash flows. We continue to generate strong cash flows to invest in our business and return value to our shareholders. For the nine months ended September 30, 2006, highlights in our cash flows included -- net cash provided by operating activities was $71.1 million, an increase of $12 million over 2005. We invested $91.7 million for rental equipment purchases, partly offset by $18 million in proceeds from used equipment sales.

Dividend payments to shareholders were $11.5 million. Net borrowings increased $14.8 million year-to-date, from $163.2 million to $178 million. We continue to have a solid, low-leveraged balance sheet.

For 2006, third quarter EBITDA increased $3.7 million or 11% to $36.9 million, compared to $33.2 million in 2005, with consolidated EBITDA margin at 47%. Our definition of EBITDA and a reconciliation of EBITDA to net income are included in today's press release and in our Form 10-Q for the quarter.

With respect to 2006 earnings guidance, based on our strong third quarter results and our current forecast for the remainder of the year, we are increasing our full year EPS guidance range to $1.48 to $1.55 per diluted share. At this point, I would like to turn the call back to Dennis.

Thank you, Keith. Our third quarter results were our highest quarterly earnings in the company's history. We increased rental revenues by 12% quarter-over-quarter and 11% year-to-date. Although reported earnings reflect a modest 4% increase in EPS growth quarter-over-quarter from $0.48 last year to $0.50 this year, when I look more closely at our results, it provided me with a clearer picture of our rental engine growth.

In last year's third quarter results, we had Hurricane Katrina related sales of $5.8 million and $0.04 in earnings. In the third quarter this year, we had non cash stock option expense under FAS 123R of $.8 million or $0.02 per share. Without either of these items, one gets a much better sense of the horsepower of our rental engine.

As we speak to you frequently, growth in the profitability of our rental operations is the best indicator of sustainable earnings levels. For our Modular rental business we produced a 14% increase in rental revenues over the third quarter 2005. This was primarily a result of new educational rentals coming on line and the impact of higher commercial activity. We had favorable rental revenue growth in our three Modular rental markets -- California, Texas, and Florida -- compared to both last year's third quarter as well as sequentially from this year's second quarter.

I couldn't be more pleased with the organizational culture created over the years in our Modular division in serving customers at a level that creates a strong competitive advantage. This is especially evident in our entry into the Florida market in 2004 and the business levels we have experienced to date.

We also saw our Modular gross margin on rent percentage returned to the low 60% range to 63% in the third quarter from 55% in the second quarter. We lowered inventory center expenses by approximately $1.1 million during the third quarter, compared to the second quarter and at the same time benefited in rental revenue stream growth from the higher spend in the second quarter in preparing equipment for rental.

Average utilization of our Modular rental fleet for the third quarter increase to 83.7% from 82.7% in the second quarter with period ending utilization for the third quarter decreasing to 82.9% compared to 83.2% at the end of the second quarter.

Rental equipment at original cost at the end of the third quarter stood at $404 million, compared to $375 million for the second quarter or an 8% increase. Thus, we experienced slightly lower utilization at the end of the third quarter as compared to the end of the second quarter but with an additional $29 million in rental assets deployed during the third quarter. This reflects continuing strong educational demand in Florida, favorable commercial activity in California and Texas, partially offset by a weaker California educational market.

Looking more closely at the California classroom rental market on a macro level, we believe there is continuing strong demand to modernize California's aging public schools. However, as we have shared in conference calls over the past few quarters, available funding from the 2004 State Facilities Bond Measure has been limited and, thus, the number of new modernization projects coming on line has been lower in 2006.

This coming November 7, there is a $10.4 billion California Educational Facilities Bond Measure on the ballot, of which approximately $3.3 billion is available for modernization projects. The most recent poll numbers are mixed with some polls showing the measure ahead, and some showing it behind.

As CEO, over the past month, I have been asked frequently what the impact will be to our Modular business in the event Proposition 1D, the California Statewide School Facilities Bond Measure, doesn't pass next week. Quite frankly, from the visibility that we have today, our initial belief is that the impact will not be very significant in 2007.

If the Bond measure doesn't pass, although we will ship fewer buildings for modernization projects in California in 2007, due to the strength of our Florida educational business and our outlook for the California and Texas commercial markets, we believe we could still see middle, single digit rental revenue growth for our Modular business in 2007.

On the other hand, if the Bond measure does pass, we believe we will see a strong increase in classroom rental opportunities beginning in early 2007, with most building shipping late in the second quarter and in the third quarter. As a result, we believe we can see high single digit to low double digit rental revenue growth for our Modular division in 2007.

We should continue to see favorable classroom rental activity in 2008 as well. Whether the Bond measure passes or not, we would expect the California classroom rental market in 2007 to be very competitive, minimally during the first half of the year as we and our competitors look to deploy unutilized classroom inventories.

Finally, if the bond measure doesn't pass, we would expect the backlog of modernization products to increase significantly throughout 2007, putting great pressure on the Legislature to place a Bond measure on the ballot in early 2008. Also, keep in mind that there is approximately $7 billion available funding for new school facilities in the November bond measure. If the bond measure doesn't pass and those monies are not available, we may benefit from school districts experiencing student population growth and the need to add new schools or permanent additions, potentially renting portable classrooms as an interim facilities solution.

Now let's take a closer look at our test equipment rental division. TRS RenTelco's quarter- over-quarter rental revenue increase of 9% to $20 million reflects continuing favorable market conditions across a broad range of product and customer segments for both our general purpose and communications inventory. We're continuing to buy the latest technology test equipment to support demand and invest in our North America market leadership position.

Year-to-date for electronics, we have net additions of new test equipment to the balance sheet of approximately $24 million. We're continuing to see favorable market conditions in the fourth quarter. We believe all of these items reflect the positive outlook for the longer term health of our test equipment rental business. Our gross profit and rent increased to $9 million for the quarter, a 14% increase over last year's third quarter for electronics. In addition, our gross margin on rents increased to 45%. These are the highest levels for both of these key metrics since the merger of TRS-RenTelco in mid-2004.

In producing these results, we benefited from higher rental revenue levels and reducing depreciation as a percentage of rents to 43% for the quarter. This resulted from higher rental revenues and from both a full quarter's impact of the drop off in depreciation expense of the pool of 24 months life assets acquired from TRS and our discipline of managing product utilization at the model number level.

A few closing comments. I wanted to take a moment to touch again on those metrics and elements of our rental businesses that matter the most in producing sustainable, long term earnings and share value growth for McGrath RentCorp. Those items include rental revenue growth, net additions of rental assets, healthy utilization ranges, increases in gross profit on rents, favorable gross margin on rents, and growing our base of rental customers.

Let's look at the McGrath RentCorp scorecard to see how we have done in these areas year to date in 2006. For electronics business, we have increased rental revenues by 10% to $58 million. We have net additions of $24 million in new test equipment assets to the balance sheet. Average utilization was 70%. Gross profit on rents was up 29% to $25 million.

In gross margin, our rent was 43% compared to 36% a year ago. For our Modular business, we increased rental revenues by 12% to $67 million. We have net additions of $37 million in new Modular rental assets to the balance sheet. Average utilization was 83%. Gross profit on rents was up 6% to $40 million. And gross margin on rents was 60%.

As for growing our base of rental customers, what matters most and what we work hardest at every day are the following -- (1) Enhancing our organizational efforts and culture in servicing customers at a level that our competitors find difficult to compete against. (2) Being the most innovative provider of rental products and services in each respective industry. And finally, always doing for our customers what we say we're going to do.

And finally, as Keith mentioned earlier, we have increased our earnings guidance to a range of $1.48 to $1.55 per share. We are very pleased with our stronger than anticipated third quarter results in rentals for Modulars and in sales for both Modulars and electronics. Although this revised earnings guidance reflects a $0.07 range, we will acknowledge that the $1.48 is conservative on the low end of the spread. However, there are a lot of moving parts to our businesses and, in particular, there can be timing issues on sale project billings or heavier than anticipated equipment returns that can impact our results. And now Keith and I are pleased 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] Our first question comes from Cliff Walsh with Sidoti. Please go ahead.

Hi, Dennis. Hi, Keith.

Hi, Cliff. How are you?

Good. How are you?

Good, thanks.

Can you talk a little bit about the California classroom market? Education was weaker, obviously, on the modernization side, but class size reduction and overcrowding -- how did that stack up and what did you see on the commercial side in that business?

In California?

In California, yes.

We had a weaker rental revenue quarter this quarter, comparably less with respect to education rentals, but the commercial activity was very strong in the third quarter in California and the big spend that we had in the second quarter, as we said, it really came through and showed in the numbers in the third quarter.

Okay. That was my next question. What you were gearing up for last quarter, how did that play out?

It showed itself very clearly in the numbers.

Okay. Great. And is all of that equipment out on rent at this point or is there more to gear up?

Well, commercial activities remained very favorable into the third quarter, so we continue to address the demand in the market and I feel very good about that activity level.

Okay. And in Florida, I guess you're seeing continued strength there and continued penetration of school districts and everything is going along reasonably well there?

Florida, we've had another very strong year. I don't think any of us could be more pleased with our results there to date. We're very pleased with our outlook and the establishment of our business as we've done it in such a short window.

Okay. And with respect to the inventory center there, what should we expect cost-wise over the next couple of quarters? Or is there anything developing on that front?

Well, quite frankly, those costs really that are involved with that are capitalized. We will have towards the end of 2007 as we add some staffing, we'll have some operational expense that goes to that; but really, obviously the purchase of the land, the building of the structures, the ground infrastructure as well, is all capitalized over very lengthy windows. So those are not really -- although they'll be in the numbers, they're just not substantial in any way.

Okay. And with respect to TRS, it seems like you had a very strong quarter. Any particular areas that were stronger than others either geographically or in certain product categories?

You know, very evenly based. I mean we seem to be firing on all engines in that business, at least in terms of the markets and customer segments, so that feels quite good right now, but nothing in particular.

Okay. Great. Thank you very much, Dennis.

Thank you, Cliff.

And our next question comes from Alan Robinson with RBC. Please go ahead.

Good afternoon. Congratulations on the last quarter.

Thank you very much.

Looking at the cash flow that you generated this quarter and in fact throughout the year, clearly a lot of strength there. Could you talk a little about your plans going through 2007 in general terms? I mean it seems over the past several quarters just about all of your operating cash flow has been plowed into new rental inventory. In general terms, when can we expect a little less plowing and a little more harvesting?

It's a very good observation, Alan. As you can see, the business has the characteristic of very strong cash flows and for the last year or two we've been investing those cash flows back into the business. We put a lot of product into the Modular business, in particular in the Florida market and also adding commercial product in both Texas and in California.

We're not really commenting on 2007 specifically. There will come a point where as we're more established in the Florida market the rates at which we'll need to add assets will start to fall off a little bit, and our base of business in Florida will be generating a lot of cash flow, if you will, to begin to self-fund itself.

We are not there yet. We think that market has a lot of potential, but right now we're definitely in a heavy growth mode and we will give some comment to what we see in 2007 when we lay out our guidance early next year.

You talk about Florida, obviously the big recent growth area. Does that imply that you're kind of at the steady state for California now since you've been involved in that market a lot longer?

The California market is without a doubt a more mature market; however, the educational site today, as we've discussed in some past calls, obviously because of the modernization funding piece, that has been in a slight downward trend there and there's underutilized equipment. But this has been a very strong year commercially.

We haven't seen a year like this for some time and we have to remember that California, being the 5th or 6th largest economy in the world, together with having the largest population of all the 50 states by a wide margin and being the third largest in square mileage, it's really a country unto itself in a lot of ways. So, we've been in this market for 25 years.

We may be seeing a resurgence here of California growth in terms of the general economy and our commercial business. I would certainly hope to see continued strength as we've seen it thus far in 2006.

Okay. Good stuff. You talked in the past a little perhaps about the potential to expand the electronic equipment rental business overseas. Any developments there? Any thoughts you might have or are you keeping quite busy enough elsewhere already?

Well, actually we have very specific strategic planning council teams that are working on looking at international growth. And I'm part of that process, as Keith is, and those work groups, and so we're continuing with our due diligence and exploration work and so forth, and hopefully we'll have more to chat about that on future calls.

I think it's also true to say that we can service a little bit of overseas business out of our Dallas facility, particularly for Latin America and that continues to build our experience with doing business in that arena.

Okay. And just finally could you talk a little bit about your perception of market share, specifically in the Florida market? I'm wondering if you can comment on any new additional competitive wins in that market recently?

Well, I'm not aware of at this point in time of any new competitors in the marketplace or any real changes on the competitive landscape. I will say I am very pleased with our ability to garner business and gain business in the market. So, nothing unusual there from our initial launch there about 2 ½ years ago.

Okay. Thank you.

Thank you very much.

And our next question comes from Amy [Rudemer] with CIBC World Markets. Please go ahead.

Hello?

Hi, Amy.

Hi. How are you doing?

Fine.

A couple housekeeping questions. The first is on the term of your leases by segment. If you could tell me what the initial term is for education, non-education, electronics? And then the average term as well.

All right. Bear with me just a moment. There's something up here. All right. For our Modular business, and we'll break this out between---

Okay.

educational and non-educational. If you look at the educational lease portfolio, and we took this snapshot at the end of the third quarter---

Okay.

If you look at that equipment that is on rent that is beyond term because that's how you measure it. So, for that equipment our average original lease term was about 22 months.

Okay.

But the actual rental term, and it's still on rent today, is about 66 months.

Okay.

For the non-educational part of our business, average rental term, and this is committed term, contractual term, 18 months, an average on-rent term about 48 months.

Okay.

If you blend the two together, the average original contract term is about 20 months and the current on-rent term is about 58 months.

58 months? Okay. So that's the Modular component?

That's correct.

Okay.

And you had a question on electronics as well?

Electronics, too, for initial versus average.

Because it's a month-to-month, a month to month rental product, we really just speak in terms of kind of an average term---

Okay.

and that would be around five months.

Five months.

But that's a mix of month to month, 12 month and 24 month, but more of it being in the less than 12 month universe.

Got it. Okay. And my second question is what percent of revenue do you drive from your largest customer?

Much less than 10%. We really don't have any concentration issues in either the Modular business or in the electronics business. We do have a lot of customers in each of those businesses that do repeat business with us---

Okay.

But none of them comes close to being a 10% customer.

And what about in the 5% range?

No, much lower.

Okay, much lower. Okay. Great. Thank you very much.

Amy, thank you.

[OPERATOR INSTRUCTIONS] One moment please for the next question. Our next question comes from Alan [Matroni] with Sylvan Lake Asset Management. Please go ahead.

Hi. Thank you. And I appreciate you guys putting the press release out after the close this time.

Thank you, Alan.

No, not a problem. I'm sure you're looking at the semiconductor industry and seeing the inventory build that's happening there and the slowdown and some of the potential fears of a slowdown in the tech sector at all. Can you talk about how a slowdown in consumer or in tech products or a filling up of utilization in a lot of these fabs impacts your RenTelco business?

Well, certainly any slowdown in technology can have a negative impact; however, remember a lot of our work for electronics especially in the semiconductor areas - - we're on the R&D side of a lot things, so product development is an area in which it's kind of a continuum. So we're less impacted from a manufacturing standpoint if demand is down.

But certainly we like to see high tech spending that's favorable, but quite frankly we have a very broad diversity of in-markets, all the way from fiber installation and cable work to, as you mentioned, semiconductor work and everything in between. So again, between the wireless markets and so forth, there's just a very broad customer different segment of customer basis as well as products segments. So---

So, do you get visibility in terms of the slowdown? How soon, when your customers start slowing down, how soon do you typically see it? Do you lag the semi industry? I mean I realize it's more broad than just straight semi's, but like you said -- and telecom. I appreciate that.

I would be very careful about tying us into semiconductors being a very big item. Certainly, it's an area in which we rent test equipment, but it's not significant relative to the mix of everything else. So that's how I would respond to that. We have a broad, diverse group of customers as well as market segments.

So, what measures -- are there publicly traded companies or [comps] that you suggest your investors look at? Is it Agilent or several others that we should look at to see what kind of growth they're seeing to be able to get somewhat of a read on this business?

You know it's certainly Agilent and Tektronix, both sources, and of course they manufacture equipment and sell it. There's much more equipment sold then there is rented. We deal with a lot of project related work and peak demand. And also maintenance of existing networks are a very big part of our business. So you can't actually correlate them one next to another. But that gives you some read.

There's also another public company, Electro Rent, who is a dealer as we are and renter of test equipment. So, any of the public test equipment manufacturers as well as Electro Rent, who is another publicly traded test equipment rental company.

Okay. And lastly, are you seeing on your commercial side of rental, are you seeing any indications of any sort of slowdown? Or are you still seeing an acceleration?

I'm sorry. Could you repeat that?

Sorry. For your renting business, not the education renting but if you have a small business that rents to commercial?

Yes.

Commercial, non-res type of customers. I'm wondering, are you seeing an acceleration of business or are you seeing a slowdown or a steady stick? Can you just give us a sense of what your expectations are for the next six to nine months?

You're talking non-res. Let me break down our commercial business because I think it's a real important point here. About 40% to 43% at any given time of our business is non-educational. And that is broken up into residential construction of about somewhere around maybe 8% to 9%; commercial construction, which is probably about anywhere from another 10% to 12%; and then the balance of it about roughly 25% to 30% is a mix of just general commercial needs; office space adjacent to existing facilities. It could be a clinic rental. It could be a rental for additional space at a special event, etc. So we just want to kind of calibrate for everyone that the commercial construction sector of the business is only about 10% to 12%, roughly of our rental base.

But with respect to your question on the rest, we're actually doing very favorably in all those areas today and there's good strength across the board. We haven't seen a weakness in commercial construction of any real significance to date. And our residential construction piece remains pretty favorable.

Thank you.

[OPERATOR INSTRUCTIONS] And right now it looks like we have no further questions in queue. I would like to turn the conference back to management for any concluding comments. Please go ahead.

Thank you. I'd like to thank everybody for joining us on today's earnings call. We'll look forward to chatting with everybody on our upcoming Q4 call toward the middle or end of February. We'll talk with everybody then. Thanks so much. Bye bye now.

And, ladies and gentlemen, that does conclude the McGrath RentCorp Third Quarter 2006 Earnings Conference Call. If you'd like to listen to a replay of today's conference you may dial 1 800 405 2236 or 303 590 3000 and use pass code 11071763# to access the conference. Thank you again for your participation today. You may now disconnect.