McGrath RentCorp (MGRC) 2013 Q2 法說會逐字稿

Welcome to the McGrath RentCorp second quarter 2013 financial results conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions.) This conference is being recorded today, Wednesday, July 31, 2013.

I would now like to turn the conference over to Mr. Geoffrey Buscher of SBG Investor Relations. Please go ahead, sir.

Thank you, operator. Good afternoon. I am the Investor Relations Advisor to McGrath RentCorp. We'll 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, Senior Vice President and CFO.

Please note that this call is being recorded and will be available for telephone replay for up to seven days following the call by dialing 1-800-406-7325 for domestic callers, and 1-303-590-3030 for international callers. The pass code for the call replay is 4627691. 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.

A press release was sent out today at approximately 4.05 p.m. Eastern Time or 1.05 p.m. Pacific Time. If you did not receive a copy but would like one, it is available online in the Investor Relations section of our website, or you may call 1-206-652-9704 and one will be sent to you.

Before getting started, let me remind everyone that the matters we will be discussing today that are not truly historical are forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, including statements regarding McGrath RentCorp's expectations, 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 relating to McGrath RentCorp's business are set forth in the documents filed by McGrath RentCorp with the Securities and Exchange Commission, including the Company's most recent Form 10-K and Form 10-Q.

I would now like to turn the call over to Keith Pratt.

Thank you, Geoffrey. In addition to the press release issued today, the Company also filed with the SEC the earnings released on From 8-K and the 10-Q for the quarter.

For the second quarter 2013, total revenues increased 4% to $87.1 million from $83.8 million for the same period in 2012. Net income decreased 6% to $9.8 million from $10.5 million, and earnings per diluted share decreased 10% to $0.38 from $0.42.

Reviewing the second quarter results for the Company's mobile modular division compared to the second quarter of 2012, total revenues increased $1.7 million or 6% to $29.5 million due to higher sales, rental-related services, and rental revenues. Gross profit on rents decreased $1.6 million or 16% to $8.7 million primarily due to a decrease in rental margins to 44% from 53% partly offset by 2% higher rental revenues.

Lower rental margins were a result of $2 million higher other direct costs for labor and materials and $0.1 million higher depreciation.

Selling and administrative expenses increased $0.3 million or 3% to $6.8 million primarily as a result of increased personnel and benefit costs.

The lower gross profit on rents partly offset by higher gross profit on rental-related services and sales revenues combined with increased selling and administrative expenses resulted in a decrease in operating income of $1.1 million or 29% to $2.7 million.

Finally, average modular rental equipment for the quarter was $541 million, an increase of $20 million. Equipment additions were primarily to support growth in the Mid-Atlantic region and for our portable storage initiative. Average utilization for the second quarter increased from 65.8% to 66.8%.

Turning next to second quarter results for the Company's TRS-RenTelco division compared to the second quarter of 2012, total revenues increased $2.5 million or 8% to $33.1 million due to higher sales and rental revenues. Gross profit on rents increased $0.3 million or 2% to $12.4 million. Rental revenues increased $0.5 million or 2%, and rental margins were flat at 49% as depreciation and other direct costs as a percentage of rents were flat at 38% and 13% respectively.

Selling and administrative expenses decreased $0.1 million or 2% to $6.3 million primarily due to decreased salary and benefit costs related to the exit of the environmental test equipment business in November 2012.

As a result, operating income increased $0.7 million or 8% to $9.1 million. Finally, average electronics rental equipment at original cost for the quarter was $264 million, a decrease of $1 million. Average utilization for the second quarter decreased from 66% to 63.5%.

Turning next to second quarter results for the Company's Adler Tanks division compared to the second quarter of 2012, total revenues increased $3.7 million or 18% to $24.3 million due to higher rental, rental-related services, and sales revenues. Gross profit on rent increased $0.3 million or 3% to $11.8 million. Rental revenues increased $1.7 million or 11%, and rental margins decreased to 67% from 72% as depreciation as a percentage of rents increased to 19% from 18% and other direct costs as a percentage of rent increased to 14% from 10%.

Selling and administrative expenses increased $0.8 million or 15% to $6.1 million primarily due to increased personnel and benefit costs. As a result, operating income decreased $0.1 million or 1% to $7.3 million.

Finally, average rental equipment for the quarter was $260 million, an increase of $42 million. Average utilization for the second quarter decreased from 70.3% to 65.8%.

On a consolidated basis, interest expense for the second quarter of 2013 decreased $0.2 million or 9% to $2.2 million from the same period in 2012 as a result of the Company's lower average debt levels and lower average interest rates.

The second quarter provision for income taxes was based on an effective tax rate of 39.2%, unchanged from the second quarter 2012.

Next, I'd like to review our 2013 cash flows. For the six months ended June 30, 2013, highlights in our cash flows included net cash provided by operating activities was $66.2 million, an increase of $1 million compared to 2012. The increase was primarily attributable to a lower increase in prepaid expenses and other assets partly offset by lower income from operations and other balance sheet changes.

We invested $56.2 million for rental equipment purchases compared to $73.3 million for the same period in 2012, and proceeds from sales of used rental equipment were higher by $2.2 million.

Property, plant, and equipment purchases decreased $4.7 million to $4.2 million in 2013. Net borrowings decreased $23 million from $302 million at the end of 2012 to $279 million at the end of the second quarter 2013. Dividend payments to shareholders were $12.1 million.

With total debt at quarter end of $279 million, the Company had capacity to borrow an additional $251 million under its lines of credit. Under issue of funded debt to the last 12 months actual adjusted EBITDA was 1.76 to 1.

For 2013, second quarter adjusted EBITDA decreased $0.2 million or 1% to $38.3 million compared to the same period in 2012 with consolidated adjusted EBITDA margin at 44% compared to 46% in 2012. Our definition of adjusted EBITDA and a reconciliation of adjusted EBITDA to net income are included in our press release for the quarter.

Turning next to 2013 earnings guidance, we have revised our previous 2013 full-year earnings guidance range of $1.85 to $1.95 to an updated range of $1.65 to $1.80 per diluted share. For the full year 2013 we expect 2% to 4% growth in rental operations revenues over 2012. Sales revenue is expected to be approximately 5% lower than 2012, but gross profit from sales is expected to be approximately 10% higher than 2012.

Rental equipment depreciation expense is expected to increase to between $67 million and $69 million driven by rental fleet growth. Other direct costs of rental operations are expected to increase from $46 million in 2012 to between $48 million and $50 million in 2013.

Selling and administrative costs are expected to increase to between $88 million and $90 million to support business growth and continued investment in Adler Tanks and our portable storage initiative.

Full-year interest expense is expected to be approximately $9 million. We expect the 2013 effective tax rate to be 39.2% and the average diluted share count to increase to between 25.6 million and 25.8 million shares for the full year.

Now I would like to turn the call over the Dennis.

Thank you, Keith. Although we are disappointed that Company-wide rental revenues increased by only 4% and EPS declined by 10% from a year ago, we are pleased with the underlying favorable business activity levels and momentum we are seeing overall in our rental business portfolio.

The primary factor for the quarterly earnings shortfall of $0.04 from a year ago with higher inventory center expenses in our modular division to the preparation of rental equipment related to increased order activity, and secondarily lower results in Enviroplex.

Modular division rental revenues for the quarter increased by $0.4 million or 2% to $20 million from a year ago. This was the highest year-over-year percentage increase in quarterly rental revenues since the second quarter of 2008, five years ago at the beginning of the Great Recession. Rental revenues also increased sequentially in the second quarter from the first quarter of 2013 by $0.6 million or 3.3%.

During the second quarter we experienced an 8% increase in division-wide year-over-year first month's rental revenue bookings for modular buildings with an increase of 12% outside of California and 1% within the state. Over the first six months of 2013, we experienced a 20% increase in division-wide year-over-year first month's rental revenue bookings for modular buildings with an increase of 35% in our markets outside of California and flat within the state. Many of these booked orders shipped either late in the second quarter or will ship in the third quarter of 2013, and thus they're not fully reflected in our quarterly rental revenue levels to date.

The business activity and opportunity levels in our Texas, Florida, California, and Mid-Atlantic modular building markets during the first half of 2013 are collectively the strongest that we've experienced in half a decade, and we are seeing this strength continue in the third quarter.

We're also beginning to see rental rates begin to rise in certain building sizes and types in each of our geographic markets, including California. This is being driven by demand exceeding readily available supply in some instances and shortages of various building sizes or types in others.

Modular division ending utilization for the second quarter of 2013 was 67.6% compared to 65.6% a year ago and 66.1% at the end of the first quarter of 2013. With the strong business activity we are seeing across all of our markets, we are cautiously optimistic that we will see further increases in utilization during the second half of 2013.

Modular division income from operations for the quarter decreased by $1.1 million or 29% to $2.7 million from a year ago. The reduction in operating income is primarily due to the increase in overall divisional booking levels and related higher inventory center costs for labor and materials to prepare and modify equipment for rental. In fact, inventory center costs primarily for equipment preparation were approximately $2 million higher in the second quarter 2013 than for the same period in 2012. The great majority of these expenditures are to support booked orders, many of them with significant customization work and with either contractual or anticipated multiyear rental terms.

Coming out of the Great Recession, these building preparation inventory center costs are compounded by needing to redeploy various rental assets that have been sitting idle for extended timeframes which tend to have higher processing costs than inventory that turns more frequently.

We are also making significant expenditures in attempting to pre-prep as much equipment as possible in our inventory centers. This allows our sales and inventory center teams to book more transactions and produce more buildings in serving short notice market opportunities. We also tend to receive higher rental rates for short-notice transactions as a result of our competitors' inability to meet customers' expedited timeframes. Unfortunately, due to our heavy volume of orders, we have made limited headway in building up a meaningful supply of sizes and types of buildings to meet these short notice market demands.

Keep in mind that almost all of our inventory center costs for building preparation and modification work are expensed in the quarter in which they are incurred. However, we benefit from the associated rental revenue stream from such expenditures in the quarters ahead.

We also have higher SG&A expenses during the quarter from a year ago primarily related to increased sales and operations staff levels to support the recovery of our modular rental business.

Finally, some of these increased costs were offset by higher gross profit on rental-related services and to a lesser extent higher gross profit on sales of equipment from a year ago.

Now let's turn our attention to Adler Tank rentals and their results. Rental revenues at Adler Tank rentals, our tank and box division, increased by $1.7 million or 11% to $17.7 million from a year ago. These results were significantly below our internal projections. This shortfall was chiefly related to various large rental projects coming off rent over the first half of 2013 primarily related to natural gas and oil shale fracking projects. We also were impacted negatively by a much more competitive fracking rental market, specifically from 21K standard tanks. This impacted both rental rates and terms for these end market transactions.

This is also reflected in Adler's division-wide rental revenue mix of fracking-related rentals declining to 11% compared to 23% a year ago and 15% at the end of the first quarter of 2013. In effect, we saw declines of 49% year-over-year and 24% sequentially from the first quarter of 2013 in fracking-related rental revenues.

Despite this decline in fracking rental activity, we were able to grow our non-fracking-related end markets 29% from the same period in 2012. Further, for the first half of 2013 across all vertical markets, first month's rent and units booked were up 43% and 45% respectively over the same period in 2012. Additionally, second quarter 2013 first month's rent and units booked were up sequentially from the first quarter of 2013 34% and 31% respectively.

We saw increased bookings year-over-year in each of Adler Tank rentals regional markets. However, these strong increases in new business only partially countered the headwinds of equipment returns. Adler is serving a wide variety of market segments including industrial plant, petrochemical, pipeline, oil and gas, waste management, environmental field service, and heavy construction. By design, we have pursued and been successful in generating higher business activity levels across a broader mix of non-fracking and historically less volatile vertical markets.

Ending second quarter 2013 utilization for our tank and box division increased to 68.7% from 67.5% a year ago and 63.5% at the end of the first quarter of 2013. Further, equipment utilization for Adler continued to increase early in the third quarter of 2013 to 69.5% through the 25th of July.

Despite an 11% increase in rental revenues for the second quarter of 2013 from a year ago, Adler divisional income from operations for the quarter was flat at $7.3 million compared to the same period in 2012. This is chiefly due to higher inventory center labor and material costs to process increased levels of outgoing equipment, costs to support geographic expansion and infrastructure investment primarily in filling key sales, management, and operations staff roles, as well as in establishing new facilities, and sales bonus costs associated with increased booking levels, all as a percentage of rents.

Over the past 18 months, Adler Tank rentals has entered eight new US markets. In addition to having relocated excess 21K tank inventory to serve these new as well as established markets, we have continued to purchase new rental equipment to support the mix of tanks and boxes needed in each region. This is supported by the fact that although average equipment utilization for the quarter is down approximately 5 percentage points from a year ago, we had an average of $171.4 million of equipment on rent during the second quarter of 2013 compared to $153.6 million a year ago.

Further, the dollar value of equipment on rent at the end of the second quarter of 2013 increased to $181.4 million from $153 million a year ago. We are continuing to execute in building our national footprint to support higher rental revenue and earnings level in the years ahead. Ideally, we'd like to see narrow or more consistent utilization ranges. However, we are at a critical juncture in our growth and it is essential that we have the right mix and depth of inventory on the ground and in all the markets in which we operate in order to respond to a variety of end market needs.

As Adler Tank rentals continues to mature as a national company, we will gain greater knowledge on the drivers of demand for various tank and box rental products in all of our regional markets, and in turn, we would anticipate a narrowing of utilization swings period-over-period.

Now let me turn our attention to TRS-RenTelco and their results. TRS-RenTelco, our electronics division, rental revenues for the quarter increased by $0.5 million or 2% to $25.3 million from a year ago. If you remove rental revenues from last year's second quarter related to our environmental test equipment business that we sold late in 2012, the year-over-year growth in rental revenues was a healthy 6%. We experienced some rental revenue growth headwinds with higher returns and less robust new activity in specific general purpose test equipment products in end markets during the second quarter. However, communications product and network bookings continued to remain favorable.

In part, we believe the softness in general purpose test equipment rentals during the second quarter is related to the federal sequester and aerospace and defense related budgets. We are uncertain as to the potential full-year impact to our electronics business related to these federal budget impasse and dynamics.

During the second quarter of 2013 we saw our yield on equipment on rent increase to 5.03% from 4.72% a year ago and 4.88% in the first quarter in 2013. This is primarily due to a greater mix of communications equipment and to a lesser extent market pricing. Communications test equipment assets have shorter depreciable lives but higher rental rates than general purpose test equipment.

Divisional income from operations for the quarter increased by $0.7 million or 2%, to $25.3 million from a year ago. The higher percentage increase in profitability as compared to rental revenues was primarily related to higher gross profit on equipment sales and lower SG&A and laboratory expenses, both as a percentage of rental revenues from a year ago. Gross profit on equipment sales increased by $0.2 million to $2.5 million compared to the second quarter of 2012. SG&A and laboratory expenses for the quarter as a percentage of rental revenues declined to 24.9% and 12.9% respectively from a year ago.

Ending second quarter TRS-RenTelco utilization was 63.3%, down from 65.7% a year ago and flat from the end of the first quarter of 2013 and continues to be in an acceptable range. Although average utilization was lower and average total equipment was relatively flat from last year's second quarter, the higher average rental rate for the period produced an overall average yield on total equipment of 3.19% in 2013 compared to 3.12% in 2012.

In producing these favorable operating metrics, we continue to benefit from our disciplined approach to equipment purchases and inventory management, appropriate depreciable equipment lives, and highly-skilled, efficiency-driven, and experience workforce.

Now let me take a moment and update everyone on our portable storage business. Mobile Modular Portable Storage continued to make good progress during the quarter in building its customer following, increasing booking levels, and growing rental levels from a year ago.

Rental revenues for the second quarter of 2013 grew by 28%, and income from operations also grew favorably from a year ago. As discussed during our first quarter call, we entered the Greater New Jersey/New York market in April. We are continuing to execute on plans for a larger geographic footprint for our storage container rental business.

At the same time we are striving to create higher business activity levels in greater critical mass in each of the markets in which we operate. We also continue to explore smaller fleet acquisition opportunities to accelerate our growth.

It should also be noted that we have favorable room to grow rental revenues within the current cost structure. As the economy continues to improve and with the infrastructure and quality team we are continuing to build, our portable storage business should benefit very favorably.

Looking forward, we continue to believe that we have an excellent opportunity to become a meaningful player in the portable storage rental industry.

Now for a few closing comments. We are lowering full-year earnings guidance to a range of $1.65 to $1.80 despite favorable new business activity across all of our rental businesses as well as utilization gains in both our modular building and tank rental businesses. However, we continue to have limited foresight on when equipment will come off rent.

The equipment returns we experienced in our tank and box rental business over the first half of 2013 have put us at a significant deficit to the rental revenue goals we began the year with. Adler Tank rentals has also been negatively impacted by lower standard 21K tank rental prices and shorter rental terms for equipment serving natural gas and oil shale fracking projects as compared to a year ago.

In addition to the uncertain rental revenue growth outlook for Adler Tank rental, we expect continuing high direct costs of rental operations in our modular business due to increased booking activity and related equipment preparation expenses and we are somewhat cautious of the general purpose test equipment market primarily related to the continuing federal sequester's impact at TRS-RenTelco.

Consequently, we have tempered our expectations for earnings per share for the rest of 2013. To be clear, the rental revenue shortfall with Adler Tank rentals is the primary reason for adjusting guidance lower for the full year in 2013. We will work diligently to make up as much of this rental revenue shortfall as possible by yearend.

More importantly, we believe each of our four rental businesses are fundamentally sound, strategically well positioned, and well capitalized, both financially and organizationally, to thrive in the years ahead. Here's how we support this statement.

Modular buildings. We believe we are at the beginning of a meaningful recovery for our historical bell cow modular building business. Booking, rental revenue, and utilization levels, as well as both factual and anecdotal regional economic information reflect this today. We have significant earnings leverage in rental assets that we already own. We are the industry leader in key geographies in which we operate, including California, Texas, and Florida, the three largest modular classroom and building rental markets in the US.

Tank and box rentals. Through the thick of the Great Recession, we were able to ramp this business well beyond our most optimistic projections. We have grown our fleet of rental assets from approximately $45 million when we acquired Adler Tank Rentals, to over $250 million today. We have the youngest, most innovative, and safest built rental fleet in the industry. We also now have a national footprint to fully leverage in the years ahead.

Electronic test equipment. TRS-RenTelco is one of the two largest general purpose and communication test equipment rental companies in the Americas. We have a stellar end market reputation for excellence in the mix and depth of cutting edge technology products, order execution and service, and have the industry's best financial operating metrics.

And finally, storage containers. Our portable storage business unit is small today comparatively to our other rental businesses, but has a very significant growth opportunity going forward. This was another business that we started at the beginning of the Great Recession. Creating exceptional customer experiences is the key to winning business and increasing market share in this industry, which is a core strength of ours. Mobile Modular Portable Storage became profitable in 2012, and we are moving very quickly to build out a selective national footprint. We are a small fish in a very large sea of opportunity in the portable storage industry.

McGrath RentCorp also has a very strong balance sheet with a funded debt to last 12 months actual adjusted EBITDA ratio of 1.76 to 1, and with current capacity to borrow an additional $251 million under our lines of credit. We can be very opportunistic in growing our business lines with the availability of such funding. We are committed to making each of our rental businesses meaningful in size and earnings contribution, and with the best operating metrics by industry. We continued to make favorable strides during the second quarter of 2013 towards achieving these goals.

Last, I realize that my comments regarding McGrath RentCorp's future outlook are significantly more positive than our actual earnings results for the second quarter, as well as our revised earnings guidance for the remainder of 2013. However, what's most important is to share as candidly as I can with the investment community on the latest and most relevant facts, trends, and other information that I believe will have the most meaningful and long term impact on the Company's earnings trajectory and share value.

And now Keith and I welcome your questions.

Thank you, Sir. We will now begin the question-and-answer session. (Operator Instructions.) Our first question comes from the line of David Gold with Sidoti. Please go ahead.

Hey. Good afternoon. Just a couple of things. One, I was curious if you can bridge a little bit more of a gap between the prior guidance and current. I know we talked about a $0.04 during the quarter, presumably from inventory costs, but I was curious presumably should we think about it as that same $0.04 impact over the next couple of quarters? I know you called that the factors, but just curious what are the magnitude, how large each of them are?

Hi, David. The way I would look at it is when we look at the full-year guidance, really a change in the Adler profitability is about 80% of the change to the guidance. And if you look at that Adler change, it's primarily rental revenue for all the reasons that Dennis spoke to earlier.

With that business we were expecting over the course of the year to see rental revenues build by quarter and see an uptick in utilization, and the second half of the year was going to be very important, the second quarter was going to be very important.

As we really evaluated everything at the midpoint in the year, we just weren't making as much progress as we had planned, and that's the key factor.

I would say secondarily at Adler, our direct cost of rental operations were higher in the first half than we'd planned. That's largely maintenance and repair work on equipment, some tank reconditioning. We did more of that than we had planned for, and that squeezed the margins further. But Adler is really 80% of the reset.

The balance is really in our modular business, as Dennis detailed, where we're spending more again in direct cost of operations in support of those higher booking levels for business that we're capturing and in the process of starting to ship.

And David, I might add that those expenditures in the modular business in Q2, that's really what we want to see. I mean if we're seeing those types of expenditures to that magnitude, then we're really seeing the business really begin to lift in terms of bookings. And what we should start seeing is even if we have additional expenses in Q3 and we're going to have a higher run rate on expenses through the end of the year, we'll start now getting rental revenue associated with the prior expenses that we've made. So there should be some good momentum here.

But quite frankly, to the extent that we're having those higher expenses, that would bode well for utilization and rental revenues going forward.

Got you. That makes sense. On that note, two things on the Mobile Modular side. First, the bookings there particularly outside of California are running at a slower pace than they were the first half of the year. Is that just a function of tougher comps or seasonality or what's sort of going on there because I know your commentary was fairly positive on that front?

I would just say this. It's really hard to look at Q1 and Q2 increases for six months versus the first quarter because it's an eclectic mix, and some of what you get in some years of Q1 you'll get the next year in Q2. So it's really kind of hard to calibrate that.

I will say this that year-to-date, just to give you some further breakdown, percentage wise, I won't talk about any dollars, but in our Florida market we're up about 48% in FMR, in first month's rent. Texas we're up about 29%, and in the Mid-Atlantic we're up about 24%. So you really have to kind of look at the first six months together to be able to get year-over-year, but that just kind of gives you some sense.

All of those markets are performing very favorably in terms of their year-over-year activities through the first half of the year.

Got you. Okay. One other, actually two other quick ones. One of them, what's your outlook, thinking Mobile Modular with the R&M or repair maintenance side? Presumably, like you say, it's sort of a double-edged -- it's the good news/bad news of yes, costs today equal revenue tomorrow. Do you expect that level to remain a little bit higher, A, and B, when you think about it more broadly, do you think there's much maintenance, or let's call it deferred maintenance required on the fleet that's been out of service for some time?

The answer, yes. We are going to see higher IC expenses related specifically to those items. When you've had some equipment that's been sitting for two or three years, or four years, the good news is now we're going deeper into inventory because we need those assets, and we're going to experience initially here some higher spend. But once we've made that spend and they turn the next time, we'll be back to really normalcy in terms of those types of costs.

So if you had to line up the scenario coming out of the Great Recession, it's all about taking utilization from 65% back up to much higher levels, and that means that you've got to make these investments as the booking opportunities come. So that's the first really sign of recovery, that A, you're getting the bookings, and B, you're spending the dollars to rotate the inventory.

And David, in conjunction with that spending, we're also very actively looking for opportunities to move market pricing up, and we're seeing success there. Clearly, lots of work still to do and a long way to go to get back to where we were a few years ago, but as an example, if you look at the overall fleet rental rate, it did uptick slightly in Q2 over Q1. And again it's more how we're operating in the field and what we're trying to achieve there and at least seeing some evidence that we can move pricing to a better place.

Perfect. That's helpful. Thank you both.

Our next question comes from the line of Joe Box with Keybanc Capital Markets. Please go ahead.

Hey. Good afternoon guys. I actually just wanted to follow up on both of those prior questions. So the first one on the inventory cost. I guess I'm just trying to understand the repair and maintenance component. Should we be thinking about the repair and maintenance and all the processing costs that are associated with putting these items back on rent? Should we be thinking about them as being a potential headwind until you see utilization normalize, or is this more of a timing blip where it's really just one to two quarters until you basically get these units out on rent and you start to collect fees from it?

You know, it's probably a little bit of both. To the extent that you get a lot of activity in a single quarter with customization work, you can have those costs really jump just tied to customization, plus the normal kind of additional costs that you're going to have to turn longer sitting inventory.

So it's really this mix of how much general activity are you getting on standard product plus what's the customization mix. And like I said, we capitalize very little and almost everything gets expensed. So both of those are good guys ultimately. And if we said for the next three or four quarters that we're going to have similar expenses, then we ought to see a direct tie to utilization going up significantly, which would be just what we want.

So it's a little bit like if you are seeing them, that should be a good indicator of the health of the business. If you're not seeing them, it says then okay, well you've got some uptick here and we're not seeing that same momentum in booking levels.

So the net of that is the more of this we can see, it should be a very good indicator until you get to some point to where you've gone deep enough in your inventory and you're now getting the turn of other equipment you had touched previously and had those deeper expenditure costs to ready.

You're right, and I'm not arguing that it's a bad thing, I'm just trying to understand how long it might persist. So when you guys specialize in a -- or when you specialize a product for somebody, do you get paid on the frontend for that or do those specialization costs get tied in over the life of the rental product?

When it's a modification typically those are amortized over the life of the lease. We get it in rental revenue obviously, but it's typically over the life of the lease and they're not paying a one-time cost to us upfront for the most part. Occasionally you will have that, but it's almost always spread.

Okay.

And Joe, one other thing I would say is with the stronger activity levels and more activity than we had expected, at the margin, our labor in terms of having more use of contractors, working a bit more overtime, that's a slight negative for us when we have to react to the market as quickly as we did.

Over time if we're at these more elevated levels of work, there'll be more opportunities to sort of manage the work a little differently and the workforce. Again, it's not a primary change to the number, but it's the kind of action we can take over time as we start seeing higher levels of business activity in the inventory centers.

Understood. Okay. Switching gears to the pricing side. I know we've talked extensively about the time it would take for new rental rates to hit parity with some of the units coming off rent. Given the more optimistic tone in the release on the Mobile Modular business, is that parity happening quicker than you had expected or can you maybe give us a sense of when we might actually see that happen?

Joe, that's a very good question, and we're still feeling our way. What's interesting is that what you don't know is what's going to come back and when. So you've got that legacy equipment that's out there and hopefully that continues to stay, and maybe we're back to normal return rates now which would be good.

And as Keith mentioned earlier, we are starting to see some higher prices in products. And especially as you get this demand bottleneck, and they're just not marginally higher prices, some of them are much more substantial back to normal returns.

So I would just say this, it's too early to tell. We're still feeling our way through here. But the good news is if you look overall and if you were to speak to the sales staff, there's no question we put an emphasis on raising rates, especially when we are dealing with supplies of equipment that are in lower availability or readily available, and we tend to be getting better rates across the board.

So all signs are favorable, but we're very early in that transition in terms of being able to really begin to see any kind of material step upwards in the way of increasing rental rates across the entire fleet.

Great. Thanks. Just a high level question for you on Adler. Obviously we've ridden Adler up on the utilization curve and it's come down, and pricing sounds like it's now a little bit more competitive. How are you guys viewing the supply demand balance in the market right now? I mean even though it's lower, are the returns still so attractive that you might see more fleet growth from your competitors, or are we starting to see that switch and maybe the returns are a little bit less favorable now and you could start to see some of your peers back off in terms of buying new equipment?

Well, to be candid, we have only really seen any kind of real significant pricing pressure on the fracking-related business. I mean our other segments are all holding very steady. In fact, if you look at year-over-year rental rates on the quarter, they're very close. So this is much more a fracking dynamic and the over-supply of equipment serving that market currently today.

The rig count -- the deployment of the rig count is down about 8% to 10% year-over-year. There are assets that are idle in these different major shale plays, and that's where the competition is coming from is too much equipment chasing too little business. And of course that ebbs and flows.

But know that X-amount of that equipment cannot be used in the other segments because it's not clean enough. It doesn't have a smooth wall interior. It can't be ready to a state for environmental construction or industrial plant use, but we built our product a certain way so that it's transferrable between and just for this very dynamic.

Right. Okay. Thanks. That's helpful. And then just one housekeeping item, and I apologize if I missed this. What was the Mobile Modular rental revenue growth within California and then outside of California? I think I just heard you say bookings?

Yes. I don't know that we quoted that directly in the prepared remarks, but outside of California, rents were up 13% year-over-year. In California they were down 6%. And then for the division as a whole, rents were up 2% year-over-year.

That's it for me. Thanks guys.

(Operator Instructions.) Our next question comes from the line of Scott Schneeberger with Oppenheimer. Please go ahead.

Thanks. Good afternoon. Hi guys. I'll jump around the segments, but in modular, following up on the question, specifically on the pricing question, what are you seeing in the pricing environment? I just want to look a level deeper since nothing's conclusive right here. Through this five years of downturn, have competitors gone away? Are you one of the only sources on the way out, and obviously looking to see if there is a great potential for pricing increases right out of the gate.

Well, we have to kind of take it by market, but let's talk about California, which was the bell cow state in the bell cow market. There really today -- there are in effect really today only, if you look at educational first, there's only two players of any significance. It's ourselves and Williams Scotsman.

Now that's down from three -- prior to the Great Recession there were three. There was ModSpace, the former GE business, Williams Scotsman, and ourselves. And then the classroom fleet that GE owned they sold to Williams Scotsman, and that was right around I think the beginning of the recession or somewhere in that era.

So coming out of the recession as we said before, typically when there's rental opportunities in California for educational product, we are the primary beneficiary. I don't know how else to put it, but we certainly have dominated that in terms of booking most of the business from those market segments, the public and private schools. And as that educational market gets healthier and healthier and it's starting to improve now, and as there's more facility bond money, we should really benefit very favorably from both the competitive environment, assets that are in good condition and that are at a low cost space as relative to any new market entrant or anybody would want to participate in the game in California.

Commercially there's really three players in California. It's ourselves, it's Williams Scotsman, and it's ModSpace. We're the largest of the three.

And then if you look at all of our other markets, all three that I mentioned, ourselves, Williams Scotsman, and ModSpace, are in the other, Texas, Florida, and Mid-Atlantic markets. However, the distinction I would make is that in the Florida market and in the Mid-Atlantic markets, we have classroom products that our competitors don't have, and those are very, very popular, and we've done very well with those. So we don't really have from an educational standpoint any kind of really typical market competition on those products.

And commercially it's a different story. It's more competitive, et cetera. But that kind of gives you just kind of some sense of as we come out of the recession and our opportunities, I think we're very well situated.

Obviously it's been competitive, still is competitive as you mentioned on commercial, and had been on education as well. Are you seeing a turn there? Just kind of a question to the behavior of your competitors or just is everyone kind of in lock steps still of trying to make their way out of it?

Well I would just say this. Let's talk about classroom pricing. California, yes. It's been very competitive for five years and it's competitive coming out of the recession. Until we get to that inflection point where there's multiple 50 or 100 unit orders and you just don't have enough readily available equipment, and if you're going to do it, you're going to charge more, et cetera.

And even in California, the commercial side now, we are seeing substantial increases in rental pricing on singlewide equipment because there's just not enough readily available assets to be able to meet market demand, and that's also in complex floors. So the commercial side is recovering much faster in California on price than the educational side. But the educational side will come as more bond money gets put in place.

If you looked at our -- look forward now on projects in California, we've got a lot of school projects, and we've got a number of those that are going to be late 2013 and into 2014 projects, and that's without a bond measure yet having passed. So things are ramping. The budgetary dynamics in California are much more favorable than they've been in five to six years, so that's a really good thing.

Thanks.

The other item I'd just mention real quickly, we never experienced in our product in Florida any really erosion in rental pricing throughout the recession. For the most part, that hybrid product because nobody else built it really was able to sustain its pricing level throughout the Great Recession.

Thanks, Dennis. And then just one more and then I'll move off to a different segment. You alluded to the fact your opportunity in modular and you just touched around the edges on it briefly, and only looking for a brief response here, but could you remind us about what you see, what makes you feel confident in the future years that you can get the lift there, particularly in education?

Well, if you look at California, let's just take that because that's been the bell cow business for a long period of time, and it took the most significant blows during the recession. And overall, let me just remind everybody, in 2007 we did $57 million with the EBIT in the modular division. And this past year I think we were what, at $17 million or $18 million in EBIT. So let's just ground ourselves in how much earnings have been lost in five to six years.

Now what makes us feel really good about the future is all of our legacy rental assets. We have a very attractive cost spaces, we've maintained them well, we were the leader in the industry coming into the recession, I think we're all that stronger coming out in all the markets that we're in.

And in California in particular, we've had a tax measure passed, we've got a $2 billion -- we're $2 billion ahead on tax revenues, corporate personal income tax, the sales taxes are all ahead, class size reduction is starting to go back in the correct direction now of getting those class sizes down from the [austerity] levels that the legislature let them have during the Great Recession. So there are a number of things that really bode very well for us.

And I can go down the list further in California in terms of the unemployment rate today is 8.5%. It was 12.6% at the peak of the recession. And just remember too, it was approximately 9.5% just at the end of 2012. Home prices up 30% year-over-year, and I could go on and on. So there are a number of factual, anecdotal pieces of information there that really speak about the rise, and we're in the very early stages here.

In the rest of the country, you know, Florida, housing prices are better, population increasing. As I said, when we were in the thick of the Great Recession, the reasons people live and work in states like Florida and California haven't really changed. Those same attractive features are still there, and we expect those to be very favorable for our return to health in the modular business.

Great. Thanks, Dennis. I appreciate that. Quickly switching to TRS. Just one question there. You were cautious this quarter. It's been the first quarter in years where you turned slightly incrementally cautious. Is that sequestration and uncertainty? Are you seeing a change because that's been a workhorse of the segment for you for a while now?

Yes. Well the business has done very well. We've positioned ourselves very well. During the five-year or six-year period we lost competitors. It's really, we're one of the two most significant players in the industry today. All good items.

But with what's going on, we've seen some headwinds in general purpose equipment. We've seen projects get deferred. Even though our numbers are still very favorable, we're just trying to be cautious, responsibly cautious. And we'll have to see. I mean there's a new fiscal year coming up October 1st. I don't know what it holds. I'm hopeful that the Executive Branch and the Legislative Branch will be able to reach some agreements on things.

So it's really just born out of let's be responsibly cautious and not because we're seeing anything so pronounced that it gives us cause, but there's enough there that we would probably be not as responsible if we didn't say something.

Okay. That's fair. And I know we're getting long on the call, so just swinging it to Adler now. Can you speak any quantification in differentiating pricing behavior in the 21Ks versus the other tanks and a mix of your total portfolio of 21K and non?

Well as you know the 21K product serves multiple vertical markets. So the standard product -- it's kind of a mixture. I think the best way to speak to it is obviously our fracking -- percentage of fracking business is down substantially from the peak. And so that means we have less of that price erosion exposure. So that's a good guy.

And pricing in that segment is where we've seen significant pressure in parts of the market. We've talked in the past about the Marcellus, but I would just say generally supporting fracking opportunities, the price points have gone down quite a bit from what they were a year or two years ago.

And Keith, the point of that is not just Marcellus but broadly and nationwide?

I'd say more broadly. Again, it differs a little bit by region, but there's pressure there.

If you look at all the major shale plays, I'd say there's 14. The rig counts are down in 10 of the 14, so they're only up in 4. Now they're not substantially down, but they're down enough to where there's pressure.

The other dynamic is that most companies now are not held by lease so to speak, so they don't have to continue drilling even when prices are not in the most favorable range. So the market's changed some to where what happened in the first few years of really the boom in gas and oil shale was that there was such a limited amount of equipment that even though prices were down, companies were held by lease, they had to drill, they had to produce, et cetera, and now they've kind of gone -- they're in a second stage here, et cetera.

And even when they weren't drilling they kept the equipment on rent because they couldn't be caught short. They had to have those assets available to them. Well that's changed when you have an abundance of supply or greater supply than demand, then you have -- they don't have to keep that equipment on rent. They can keep it on the site, but they take that off rent because they know they're going to need it again the next time they're ramping. And that serves both the lessor and the lessee.

But those are just some of the dynamics there of the kind of ebb and flow in how the maturation process occurring in the different shale plays.

By the way, shale business is here to stay. I mean, it's likely to be 15% or 20% at this time next year of our whole mix. Who knows? I mean it's a good business, but it's just going through the ebbs and flows of supply, demand, and market pricing.

Thanks. I guess just to summarize that up with a question, Keith, what is the percentage now? Dennis just mentioned it could be 15% next year. What is it now? What was it one year ago, two years ago as percentage mix?

Sure. Fracking was 11% of our rental revenues in the second quarter of this year. That compares with 23% in the second quarter of 2012 and it compares with 35% of the business mix back in 2011.

So again, when we look at things that have played out differently from what we expected, we thought we'd bottomed out with the deterioration in the fracking portion of our rental revenue, but as Dennis said earlier in the prepared remarks, the fracking revenues that we were getting in Q2 were down 49% year-over-year and they were down 24% sequentially.

So that's not something we anticipated, and it really, if you will, it eroded some of the base in our business. And even though we're growing the non-fracking quite successfully, it's very hard to make up that shortfall.

Understood. One last one for me. CapEx in the Adler segment. Could you give us an update on where you are and juxtapose that to past quarters and what you anticipate going forward given the dynamic?

Sure. I'll just give you year-to-date numbers. To the first six months of last year we added $34 million to the fleet. First six months of this year it's been $16 million. So given where utilization is at, we don't need to add equipment at the same pace. Much of what we're adding is either specialty units or box units. So tanks, we have a lot of them in most of the markets. We'd like to get more of them on rent.

I think you'll see the pace of CapEx at Adler on a slower momentum than it was a year ago just because as I've noted in the first half of this year.

Okay. I'll cut it off there. Thanks so much for taking all the time with us.

Our next question comes from the line of Les Bryant with UBS Financial Services. Please go ahead.

Since you're seeing more demand for used classrooms, could you give us some color on what's happening at Enviroplex division?

Enviroplex is moving along. One of the challenges they've had is without available state bond money, they had to turn to other sources of revenue generation, which they've actually done a very admiral job through the Great Recession in doing more private and charter school type work. And they've built up a pretty nice following there.

With general demand increasing for classrooms and austerity measures being throttled back, that can only be good for Enviroplex in the long run. But what they're going to need really here is this next year, ideally if there's a bond measure passed and there's more monies available for new construction, which is really the bucket they pull from. The used market is kind of separate from their needs, but in some respects if you're seeing higher demand in all rental assets, that bodes well for the other side as well.

It means that there's likely smaller class sizes, increasing student population, and less austerity there overall.

You're not seeing much demand growth right there at present for new construction?

And that's tied directly really to the state bond monies availability. The way new school construction in California gets financed is half of it comes from the state and half comes from the district, and the district does that through parcel taxes and also through special bond measures locally. That funding has been pretty healthy right through the Great Recession, but what hasn't been there has been the state bond monies availability, and that's what Enviroplex and other manufacturers are looking for come 2014, because the last bond measure to pass was in 2006. That's at a state level that allowed for funding for new construction, and that took a number of years to use that up, but they've pretty much had a dry bucket for some time.

So if there is a bond measure in 2014, which we expect, and it passes, that should be a great shot in the arm for Enviroplex and other modular classroom manufacturers in the state.

Okay. Thank you.

Our final question is a follow-up question from the line of Joe Box with Keybanc Capital Markets. Please go ahead.

Yes. Just one quick follow-up, and I apologize if you gave this, but what was the TRS end of the quarter utilization rate?

End of quarter 63.3%, and that was unchanged from the end of quarter number, at the end of the first quarter but down when compared to the end of quarter number from a year ago, which was 65.7%. So 63.3%.

Is it normal for the utilization to trend down throughout the quarter?

You know that business, you can get big returns or a lot of equipment going out at once. It's really tough to gauge utilization in that business within a quarter and a time of year, perhaps except for the fourth quarter, which typically can be -- there's ramp down towards the end of it, but otherwise it's tough to draw any conclusions within a quarter in that business.

Understood. Thanks guys. Have a good night.

Mr. Kakures, there are no further questions at this time. Please continue with your closing remarks.

All right, thank you, Lilly. Well thank you all for joining us on our Q2 call this afternoon. We greatly appreciate your continued support. The next time we'll be chatting with everybody will be in very early November when we report our Q3 2013 results. Thank you again. Bye-bye.

Ladies and gentlemen, this concludes the McGrath RentCorp second quarter 2013 financial results conference call. This conference will be available for replay after 7 p.m. Eastern Standard Time today through August 7, 2013 at midnight. You may access the replay system at any time by dialing 800-406-7325 or 303-590-3030 and entering the access code of 4627691.

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