McGrath RentCorp (MGRC) 2013 Q3 法說會逐字稿

Welcome to the McGrath RentCorp third quarter 2013 conference call. (Operator Instructions) This conference is being recorded today, Wednesday, October 30th, 2013.

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

Thank you, Operator. Good afternoon. I'm the Investor Relations Advisor to McGrath RentCorp and will be acting as moderator of the conference call today.

On the call 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 4643659.

This call is also being broadcast live over the Internet and will be available for replay. We encourage you to visit the Investor Relations section of the Company's website at mgrc.com.

Our press release was sent out today at approximately 4.05 Eastern Time, or 1.05 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, 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 release on Form 8-K and the Form 10-Q for the quarter.

For the third quarter 2013, total revenues increased 10%, to $108.9 million from $99.4 million for the same period in 2012. Net income increased 1%, to $12.6 million from $12.5 million; and earnings per diluted share decreased 4%, to $0.48 from $0.50.

Reviewing the third quarter results for the Company's mobile modular division, compared to the third quarter of 2012 -- total revenues increased $6.7 million or 20%, to $39.7 million due to higher sales, rental-related services and rental revenues.

Gross profit on rents decreased $2.6 million or 27%, to $7.2 million, primarily due to a decrease in rental margins to 34% from 49%, partly offset by 5% higher rental revenues. Lower rental margins were a result of $3.6 million higher other direct costs for labor and materials and $0.2 million higher depreciation.

Selling and administrative expenses increased $0.9 million or 11%, to $9.4 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 $2.1 million or 45%, to $2.5 million.

Finally, average modular rental equipment for the quarter was $549 million, an increase of $23 million. Equipment additions were to support growth in Texas, Florida and the Mid-Atlantic region and for our portable storage business. Average utilization for the third quarter increased from 66.2% to 69.1%.

Turning next to third quarter results for the Company's TRS-RenTelco division compared to the third quarter of 2012 -- total revenues were flat at $33.9 million, as higher sales revenues were offset by lower rental and rental-related services revenues. Gross profit on rents decreased $0.9 million or 7%, to $12.1 million. Rental revenues decreased $0.8 million or 3%, and rental margins decreased to 47% from 49%, as depreciation as a percentage of rents increased to 39% from 36%, and other direct costs as a percentage of rents decreased to 14% from 15%.

Selling and administrative expenses decreased $0.5 million or 8%, to $5.7 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 decreased $0.6 million or 6%, to $9.5 million.

Finally, average electronics rental equipment at original cost for the quarter was $266 million, a decrease of $6 million. Average utilization for the third quarter decreased from 65.7% to 62.5%.

Turning next to third quarter results for the Company's Adler Tanks division compared to the third quarter of 2012 -- total revenues increased $2.4 million or 10%, to $25.8 million, due to higher rental and rental-related services revenues, partly offset by lower sales revenues. Gross profit on rents increased $1.3 million or 11%, to $13.1 million. Rental revenues increased $2.3 million or 13%. And rental margins decreased to 68% from 70%, as depreciation as a percentage of rents was flat at 18%, and other direct costs as a percentage of rents increased to 13% from 12%.

Selling and administrative expenses increased $1.4 million or 29%, to $6.4 million, primarily due to increased personnel and benefit costs. As a result, operating income increased $0.9 million or 12%, to $8.5 million.

Finally, average rental equipment for the quarter was $268 million, an increase of $36 million. Average utilization for the third quarter decreased from 68.9% to 66.8%.

On a consolidated basis, interest expense for the third quarter 2013 decreased $0.2 million or 7%, to $2.1 million from the same period in 2012 as a result of the Company's lower average debt levels, partly offset by higher average interest rates. The third quarter provision for income taxes was based on an effective tax rate of 39.2%, unchanged from the third quarter 2012.

Next, I'd like to review our 2013 cash flows. For the nine months ended September 30th, 2013, highlights in our cash flows included -- net cash provided by operating activities was $99.9 million, an increase of $8.9 million compared to 2012. The increase was primarily attributable to a lower increase in accounts receivable and prepaid expenses and other assets, partly offset by a lower increase in deferred income, lower income from operations, and other balance sheet changes.

We invested $93.4 million for rental equipment purchases, compared to $106.2 million for the same period in 2012. And proceeds from the sales of used rental equipment were higher by $4.8 million. Property, plant and equipment purchases decreased $3 million, to $8 million in 2013.

Net borrowings decreased $21 million, from $302 million at the end of 2012 to $281 million at the end of the third quarter 2013. Dividend payments to shareholders were $18.3 million.

With total debt at quarter end of $281 million, the Company had capacity to borrow an additional $249 million under its lines of credit. And the ratio of funded debt to the last 12 months' actual adjusted EBITDA was 1.76 to 1.

For 2013, third quarter adjusted EBITDA increased $1.2 million or 3%, to $43.4 million, compared to the same period in 2012, with consolidated adjusted EBITDA margin at 40%, compared to 42% 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 reconfirm our previous 2013 full-year earnings guidance range of $1.65 to $1.80 per diluted share.

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

Thank you, Keith.

Although we are disappointed that companywide net income was relatively flat, and EPS down 4% 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. A higher fully diluted share count from a year ago led to the $0.02 reduction in EPS.

Now, let's take a closer look at each business for the quarter. Modular division-wide rental revenues for the quarter increased by $1.1 million or 5%, to $21.1 million from a year ago, as well as sequentially from the second quarter of 2013.

During the third quarter, we experienced a 15% increase in division-wide year-over-year first month's rental revenue bookings for modular buildings with an increase of 39% in California and a decline of 3% outside of the state. Over the first nine months of 2013, we experienced an 18% increased in division-wide year-over-year first month's rental revenue bookings for modular buildings, with an increase of 24% in our markets outside of California and 11% within the state.

Rental bookings in 2013 are at their highest levels since 2007 prior to the Great Recession. Rental bookings have continued favorably into the fourth quarter. A number of orders booked over the past few months only billed for a portion of the third quarter or are not scheduled to ship and bill until either the fourth quarter of 2013 or the first quarter of 2014. We also continue to see rental rates rise for various-size products as demand exceeds readily available supply.

Modular division ending utilization for the third quarter of 2013 rose to 70.4%, compared to 66.6% a year ago and 67.6% at the end of the second quarter 2013. This is the highest modular division utilization level since the second quarter of 2009.

Modular division income from operations for the quarter decreased by $2.1 million or 45%, to $2.5 million from a year ago. The reduction in operating income is directly related to the increase in overall divisional booking levels and the significant increase in related inventory center costs for labor and materials to prepare and modify equipment for rental. This is compounded by needing to redeploy various rental assets that had been sitting idle for extended timeframes which tend to have higher processing costs than inventory that turns more frequently.

In fact, inventory center costs primarily for the preparation of booked orders and anticipated near-term orders were approximately $3.6 million higher during the third quarter compared to a year ago. For the first nine months of 2013, these equipment preparation costs are approximately $5.9 million higher than for the same time period in 2012.

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 are beginning to see the early signs of quarterly rental revenue and utilization lift from the past few quarters of these higher-than-normal inventory center expenditures.

We also had higher SG&A expenses during the quarter from a year ago. These costs were primarily related to increased sales and operations staffing levels to support the recovery of our modular rental business, as well as a continuing expansion of our portable storage rental business.

Finally, some of these increased costs were offset by higher gross profit on sales of equipment, as well as on rental-related services 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 $2.3 million or 13%, to $19.1 million from a year ago. New business activity as measured by first month's rent in units booked continued favorably, with increases of 20% and 26% respectively from the same period a year ago.

With an increasing mix of non-fracking-related rentals, we are seeing shorter average rental terms and greater turn of rental equipment, which has put downward pressure on utilization. Average utilization was 56.8% for the third quarter, compared to 68.9% in 2012. However, average equipment on rent was $179.4 million during the quarter, compared to $159.8 million a year ago.

This is reflective of our need to continue to acquire a variety of tanks and boxes other than 21K standard frack tanks, to support non-fracking end markets. In fact, during the third quarter, non-fracking-related rental revenues increased by 24%, to 88% of our rental revenue mix from 81% for the same period in 2012.

Adler is serving a wide variety of market segments including industrial plants, 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.

Although we were disappointed with Adler's results for the first half of 2013, third quarter divisional income from operations increased by $0.9 million or 12%, to $8.5 million from a year ago. We benefited favorably from increases in both rental and rental-related services gross profit during the quarter due to higher business activity levels and movement of incoming and outgoing equipment from the same period in 2012.

However, we also experienced significantly higher SG&A expenses overall from a year ago, primarily due to increased business activity levels and related sales compensation, additional headcount and facility infrastructure costs associated with building out a broader national footprint, and higher bad debt and health insurance costs. Over the past 21 months, Adler Tank Rentals has entered 10 new US markets to support higher rental revenue and earnings growth in the years ahead.

Finally, inventory center expenses were also higher as a percentage of rents from the same period in 2012 due to the increased flow of incoming and outgoing equipment.

Now, let me turn our attention to TRS-RenTelco and their results. TRS-RenTelco, our electronics division -- rental revenues for the quarter decreased by $0.8 million or 3%, to $25.7 million from a year ago. The decline is directly related to the sale of our environmental test equipment assets and related rental revenue stream late in 2012.

We also experienced lower business activity levels for general-purpose test equipment with high-tech and aerospace and defense firms. This is further reflected in average utilization for the quarter of 62.5%, compared to 65.7% in 2012. In part, we believe the softness in general-purpose test equipment rentals during the third quarter is related to the federal sequester in aerospace and defense-related budgets.

Average monthly rental rates for the quarter actually increased to 5.15% from 4.95% compared to a year ago. However, this is primarily due to an increased mix of communications test equipment which has shorter depreciable lives but higher rental rates than general-purpose test equipment.

Excluding environmental test equipment rental revenues for 2012, TRS-RenTelco rental revenues grew by approximately 1%. However, divisional income from operation decreased by $0.6 million or 6%, to $9.6 million for the quarter. The higher percentage reduction in income from operations as compared to rental revenues is primarily due to higher depreciation expense as a percentage of rents and lower profit on equipment sales, partly offset by lower SG&A and laboratory costs, as compared to the same period in 2012.

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 revenues from a year ago.

Rental revenues for the third quarter of 2013 grew by 35% from a year ago, as well as 16% sequentially over the second quarter of 2013. Income from operations also grew favorably from a year ago.

We are continuing to execute on our 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're also continuing 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. As I shared with our second quarter 2013 results, we believe that each of our four rental businesses is fundamentally sound, strategically well positioned and well capitalized, both financially and operationally, to thrive in the years ahead.

Although modular building inventory center preparation expenses incurred during the third quarter and year-to-date are significantly higher than a year ago, we couldn't be more pleased to finally experience the strong modular building market activity that is driving these higher costs in 2013.

To emphasize -- these costs are for modular building equipment preparation, including labor and materials to support maintenance, repairs and customer-driven modifications. We should benefit from these expenditures in the quarters ahead through rental revenue in utilization growth.

To the extent that we continue to experience elevated inventory center expenses for modular building preparation, it would likely mean that market demand is staying strong and that rental revenue and utilization levels are recovering further. At some point in the quarters ahead, these inventory center modular building preparation costs should normalize as we benefit from equipment turns that do not require the extent of work that some of the sitting inventory has over the past year. We should also see favorable gross profit on rents and margin expansion at that time.

Please keep in mind that McGrath RentCorp 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 $249 million under our lines of credit. We can be very opportunistic in growing our business lines with the availability of such funding.

Finally, 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 third quarter of 2013 towards achieving these goals.

And now, Keith and I welcome your questions.

(Operator Instructions) David Gold, Sidoti & Company.

A couple of questions around mobile modular. First, wanted to get a sense -- obviously, it's at this moment, really good news with a little bit bad news story of the step up in revenue utilization and a little bit more cost. I wanted to get a sense for, if we can, how much more could be out there by way of cost? So in other words, maybe an easy way to do it is to think about it on a unit basis of how many units might be subject to preparation and maybe repair and maintenance costs, for them to be able for you to get them back out there on rent?

David, just a couple of thoughts on this. And as Dennis's comments reflected, the direct cost of rental operations -- it's really about preparing units for rent. And if we look at year-to-date, the expenses we incurred were up 32% compared to last year.

And the way I'd frame it is the following. The money we spent was really driven by three reasons. The first is we did experience a big uptick in modifications or customizations that are customer-requested. And typically, we get paid for doing that work, but we don't get the revenue. We only get that over the course of the lease. So we're spending the money up front. You're seeing that in the income statement. But we don't get the revenue benefit until future periods.

The rest of the spend is really a combination of much higher volume in terms of units and square footage that we're preparing for customer orders. And in some cases, we're spending more because some of those units have sat idle for an extended period.

So the way I'd look at it is about a third of the increase year-over-year was related to those customer modifications and customizations. The rest is really tied to volume issues and, probably secondarily, to more cost per unit that sat off rent for an extended period.

So we're incurring a lot of this expense ahead of really seeing the revenue. Some of the units that we did work on did go on rent in the third quarter. But we only recognized revenue for part of the quarter. And we're going to see more units go out in the fourth quarter and some even early next year.

So it's hard to be precise about how much more of this expense we're going to have. It's all really tied to the health of customer demand. And we're pleased to see the demand much more healthy today than we've seen really in the last several years.

And Dave, I might add the other piece. Keith has done a very good job of outlining the cost surge. I think the other piece is you should start seeing -- if we're continuing to have these higher expenses, you should start seeing considerable lift in rental revenues and in utilization over the quarters to come.

So they're the best expenses a company can have in terms of taking legacy inventory and getting it turned around; back out. And when that equipment recycles again, we will have the lower costs typically associated with future turns.

Sure. That's definitely helpful.

I guess what I'm trying to get a better sense for -- and obviously it's hard, from the outside looking in -- is if we think about it, presumably since, let's say, 2008, basically utilization has jumped around. So presumably, you have units that are out there that maybe haven't been touched in four or five years. And so just a better sense for -- if we looked at in aggregate, what the potential cost -- whether it were in one quarter or over the next two years -- what we might be looking at -- just have a sense for what the potential exposure is before we start to see that return on it.

Yes. What I'd say -- the way the calculus will work is -- as utilization increases with more units being on rent, [we're] also have more of an opportunity to see rates move up in many categories of product around the country. Not everywhere, and not all at the same time. But what we'd look to see is the benefit of improving utilization, more units out on rent, and the rental rates also adding to the revenue lift.

And as we get these units out on rent, our typical rental terms can be two years plus. Contractually, we're at close to two years. A lot of units will stay out on rent beyond the initial contract. What we're really absorbing is the upfront cost of getting units out on rent which haven't been out on rent because our utilization was in that sort of 66% to 68% range for the last four years.

Yes. And David, I would also emphasize -- it's a near-term, if you want to call the next year to 12 to 15 months -- it's a near-term [phenomena]. But it's the absolute one that we need to really get that business turned around and see the kind of margins we're experiencing historically for that business prior to the Great Recession.

So it's a near-term -- as you said, it's kind of a near-term bad news. But it's tremendously good news supporting the growth side. So granted, it's hard to have the exact crystal ball here to know what -- we do know this year, there's about $0.14, if you look at EPS, that's associated with the higher cost in the inventory center over last year.

Now, you can imagine the horsepower going forward when you're not having those type of heavy inventory center expenses.

Yes. And David, I think you'll find, when you look at fourth quarter, we'll see the benefit of the units that have gone out on rent will be in the numbers for the full quarter from a revenue point of view. And when we're busy in the inventory center, typically the second and third quarter are the busier periods.

So when we look at the fourth quarter, our expenses may well be higher than a year ago, just related to better business conditions. It's unlikely they'd be as high as what we saw in the third quarter.

Got you.

One last sort of crack at it, or just another look -- can you give a sense for, say, on an average mobile modular unit, what the incremental cost is of prepping it, if it's been on the sidelines for three or four years? Is it $1,000, $2,500, $3,000?

David, it really depends on the type of equipment that you're dealing with. For example, a classroom product typically has less expense than potentially a commercial complex building. If you had a commercial complex building that had an existing floor plan, if it has to be basically retrofitted or re-modified to be able to support a new floor plan, et cetera, those expenses can be very significant.

For the classroom, it may be the fact that you're going to replace the carpet, that you're going to reload the foundation material, because it can really only be used once. And those are costs that we have to absorb to be able to get that classroom back out. But really not a lot of repair to the product, or certainly no modification work, just in our classrooms.

The one item here that we should talk a little bit about is mix. A lot of the work that we've been doing over the last couple quarters -- there's been some classroom work. But a lot of it has been commercial, which is probably our higher-touch products, both in single-wides as well as in complexes. Because they already have certain prior tenant improvements in them. And to re-outfit those buildings, et cetera, can take some added cost during the period. Now, we're actually in a situation where we're having to go deep into our inventory levels because of shortages of equipment in various sizes.

So some good problems to have in near-term cost, that certainly make perfect sense to us. And it's all about driving utilization higher, getting higher rental rates, which we're seeing as well in various product sizes very favorably; and then driving that top rental revenue line. And then we'll get to some normalization on inventory expenses here in the not-too-distant future. And then we should really see margin expansion grow quite favorably.

Perfect. That's helpful, thank you both.

Joe Box, KeyBanc Capital Markets.

Couple of questions for you on Adler. I get that the mix has shifted toward shorter-duration rentals. Can you just help us understand -- one, what the typical difference is in yield between long rents versus short rents? And then, two, can you maybe put some color around what the specific variable costs are, just from touching the assets more?

Well, if you look at -- let's go back to the big mix of fracking rentals that we had when we were about -- they made up about 35% of our rental revenue mix. A lot of those transactions were multiyear. They were one-, two-, three-year transactions. And you can imagine, you ship a brand new piece of equipment from a factory -- it goes onsite and it goes on rent, and you don't touch it for two to three years. And that was in a market, too, where rental rates were very high, because there was a supply-demand problem with equipment versus demand.

So when you look at that type of income stream -- contiguous, coupled with very low costs, because you're using brand new equipment -- the kind of margins you're able to drive out of that business are very significant.

In the world here where there's less fracking, or fracking is more competitive and we're changing the mix, these transactions -- when a piece of equipment turns, there aren't really high touch costs for Adler in turning equipment. What happens, though, is equipment is on rent for three or four months. It comes back in, it sits for a month, and then it goes out for another two or three months, and then comes back in and sits for a month or two and goes out for another three or four months.

So you lose the contiguous nature of that income stream. Plus you still are having to touch it maybe three times in a year, whereas before you weren't having to really touch it but every two or three years. And those touch costs are -- typically, you're doing some painting, maybe have to change a valve. Very different product in the modular product; it's a fairly low touch cost to that product.

So those are kind of the differences. That longer-term -- term is everything in our rental businesses when you start looking at really strong margins.

Yes.

So the other piece is here -- and as I mentioned in the prepared comments, the movements in and out -- when there's more turn, we actually benefit from that. Because that business, we can generate healthy margins on the shipping expenses as well as on the return expenses. So that really helps on the profitability side of things.

But if we had our druthers, we'd love everything to be out on rent for two to three years, and not have to touch it. But this is actually very healthy business that we're picking up. It's the industrial plant business, it's more maintenance-related. It's a lot of pipeline work, it's building infrastructure, et cetera.

So we still love the fracking business. But we've done a good job of really rounding out these other verticals that are less volatile.

And --

That's helpful. I'm sorry, Keith, go ahead.

Yes. Joe, one metric you can look at on the income statement, when we break out the individual segments -- if you look at that direct cost of rental operations other for the Adler business, that in the last seven or eight quarters has typically been somewhere in the 10% to 15% range.

So you can think of it as shorter-term project, if you still have to touch the unit; get it prepared for the next rental. Shorter terms are going to drive you higher in that range. Longer terms are going to drive you lower. But if you just look at our experience -- we've been in that 10% to 15% range in terms of that cost as a percentage of the rental revenue.

Okay.

And obviously, there's a lot of moving pieces here. And I guess, Dennis, I would've thought that even though maybe you were able to charge for transportation more, ultimately, the more you're touching the assets, the lower the gross profit would be.

So I guess my next question is -- as you look at gross profit for Adler, should we think about the margin profile in the mid-50s being an appropriate margin? Or do you think that there's probably some things that you could adjust to eventually bring that back into the 60% range? Given the mix shift that you're seeing now, how should we think about that margin profile?

Well, let me add in one other item to help complicate matters, at least on this past year's numbers. Remember in the last 12 to 15 months, due to the Marcellus Shale dynamics and the redistribution of equipment, we have a category that's called freight-in expense. That's that cost to be able to move equipment either intra-regionally or inter-regionally, to be able to get it into markets, more fully utilize our newer markets, et cetera. Those are costs that we would not expect to have to the same degree going forward. That's in those numbers currently. So I'm just adding -- that's another variable that just because of the build-out if the business over time, coupled with that returning equipment -- those are expenses that you really would not have to the degree that we have going forward.

So that's a good guide that will help on margin. And those costs were not insignificant in the past 12 to 15 months. But they certainly have steadily gone down here over the past year.

And Joe, keep in mind we're still building out the Adler Branch network. We've had equipment moves, as Dennis described it. But I would say another metric we look at, which is the depreciation expense as a percentage of the rental revenue -- that also is not at a steady state. Our utilization's a bit lower than we'd like, and that hurts us on that metric. And that erodes some of the gross margin opportunities.

So it's just another factor to consider when you look at the fleet we have today, how many of the units are on rent today, and where that might be at some point in the future.

It'll be five years owning the business come early December this year. Imagine that. [We're] almost been at it five years. Yet, we're still trying to find out what normal looks like. And that's not a bad thing; that just means that the business is moving quickly; it's growing. We're trying to make the right chess moves based upon what we learn as we go. And we should be able to have greater visibility on the margin picture over time here.

And again, we're just continuing to make appropriate adjustments. But very healthy margin business over time. And we're going to have some of this ebb and flow.

Understood.

Switching over to the modular business -- Dennis, you've always talked about modular pricing potentially correcting upward when demand starts to outstrip supply. You alluded to it earlier. I'm curious if that's across the board for all product types, or is it still just the large building complexes that are maybe a little bit tighter on supply?

Well, it's certainly in the large complexes. And where we started [begin] seeing it, particularly in California, has been in the single-wide fleet, when you look at 12-by-60 product, 12-by-42, et cetera. Just having that initially, when business uptick was still fairly competitive.

But what starts happening is the further you've got to go into your availability supply and longer days to ready to prepare equipment -- inventory centers take on costs. You want to help cover those costs. And anybody in the business is dealing with the same dynamic. Demand picks up, and you can actually -- if a customer's trying to get his unit in a timeframe to support his project, in effect, you can charge more to be able to turn that product.

But we've seen very healthy increases in single-wide product, whether it's general construction or general commercial office space needs. That has been a very good [find] for us. And we'll continue to repair and bring up to speed existing inventory that we have to be able to support that. But we're also starting to see it now in some of the smaller complex product as well.

So there's a lot of goodness happening across the board. And if you look at our other markets, our Texas market is seeing similar dynamics but probably on a much broader scale than we have yet in California. And then, the Florida market has continued very strong in terms of the hybrid classroom product being in very favorable pricing, and with some uptick here a little bit on the commercial, but still pretty competitive there.

Thanks. And actually, just one follow-up on that, and then I'll hop back in queue.

And I know I ask this every time, but are you at the point now in the cycle where rates for units that are going out on rent are actually going out at a higher rate than the ones that are actually being returned? And I know it probably varies significantly across the fleet.

Well, it depends on what's being returned. If it's equipment that went out during the Great Recession that's being returned, it's likely it could be higher. But it really depends.

I want to add one other item here that helps getting rates higher. Anytime a customer, regardless of the building size, has a modification to be made -- and these are, in effect, our tenant improvements; they want a certain layout, et cetera -- that's one of our great strengths. We do all of that work in-house with our own folks. And when we get really busy, we bring in outside contractors that work in our inventory centers. That helps to be able to drive the base rental rate higher in the building. Because unless you can do that modification, you can't really get that rental.

And not everybody can do it as quickly, as efficiently and as professionally as we can. And that really helps us be able to drive the overall rental rate higher for that product.

Thanks. I'll hop back in queue.

(Operator Instructions) Scott Schneeberger, Oppenheimer.

On TRS-RenTelco, you cited some headwinds with government, the sequester, and high-tech. Could you take us a little deeper there? We're seeing the utilization trickle down a little bit. And I'm wondering how long you think this'll be sustained on the government side. And then, if you can delve a little bit deeper into what you're seeing on high-tech? Thanks.

Yes. The high-tech [convet] is primarily related to the semiconductor industry that has had some softness. And so in aerospace and defense, I think that speaks for itself, with some of the defense cuts.

Quite frankly, I'm not overly concerned with either of those segments at present. In fact, we're looking for greater lift on the high-tech side of things, come in the second part of the first quarter next year; maybe second quarter, third quarter. So we think there are just some timing issues here, but no real structural issues in those industry sectors. So fortunately, we've done a good job of being able to keep costs down for that business. And even despite some of the revenue shortfall there, they've been doing very well. And we think we're well positioned going into next year. So this is just some near-term softness that we have felt.

Thanks, Dennis. And your answer right there was not only to high-tech but also to aerospace and defense on timing?

Right. It's interesting, if you look at aerospace and defense -- we have one or two customers we're doing very good business levels with, and there's some other ones we're not. So it's a little bit of who's in your mix versus your competitors. And you just kind of go with the flow there.

But we're not seeing anything too demonstrative there on the downside. And overall, I think both those sectors will be fine over time. But there's some current softness.

Thanks.

Switching [over on the horn] a bit -- on Adler, one of the things -- and this might be broadly for across the whole group -- but Adler -- you've cited healthcare costs. Is that because you're hiring rapidly? Or does that have anything to do with what you're anticipating upcoming for 2014 for the whole business, and maybe some positioning you're doing?

I will just say this -- it's too early in the whole healthcare view of things to make complete predictions there. I will just say two things. One is there is some added expense on the healthcare side, mostly related to additional hires. That's our biggest bucket. And we would expect that to occur as we're growing, et cetera. And we're obviously, as a management team -- we over the last couple years have spent a lot of time analyzing healthcare costs and how best to address a more costly world. And we continue to do that work, and we're still in the throes of that currently, with our 2014 financial planning.

So, more to come on that front. But we're looking at a lot of different ways to help reduce those costs, including potentially self-insuring within the Company. So again, there's just a lot of pieces to that.

Okay, thanks. That covered what I was looking for there. I appreciate it.

Sticking in Adler -- on the CapEx side, you made the comment just a little while ago, Dennis -- you're still trying to find your way on what is normal in that business after five years. And you certainly have been aggressive in continuing to grow in size. You cited buying some less standard type of equipment to fund non-fracking markets. And again, I think all of this is very constructive. But can you speak to how you think about balancing CapEx, and pushing forward as opposed to maintaining the utilization level, and just delving into it? Hopefully, you understand the concept of the question.

Absolutely.

As I mentioned, we've entered 10 new markets in the past 21 months. That's no small undertaking. And each one of those markets is at a different point in its evolution. And one of the things is you've got to make certain that they're outfitted with various types of equipment.

Now, we certainly have not been ordering, we have not ordered, any 21K frack tanks for quite some time. Because we're really making use of that distribution of equipment.

Now, there are different types of tanks. Whether they're Weir tanks or open-top tanks -- we have vacuum boxes, we have regular standard [falluds] boxes, mix tanks, double-wall tanks. There's a wide variety of equipment that's used in the industry. And as we shift more towards perhaps a non-fracking or building out the verticals that are non-fracking, they have higher demand in various product areas.

But if you were to look across the board at our inventory, and if you had a list in front of you -- the only real weak area would be in the 21K fracking arena. I would say virtually everything else is pretty healthy utilization levels. And we realize that, with the size we're becoming, we need all that 21K fracking equipment that we have already. It's just a matter of getting it distributed properly, and we've done that for the most part; and seeing some greater lift overall in some of those markets.

So we think we're making the chess moves correctly. But it just takes time to have things settle out. But the purchase [orders] we're making almost exclusively are for much higher-demand product.

Thanks.

And then, lastly, a question in modular, and it's actually kind of re-asking one of David's questions. Obviously, you're going to have these elevated operating expenses when you are getting the stuff that's been lying fallow back out on rent.

One of your responses to David was -- it could take 12 to 15 months of heavy cost. And therefore, obviously we know what comes after that. It would be a very ideal earning scenario if you have elevated growth over the next year. But it seems like it may be even be an earnings headwind over the next year under the way it simply worked on the timing over the life of having these out on rent, and the upfront costs.

But you also said, Dennis, that year-to-date -- you'd cited, I think it was, year-to-date up 32%. And I'm curious -- might we annualize sooner than 12 to 15 months in a really bullish environment on the cost? Did this build start earlier, or is that growth really predominantly third quarter? I hope the question is clear.

Yes. Hopefully, I'll be able to give you an answer that kind of rounds out everything.

We've had a couple quarters in a row here, the second and third quarter this year, that have had very lofty building preparation costs that really speak to demand. In fact, the first quarter, I think, was fairly up there as well. So we're already into it. When I talk to 12 to 15 months, we've already been at it for a couple of quarters now minimally.

And as I sit here, if we're going to continue to spend at this level, it's kind of like the best thing that we could have asked for if it's related to, as Keith mentioned, increased volume and modification work. And you're always going to have with that some additional prep costs if you've had equipment sitting for extended periods of time.

Personally, I think, going forward from here, we should see rising rental revenues and utilization in the quarters ahead. And when you look at margins, I would think they're getting healthier already because of the income stream we're going to be getting for what we've already put out, and for what we've booked and haven't built yet, which -- we've got some good work in Q4 and Q1 that we're looking towards. And again, those will be there for, in many cases, many years to come. Because they're longer-term transactions.

So the way I'd answer that is that even though I speak to potentially higher expenses going forward, this year was a pretty heavy spend year so far. If we did this again, we'd likely have much higher utilization. We'd be bucking north of 75% next year sometime.

So it's tough to kind of get a complete feel for everything. But quite frankly, I think, with what we should be seeing in the way of rental revenue growth, that that is going to really help offset any increased expenses that we see from the [ISD].

And again, I would be surprised personally if next year was higher than this year, in the way of ISD expenses. We have done a lot this year. Next year will likely be more classroom-related, I would think, which tend not to have as much of the deferred maintenance or of the major re-outfitting involved with them. But time will tell.

But I think we're -- I wouldn't be surprised if we saw better margins even in the first quarter of next year.

Thanks very much. And thanks for taking all the questions.

There are no further questions at this time, gentlemen. Please continue with your closing remarks.

I'd like to thank everybody for joining us this afternoon. We appreciate you and your good questions.

Our next investor get-together will be towards the end of February 2014, when we share our fourth quarter results as well as our 2014 guidance.

Thank you all for being with us. Have a good evening.

Ladies and gentlemen, this concludes the McGrath RentCorp third quarter 2013 conference call. You may now disconnect.