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Welcome to the McGrath RentCorp Third Quarter 2018 Conference Call. [Operator Instructions] This conference call is being recorded today, Tuesday, October 30, 2018.
Before we begin, note that the matters that company management will be discussing today that are not statements of historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our 2018 total company operating profit outlook as well as statements relating to the company’s expectations, strategies, prospects or targets. These forward-looking statements are not guarantees of future performance and involve significant risks and uncertainties that could cause our actual results to differ materially from those projected.
Important factors that could cause actual results to differ materially from the company’s expectations are disclosed under risk factors in the company’s Form 10-K and other SEC filings. Forward-looking statements are made only as of date hereof. Except as otherwise required by law, we assume no obligation to update any forward-looking statements. 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.
Speaking today will be Joe Hanna, Chief Executive Officer; and Keith Pratt, Chief Financial Officer.
I will now turn the call over to Mr. Hanna. Go ahead, sir.
Thank you, Latif. Good afternoon and thank you for joining us on today’s call. I will start the call with some comments on our third quarter performance and then Keith will provide greater detail in his financial review and outlook comments.
First off, we delivered very strong performance during the third quarter. Overall rental revenues grew 11% and operating profit grew 18%. I was especially pleased with our performance at Mobile Modular and Adler. During the third quarter, Mobile Modular shipments were robust with broad-based demand resulting in quarter-end utilization above 79% and a 21% increase in operating income. At Adler, we continued to see positive market trends resulting in quarter-end utilization rising to 64% and a 30% increase in operating income. In both cases, our focus on deploying fleet we already own can be seen in these healthy utilization and operating income gains. We are realizing growth from all of our business units across a wide range of customer verticals. I am happy to say that each of our leadership teams have embraced our capital allocation strategy and performance improvement initiatives to take advantage of good market conditions. We have been able to move through a lot of intense work over the past few years and our efforts are being realized in our positive performance trends. Most important during the period of change and readjustment and how we run the business, we have been listening to what our customers tell us and we have not missed a beat. They have appreciated the consistent exemplary service experience, which highlights our execution ability. Culture matters, and at McGrath RentCorp, we have a carefully groomed culture of service and performance that our customers have come to associate with our brands. We call it the McGrath way.
As we move forward, I still believe we have more opportunities to improve performance. Our efforts to increase pricing with better analytics and information has helped the Modular division deliver a 9% improvement in run-rates this quarter, an upward trend that has been maintained throughout the year. We have focused our sales teams in Mobile Modular, Adler and Portable Storage to spend time with customers that will provide more favorable long-term results and more profitable transactions and we are encouraged by the progress we have made so far.
Looking at CapEx, we will most likely end the year spending over $100 million for rental equipment and most of that is for TRS and Mobile Modular. We are committed to deploying capital wisely on behalf of our shareholders. We have a good process in place to estimate the financial returns for rental equipment purchases and our approvals come with the expectation we meet certain thresholds. Overall, the net increase in the fleet was 3% year-to-date. So, we are managing the inventory appropriately by selling underused fleet and buying to meet demand where it is needed most.
In the third quarter, we completed a small acquisition for a provider of blast-resistant modules or BRMs. This product is used in petrochemical plants and refineries to provide workspaces in blast hazard zones. It is an established product and we have had a great opportunity to augment our modular building fleet with a complementary rental product line. Demand for the BRMs is strong and we expect to make more investments in this product category. We are pleased to add this product to our fleet and look forward to growing it.
Looking ahead, we feel good about our fourth quarter and due to our strong results we are raising our guidance for 2018 as Keith will detail later in the call. Business conditions are good and funding is available for projects. Rental revenue growth is strong and we are focused on our initiatives to deliver improved financial returns. Our strong third quarter performance would not be possible without the incredible commitment and dedication of our employees. Thank you for caring as much as you do and for working so hard to keep our customers happy and our company strong.
Let me turn the call over to Keith now who will take you through our financial review.
Thank you, Joe. Total revenues increased 6% to $143.1 million for the third quarter of 2018 from $135.4 million for the same period in 2017. The company’s 18% operating profit increase for the quarter was driven by a $5.2 million increase in gross profit from rental revenues. Net income increased 48% to $24.8 million from $16.8 million, and earnings per diluted share increased to $1.01 from $0.69. The third quarter of 2018 includes a net income benefit associated with the Tax Cuts and Jobs Act or the tax act that was enacted in December 2017. The tax act reduced the U.S. federal corporate statutory rate from 35% to 21%, which contributed $0.19 to earnings per diluted share in the third quarter 2018.
Now, let’s review rental divisions’ performance compared to the third quarter of 2017. Mobile Modular total revenues increased $6 million or 9% to $74.9 million on higher rental and rental-related services revenues, which were partly offset by lower sales revenues. Rental revenues for the quarter increased 14% from a year ago, primarily driven by a 9% improvement in average rental rates and 4% higher average equipment on rent. Sales revenues decreased $0.4 million or 2% on lower used equipment sales. Rental revenue growth continued to be healthy across our commercial and education markets as well as in our portable storage business. Equipment preparation cost or other direct costs of rental operations increased $1.3 million, or 13% to $10.7 million. Rental margins increased to 61% from 59%. The combined result of higher rental revenue and higher rental margin was a 17% increase in gross profit on rents. Finally, average modular rental equipment for the quarter was $760 million, which was an increase of $11 million. Average fleet utilization for the third quarter increased to 78.6% from 76.3%.
TRS-RenTelco total revenues increased $0.8 million [ph] or 3% to $28.1 million on higher rental revenues partly offset by lower sales revenues. Rental revenues for the quarter increased 6% primarily driven by 8% higher average equipment on rent, which was partly offset by 2% lower average rental rates. Rental margins decreased to 42% from 45%. The combined result was a gross profit on rents comparable to 2017.
Test equipment rental revenues for general purpose and communications increased by 7% and 1% respectively. We continue to invest in general purpose test equipment for growth opportunities. Finally, average electronics rental equipment for the quarter was $280 million, which was an increase of $26 million. Average utilization for the third quarter decreased to 61.9% from 63.4%.
Adler Tank Rentals total revenues increased $2.6 million or 11% to $26 million on higher rental and rental related services revenues, which were partly offset by lower sales revenues. Rental revenues for the quarter increased 13%, primarily driven by 11% higher average equipment on rent and 2% higher average rental rates. Rental margins increased to 61% from 60%. The combined result was a 16% increase in gross profit on rents. Adler’s rental revenue growth was broad-based with increases in four of our five regions and five of our six vertical markets. Upstream oil and natural gas accounted for 10% of total rental revenues. While our average fleet size was up only 1% year-over-year, we continued to focus on better utilization of the existing fleet.
Now, with this division review complete, the remainder of my comments will be on a total company basis. Selling and administrative expenses decreased $0.2 million or 5% to $28.3 million primarily due to lower bad debt expense. On a consolidated basis, interest expense for the third quarter 2018 increased $0.2 million or 5% to $3.1 million. Higher net average interest rates were partly offset by lower average debt levels. The third quarter 2018 provision for income taxes was based on an effective tax rate of 23.9% compared to 38.7% in 2017. As discussed earlier, the primary driver of the decrease was the passage of the tax act.
Next, I would like to review our 2018 year-to-date cash flow highlights. Net cash provided by operating activities was $96.8 million, an increase of $15.7 million compared to 2017. The 19% increase was primarily attributable to improved income from operations partly offset by a higher increase in prepaid expenses and other assets. We invested $84.7 million for rental equipment purchases compared to $73.2 million for the same period in 2017 due to higher purchases at TRS-RenTelco and Mobile Modular. In addition, we invested $7.5 million in cash to purchase a BRM rental business during the third quarter as discussed by Joe. Property, plant and equipment purchases decreased $0.4 million to $12.5 million in 2018. Net borrowings increased $5.6 million from $303.4 million at the end of 2017 to $309 million at the end of the third quarter 2018. Dividend payments to shareholders were $22.7 million.
As highlighted in our press release, the increase was primarily due to a 31% increase in the dividend rate year-over-year. At quarter end, the company had capacity to borrow an additional $223 million under its lines of credit and the ratio of funded debt to the last 12 months’ actual adjusted EBITDA was 1.58 to 1. Third quarter 2018 adjusted EBITDA increased 13% to $57.3 million compared to the same period in 2017. Consolidated adjusted EBITDA margin was 40% and 37% in the third quarters of 2018 and 2017 respectively. Our definition of adjusted EBITDA and a reconciliation of adjusted EBITDA to net income are included in our press release for the quarter.
Finally, turning to our 2018 financial outlook, we are raising our expectation that full year company operating profit will increase 18% to 21% above 2017 results as compared to our prior expectation of an 11% to 15% increase.
That concludes the prepared remarks on our quarterly results. Latif, you may now open the lines for questions.
Thank you. [Operator Instructions] Our first question comes from Scott Schneeberger of Oppenheimer. Your line is open.
Thanks very much. Good afternoon. Hey, guys. I would like to start in Modular, just few questions there. You mentioned in -- strange nitpick I am going to do, but you mentioned strong across commercial and education markets in most regions. Was there any weak region and then a follow-up question on this is, in the fourth quarter, how might be and year-over-year comps how may have the hurricanes impacted third quarter and then again what happened here in fourth quarter? Thanks.
Sure. Yes, the one region where we have seen just a little bit of weakness in or flattish opportunity has been in Texas and that was characterized mostly by strong returns that we got. We had some large projects that were out and we got those returns back during the year, but I was down there with the team a week or two ago and we have got a lot on the horizon. There is a lot of activity and I was encouraged to see that we have got some very nice projects that were in the process of quoting right now. So even though we got off to a little bit of a rocky start there, I am very pleased about how the demand picture looks. And then just to answer the hurricane question, Florence not much. It’s been fairly quiet for us on that front. Michael, the one that came up through Florida, we had a team on the ground there and there is going to be some classroom demand that we should see as number of schools in Bay County in Florida there got severely damaged and so we are in the process of working with some of those officials to solidify what that demand might look like. So, that’s kind of how the picture looks. So, I don’t see it really going to be a big influence on our results, so.
Alright, thanks for sharing that. One more in Modular, in the broad segment, BRM sounds very interesting, could you elaborate a little bit more on why and the opportunity and will there be some build with buy, should we expect additional buy there? Thanks.
Sure. So, it’s a great opportunity for us as an adjacent product, because in the petrochemical plants and refineries that we operate in there are these blast zones. And so, you can put modular buildings in certain blast zones and then as you get closer into the hazard areas, you need a more robust structure to house workers. And so, this really fits very nicely in with the same people that we talk to and the needs that they have to house workers in these plants, and so this acquisition came available. We thought it was a nice add for us. So far, in addition to what we purchased that was in the fleet already, we have orders placed with the manufacturer to produce more, and we have demand for those units and we think it’s going to be a very nice product line for us over the next year or so. So, demand looks good, there is a lot of activity and we are very happy about it, but it’s fairly small, it’s not going to influence on our results greatly, but it’s a nice tuck-in additional product line for us.
Understand. But just one follow-up on that, Joe, what’s the competitive environment like there, is this a highly fragmented industry, I would imagine, would it be easy to roll up? Is there a large player that we should be aware of?
Yes. There’s not any large player that dominates. It’s fairly fragmented, and we have a great reach and touch in the petrochemical accounts that are located in the U.S. to be able to place this product. And so, we are -- that’s one of the advantages. Typically, these manufacturers and renters of this equipment have been smaller operators and they just don’t have the infrastructure that we do to place these units. So, we think it’s a very nice opportunity for us.
Scott, one way to think of it is, it’s a bit of a niche product, but it’s a very logical product line extension for the modular business, and it has a really good fit with our existing customer base and in some of the regions that we have a good presence.
Thanks. I appreciate all the color on that, guys. I am going to hit on each other segment real quick. Just 5G timing, considerations for rates, two separate questions there, essentially but what do you think, is rates are a little weak in TRS in the quarter? But I just want to – I know the visibility is not the best in that segment, but how does it look as far as you can see?
Yes. Demand for 5G, we have been fairly consistent to say it’s a 2019, 2020 timing and we are still standing by that. Right now, the work that’s going in is all the wired preparation and the tower work is only really starting to get going as you can see in some of the announcements that some of the carriers are starting to put out, and so we just think that will start to get more intense during the next year, so not quite yet for us. And Keith will hit the rate question.
Yes, Scott, just to help you out on the rate issue. The rate change we saw in the quarter compared to a year ago, almost entirely mix related. And again, just to remind folks about the types of equipment we own in the electronics business, the life of that equipment can be as short as 2 years or 24 months or as long as 7 years and 84 months. So, there’s quite a spread there. And for equipment with a short useful life, we have to charge more to make the economics work. For equipment with a much longer life, we can charge a different rate and still get very good economics. So, if you look at some of the comments on business mix that I mentioned in my prepared remarks, the overall business saw the general purpose side growth, 7% in rental revenues, just 1% in the communications side, and it is the general purpose product that is generally the longer-lived product. So, when you see that shift to general purpose, it’s quite common to see the rates decline slightly because of the -- what I just discussed.
Thanks. Appreciate that color. Lastly, Adler, you did mention one area weak, and I am curious if you would mind sharing, would like to know what that is? And then on rate, just overall, obviously oil and gas picking up nicely, you guys haven’t been spending a lot of CapEx there growing the utilization, just kind of the thoughts about rate looking ahead?
Yes. The one industry segment is it’s our refinery business, and essentially, we just had a big project, and that big project returned and so we are in the process of redeploying that equipment. And so, I don’t see it as – it’s just a timing issue and we see a lot of demand in the picture out there to get that redeployed and so – and then the other.
Yes, rate was up 2% on average during the quarter. And I think it’s a really impressive work by our team in Adler. As you know, Scott, that whole industry went through a very tough period after the collapse in the oil price. We have seen recovery over the last few quarters from a utilization point of view. I think pricing has lagged in the recovery, but in our business, we have been very focused on trying to get paid a fair price where we offer a lot of high service and good equipment to our customers. Our team has been working that and you have now seen for the last couple of quarters not only improved utilization, but also improved average pricing as we have done it and I think that’s impressive. We have got to keep working at it. And I think it speaks to generally better industry conditions, and we will be working hard to keep building on those improvements.
Alright, great. Thanks. I appreciate the time and all the color and great job though in the quarter.
Thank you.
Thank you. Our next question comes from the line of Marc Riddick of Sidoti. Your line is open.
Hi, good evening.
Hi, Marc.
Hi, Marc.
I wanted to go over if you would the sort of the funding environment that you are seeing out there. If there are much of any changes on the education side and if there are any funding issues on any upcoming ballots that we should be keeping an eye on for next week?
Sure. Funding continues to be good and State of California from Prop 51 that was passed in 2016 just sold another $447 million worth of bonds in October and that money pretty much was immediately allocated to projects that are on the to-be funded list. And so that money we are going to see flowing into the market. And I would say that that’s a similar dynamic that we’re seeing in all of the states that we operate in. The funding environment is pretty good, and some of that’s driven by student population growth, which is favorable in the markets that we operate in like Texas and Florida. On an upcoming basis, we don’t see any large statewide bonds that are on the ballot right now, particularly in California. However, on a local level there are almost $12 billion worth of bonds that are yet to be voted on, and typically, we have a 90% or above approval rate on these bonds, and so we’re thinking that that trend is going to continue. Folks want their schools fixed and they want them updated, and so the economy is good right now and we think that most of those bonds will pass as they have in past elections. So again, it’s a fairly good environment for us.
That’s good to hear. And I was wondering if you could sort of give some thoughts on the construction side. I mean, I am getting the sense that I mean if there is any kind of bottleneck of what we are looking at, it might just be a form of labor availability for folks to do the things that they want to do. But I was wondering what you were thinking on sort of the construction demand and maybe what that outlook might look like for you? Thanks.
Yes, construction demand is also good. We pay attention in non-residential construction and that’s been fairly good. It was somewhat flattish Q2 to Q3, but some of that could be a moderation that we are seeing in response to really remarkable growth that we have seen in prior quarters. However and as we also know that the demand for workers could potentially be a throttle on some construction projects, we are not necessarily seeing any slowdowns out there right now. The folks that we are working with have a number of projects planned, some of them extremely large, particularly in the Gulf Coast, etcetera, as we continue to build the petrochem plants there. And so we believe the demand picture is going to be good for the next several quarters.
Okay, great. And then one last question for me, I wanted to circle back to the acquisition for a moment. I was wondering if you could give a little bit of color or maybe sort of back story as to how the acquisition came to be. Is this sort of – it seems as though it’s something that was an adjacency that you are familiar with, but I was wondering if you could sort of give us some color or thought as to sort of how this unfolded and then what that might do for future appetite to similar types of opportunities? Thanks.
Yes. Well, this product line, we have actually kind of been keeping an eye on it for a number of years. We did some analysis on it and thought, hey, this could be a nice product line to add into the fleet. And we keep our tabs on folks that are in the industry and through our normal touches that we make we realized that this particular product line was available and so we decided to purchase it. And we look for these types of things and we’ll continue to look for products like this to augment our product line and serve the customer base that we already serve very well. And so it was again a natural fit for us.
I think, Marc, one way to think about this is the work we have done on the business over the last few years. It started with a lot of focus on return on invested capital. We sort of broadened the lens there to just general performance improvement, and as we’re seeing more being delivered from the existing businesses from the assets we already own, now we are turning our attention to really looking at any logical extensions of those core businesses. And this is just an example of looking around where we fit for logical adjacent opportunities, where there is a good fit and potential for good economic returns.
Okay. And then I guess a last one for me is wondering if you could sort of give an updated thought around where you are heading for year-end headcount and what type of whether this includes the acquisition or not, I guess, maybe you can sort of put it the way whatever way you wish, but how we should be thinking about headcount growth going forward, taking advantage of some of the growth opportunities that you have before you? Thanks.
Yes. I don’t think there will be any dramatic changes in headcounts through year end. Maybe small increases in a couple of production related areas, but we’re fairly adequately staffed. I don’t know if your question relates to SG&A. I will point out SG&A took a dip in the third quarter and actually was down sequentially. But I think that will get back to a normal run rate, closer to $30 million in the fourth quarter, less driven by headcount and more just timing of expenses we have in the business, but if that’s helpful to you, that’s another bit of context.
Marc, one thing to note too is that the acquisition did not bring any headcount with it, so it was an asset purchase although we will add a few folks to be able to run that part of the business.
Okay, that’s very helpful. Thank you very much, gentlemen.
Yes.
Ladies and gentlemen, that appears to be the last question. Let me now turn the call back over to Mr. Hanna for any closing remarks.
I would like to thank everyone for joining us on the call today and for your continuing interest in our company. We look forward to speaking with you again in late February to review our fourth quarter results.
Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.