McGrath RentCorp (MGRC) Q4 2012 Earnings Report, Transcript and Summary

Welcome to the McGrath RentCorp Fourth Quarter 2012 Conference Call. At this time, all conference participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) This conference is being recorded today, Thursday, February 23, 2013. I would like to turn the conference over to Geoffrey Buscher with SBG Investor Relations. Please go ahead.

Thank you, operator. Good afternoon. I am the Investor Relations advisor of McGrath RentCorp and will be acting as moderator of the conference call today. Representatives 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 4584516. This call is also being broadcast live over the internet and will also 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 PM Eastern Time or 1:05 PM 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 release on Form 8-K. The company also announced a 2% increase of the cash dividend to $0.24 per share for the first quarter of 2013 representing on an annualized basis a 3.3% yield on the February 20, 2013 closing stock price. For the fourth quarter of 2012, total revenues increased 20% to $102 million from $85.2 million for the same period in 2011. Net income decreased 10% to $11.9 million from $13.2 million and earnings per diluted share decreased 11% to $0.47 from $0.53. Reviewing the fourth quarter results for the company’s Mobile Modular division compared to the fourth quarter of 2011. Total revenues increased $0.4 million or 1% to $30.6 million primarily due to higher sales and rental related services revenues partly offset by lower rental revenues. Gross profit on rents decreased $0.9 million to $11.2 million primarily due to lower rental margins of 56% compared with 60% in 2011 and the lower rental revenues. Lower rental margins were a result of $0.7 million higher other direct costs for labor and materials. Selling and administrative expenses increased 8% to $8.7 million as a result of higher bad debt expenses and higher salary and benefit costs primarily related to the expansion of our Portable Storage growth initiative. The lower gross profit on rental revenues and higher selling and administrative expenses partly offset by higher gross profit on sales and rental related services revenues resulted in a decrease in operating income of $0.5 million or 8% to $5.6 million. Finally average modular rental equipment for the quarter was $532 million, an increase of $19 million. Equipment additions were primarily to support growth in the Mid-Atlantic region and for our Portable Storage…

Thank you, Keith. Although companywide rental revenues increased by 4% from a year ago, we had an 11% decrease in EPS for the quarter. This is primarily a result of lower rental revenues for our tank rental business relative to its current cost structure. While Adler rental revenues grew by approximately 6% over last year’s fourth quarter, its income from operations declined by approximately 39%. Over the past year, we have executed on ramping Adler Tank rentals national footprint to support higher rental revenues and earnings levels in the years ahead. These costs are primarily related to filling management, sales, office and inventory center positions, facilities and winch/roll-off tractor infrastructure. This is all by design. Adler’s profitability was also impacted negatively during the quarter by $1.3 million higher bad debt write-offs from a year ago. Finally, we also experienced $0.7 million higher expenses during the quarter from a year ago in relocating underutilized equipment from the dry gas Marcellus region to other Adler geographies in need of equipment. We have now completed the great majority of these interregional asset movements and we anticipate this expense category will be materially lower in 2013. Adler’s average rental equipment utilization for the fourth quarter 2012 stood at 69.9% compared to 86.8% a year ago and 68.9% in the third quarter 2012. Although we would like to see higher utilization levels as we continue to expand our tank and box rental business across the U.S., it is essential that we have the right mix and depth of inventory on the ground in all of the markets in which we operate in order to respond to a variety of end market needs. Adler is serving a wide variety of market segments, including industrial plant, petrochemical, pipeline, oil and gas, waste management, environmental field service, and…

We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from the line of Andrew Gadlin with CJS Securities.

In regards to your guidance, you have to comment that sales revenue is expected to be 10% lower, and I was curious what’s driving that? Historically when you have a weak sales year, your next year tends to be pretty strong.

I’d say there are two primary things. One is the disposition of the TRS environmental assets that was $3.7 million in the fourth quarter of 2012, that’s really not a recurring or expected item that we’d see in 2013. The other comment is Enviroplex had a big sales year in 2012, but as we know some of the issues we ran into that we discussed on the last call with certain project meant that, that sales revenue didn’t bring a lot of profit. As we look into 2013, we think the sales revenue will be lower at Enviroplex, the profit margin should start to move over the course of the year back to the normal range, although we will have some of the problem projects being recognized in Q1 of this year really to complete that project. I would say in standard modular business and TRS business, not a significant change that we are expecting in the level of sales.

And at the margins?

Yes, and margin is sort of staying in their normal ranges for both normal modular and TRS sales.

So, really it’s just projecting sales to stay level year-over-year except for taking out the low margin Enviroplex sales and the environmental?

That’s a reasonable way to look at it.

Okay. Next question in terms of Adler, can you talk about some of maybe some of the regions that you are targeting as well as maybe some of the end markets that you are investing in?

For competitive purposes, I will just make this comment. I won’t give out any specific markets that we are targeting, because those are in the process of happening currently. I will say this that by the end of 2014, 2013 Adler’s footprint will pretty much be throughout the U.S. in terms of being able to touch any of the major markets, where there is very active tank and box rental activity. But I am just trying to be very careful about this process and obviously we also are looking for employees and facilities and so forth that support that. So, I am just being very guarded with that. So, I apologize.

That’s fine. Thank you very much.

Our next question comes from the line of David Gold with Sidoti.

Can you -- and this is going to be probably a tough one for you guys to answer, but can you give us a sense for how we should think about the movement that’s happened on the Adler side, whether it be by, say, number of units sort of been moved or – and/or maybe sort of the aggregate spend on that. Just so, we can get sort of a better sense of the movement that’s happened there?

Yes, a couple of comments, David, I think as you followed the journey of 2012, we started moving some equipment in Q2, we did a little bit more in Q3, and then we did more again in Q4. For the full year, we probably moved in the neighborhood of 400 tanks. And we probably spent in the neighborhood of a $1.5 million for the full year for equipment moves between regions.

And those costs even though we will have some interregional relocation of equipment costs quarterly, it should be materially lower in 2013 and going forward.

Got you. And then on the same note, Dennis you commented on the utilization side, presumably a bit wider band in that business, but when you think about it and when you do your planning, what utilization target do you use?

You know actually we’d love to - we think long-term maybe mid-70% range is probably the appropriate range. We don’t know that for certain, but as we work our internal analysis and when we do our modeling, it’s somewhere in that mid-70% range is probably where we line up that and again, we have to learn more about the different geographies and the different cyclical natures of various end markets.

Perfect, okay. And then shifting to California, I think to your point, there are a lot of pluses going on there, but also still some minuses and presumably we’re still seeing booking levels decline a little bit. How do you think about a bottom there and given the passage of proposition in November? Do we think that this booking season maybe we see a little bit of a turnaround to some flattening?

Yes. First of all, if you look at California and its numbers, you have to keep in mind that from a shipment of equipment out versus in, it may be pretty close to a push currently and where we’re seeing the continued erosion is in the - difference in rental rate. The equipment that’s going out is going out at a lower rental rate than legacy equipment that’s returning, that was at a higher rental rate. So, the good news is that the market is quite a bit more active in terms of equipment going out. It’s -- the struggle is on the rate side and that will only take care of it as utilization rises across the industry. As for 2013, we’ve started off the year very favorably here. It’s better here than it was a year ago. There is a lot of good indicators. The Prop 30 initiative that passed in November we think is a real good guy, although there won’t be a facility bond measure on a state wide basis until 2014. So, and then the state in January actually had a $5 billion surplus in tax receipts that - that’s a one-time event there, but the good news is that the cash flows are very favorable currently, let’s hope the government spends that cash wisely. But I think California is without question taken the tonic it needed to and now it’s a matter of letting the economy do its thing and it’s definitely gotten better and again we are anxiously awaiting to see it in the numbers, which we haven’t yet. We’re being very candid here that it’s continued to erode to some level, but that has much more to do with rate than it does with activity.

Okay. And if you look at sort of how maybe things there have changed in the last few months have you seen a noticeable difference then in inquiries since, let’s say November or sort of throughout the year?

There is no -- in my mind, anecdotally from chatting with folks and also booking numbers, I don’t think there is any question that it continue to get healthier every quarter over the past year. I know that intimately from our own experience and then also how that translates then into the numbers is what -- is the struggle. Because we have to see it in the numbers before we get on any kind of a trend train here and say okay, it’s really turned the corner. But everything anecdotally as well as factually as you start lining up real key elements in the economy it seems to be going in the right direction, but again we need to see it in the numbers.

Sure, sure, okay. And then just one last one, certainly interested and intrigued by the growth that you are seeing on the storage side and I was curious there - well a couple of things. One, we don’t have the basis for those numbers. So, I have to believe based on what we know but it’s more, for lack of a better term, market share gains and then if you will – growing off a smaller base. And so I was curious on that and then two on the G&A side, where you are investing, is it pure hiring, are we building out a sales force, what’s - where is that money going to work?

Yes. Most of the money that we’re putting into the portable storage businesses for additional sales people, sales management. We have some outlined facility yards where we’re paying rent, etcetera or buying property. But for the most part it’s building that professional team of individuals that can book business etcetera. So, and if - yes, it’s small base but growing nicely. And the interesting thing is, we didn’t - we only expanded into one new market in 2012, although we have a few of them, very favorable ones planned for 2013. So, in 2012 we in effect focused on our existing markets, worked on critical mass in spite of the economy still struggling and we accomplished what we set out to. We met our profitability goals and our rental revenue goals. And so we are very pleased with that and we have a bigger base now and we plan to expand the footprint, so.

Perfect. That’s all I have. Thank you, both.

Our next question comes from the line of Scott Schneeberger.

This is Daniel Hultberg filling in for Scott. I am kind of following up on a previous question, I understand, Dennis, your commentary about the competitive reasons there. Is there any way you can give any color on the verticals driving Adler in the quarter. I know you saw a nice sequential improvement in utilization, any color there would be helpful?

Well, when you look at it - the oil and gas industry as a whole, other than E&P as an area, in which refineries and the petrochemical industry are all areas in which we want to do more business in and is a sweet spot for us. So I would say that those are certainly been quite favorable. And the heavy construction market also has been more favorable. So those are probably some of the prime drivers in the vertical.

Okay.

The contribution from frac-ing dropped to 15% in the fourth quarter of 2012 and that compares with a number in the mid-30s percentage range throughout 2011. So, that part of the business went down, and as Dennis said, the other traditional segments for tank rentals, we saw a good growth.

Okay. Thank you. And as far as the frac-ing mix going forward, should we think about this in terms of its current mix in 2013 or is that expected to increase a bit?

That’s the $64 question, and we like the frac-ing business and it’s a question of concentration, customer concentration as well as geographic concentration. And there are a number of dynamics that play out related to U.S. Energy Policy. And if we are going to be drilling for decades to come in the Marcellus and the Bakken, in other oil and gas shale plays well then -- we will have to respond appropriately. But again we need to keep an appropriate mix and balance that’s very healthy, because as anybody who has ever tracked oil and gas knows that it is a -- it can be a volatile industry. Although I would say based upon how the U.S. Energy Policy gets defined going forward, it may not be as volatile domestically as perhaps it has been historically in most markets. We will see.

Okay, understood. Shifting to TRS, the utilization in the quarter was down year-over-year, what’s the specific dynamic there? Any color that would be helpful? Thanks.

There is nothing really anything specific there and you can have fluctuations in numbers at the end of a quarter. You got a certain amount of equipment back and we take an inventory on December 31st. Those are the numbers, but there is nothing of a material nature there, in fact we are holding a very nicely this year with our rental rate throughout the year thus far in the first six to seven weeks. In spite of an unknown sequester or there is other dynamics going out with the economy that nobody can quite figure out right now, but there is nothing to read into that.

Yes. And I would say, Daniel, seasonally for TRS it’s pretty typical to see some drop off in utilization over the course of the fourth quarter. We typically expect to see that anytime from middle of November onwards.

Okay. And a final question on Portable Storage, how should we think about that in 2013 in terms of that as a contributor to operating income? Do you have any color to provide please?

Very small, but growing and at some point here we’ll be able to share more information, it’s essential for our growth plans that we probably are just very careful with what we share, because it could impede us in terms of growing as fast as we’d like to and as profitably as we’d like to. So - but, we will have more information to share on Portable Storage as we go forward, and it will become a more meaningful business over time.

Okay. Thanks guys.

(Operator Instructions) And our next question comes from the line of Joe Box with KeyBanc.

Keith, you gave us a good target earlier for just total company SG&A. Can you maybe give us a sense for run rate by segment?

I would say, I would just look at the run rate you have today in the business. Alder is probably where we’re going invest a little bit more, as Dennis mentioned earlier, with a goal of serving more markets and having people in place to do that. TRS, I wouldn’t expect an unusual increase there. Modular’s includes portable storage, so there’ll be a little bit more investment there, but no, nothing dramatic in any of those segments. Part of the costs here is just the normal employee related costs, benefit costs. We’ll see a little bit of an uplift there and we are operating with a bigger team today than we had in February of 2012.

Okay. That’s helpful. Can you give us an update on the percentage of your TRS fleet that is currently communication equipment? I think it used to be one-third communication equipment, and maybe just how do you see that trending next year or this year, I should say?

Yes. It’s probably in the same neighborhood, but growing more quickly than the GP side, so it’s moving higher a bit, I wouldn’t say it’s materially higher.

Is it fair to say then that there should be more upside to the yield just as you get more favorable mix?

It’s possible. The yield right now is pretty good. I mean, as Dennis mentioned in the prepared remarks that the high yield we saw in the Q4, it’s largely a mix issue. I would say that’s a pretty high number.

Alright. I’m just trying to understand I mean if you’re going to continue to grow your communication equipment, will you have a positive mix shift throughout the year?

It’s - I think, we’ve answered as best we can at this juncture. It should be - it should be ticking upward and then we’ll have to see what happens on the general purpose side, in difference of the activity because that’s a big question, Mark now with aerospace and defense spending, potentially week from today or week from tomorrow, being cut to this sequester dynamics. So, there is a number of things up in the air.

Okay. I appreciate the color there. Dennis, can you maybe just put a little bit more color around the 45% booking increased that you talked about at Adler?

Well, I think that’s representative of the fact that Adler is becoming just a much more well-known name in the industry. They have the youngest fleet in the industry. They have got an exceptionally good sales force. We are focused on just doing tanks and boxes, we don’t do filters and pumps and other things. So, I think what you are seeing is just the natural progression of us building out branches and staff getting more tenured and qualified. And that’s been able to now fully support with equipment that people were so starved for a year ago. So, I think you put all that together, that’s why you are seeing those types of numbers.

Got you. I think you said earlier that there is more outbound activity in California than there has been in the past. And one of the issues that you are seeing there is it tends to be more on the rate side. I guess based on the activity levels that you are seeing now, where do you think you need to see utilization at before you reach rate parity or even maybe asked a different way, how long do you think it might take before we get to rate parity?

That is a great question. And we have been trying to answer that for some time now. I would say personally once you start seeing movement continually on utilization going up in consecutive quarters you are likely to start seeing some of that. And what will happen is it won’t be across the board on all sizes and types of equipment, it will be like today, for example, there are certain pieces of inventory like larger complex floors that are very scarce. They are in high demand and so rates on that product, for example, has actually gone up very favorably over the past few quarters. So, those are the types of things. You will start seeing it in pockets of certain types of equipment, but again it will take consecutive quarters of utilization uptick, and then you will start seeing likely some form of progression there. When you actually get to that across the board in the entire fleet that in the early 70 - the low 70% range, it very well might be. That probably wouldn’t be an unreasonable area so…

Great, that’s good color. And that’s all I have. Thank you.

There are no further questions. At this time, I would like to turn the call over to management for closing remarks.

We would like to thank everybody for their participation on today’s call. We greatly appreciate the support and we’ll look forward to chatting with everybody again on our Q1 2013 call in early May. Thank you so much.

Ladies and gentlemen, this does conclude the McGrath RentCorp fourth quarter 2012 financial results conference call. Thank you for your participation. You may now disconnect.