Mcgrath Rentcorp Q2 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to the McGrath RentCorp Second Quarter 2020 Conference Call. At this time, all conference participants are in a listen-only mode. Later, we will conduct a question-and-answer session. This conference call is being recorded today, Wednesday, July 29, 2020. Before we begin, note that the matters the 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 third quarter 2020 financial 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. Furthermore, you should notice that the full impact of the COVID-19 pandemic continues to evolve. As such, the full magnitude of the pandemic will have on the company's financial condition, liquidity, and future results of operations is uncertain. The following discussion by management about the company's financial condition is subject to the future effect of the COVID-19 pandemic. In addition to the COVID-19 pandemic, 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 the date hereof. Expect 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, Catherine. Good afternoon and thank you for joining us on today's call. I will start the call with some overall remarks and comment on our second quarter 2020 performance and our look ahead. Keith will provide additional detail in his financial review and outlook comments. The second quarter brought with it unprecedented and challenging conditions for us to navigate, through which we were able to deliver adjusted EBITDA growth of 11%. The COVID-19 pandemic resulted in some customer project work stopping and then starting, our workforce transition to new safety and operating protocols, myriad additional federal, state, and local guidelines to follow, and uncertainty at every turn. Nevertheless, we adapted quickly and delivered good results. Everyone in the company stepped up and put our customers first, preparing, delivering, and returning equipment throughout the quarter without missing a beat. Overall, our workforce remained safe and healthy during the quarter. Here are some of the highlights. Mobile Modular rental revenues grew 4%. During the quarter, most of our education projects progressed on schedule and without significant disruptions. Some school districts were able to accelerate schedules due to empty campuses. We closed out a number of education classroom sale projects at Mobile Modular and Enviroplex, which contributed to our strong quarterly profits. In our commercial end markets, despite some project shutdowns earlier in the quarter, areas opened back up, and projects resumed. Our Portable Storage business grew rental revenues by 3%, although we noted softer demand for new projects during the quarter. Turning to TRS-RenTelco, we grew rental revenues by 2%. Despite business disruption from COVID-19, bookings steadily increased during the second quarter as project work gradually resumed. Most of the demand weakness was in our communications fleet as many contractors and field personnel who used our equipment stopped working. Over the course of the quarter, as these contractors returned to field work, they began to place rental orders again. Rental revenue growth in the quarter came from our general-purpose customers with relatively healthy demand as projects in aerospace, defense, and semiconductors continued. Adler rental revenues decreased by 27%. COVID-related economic disruptions and the drop in the price of oil and gas from both global overproduction and lack of demand slowed rental activity as projects were canceled or pushed out. We saw a decrease in five of our six industry sectors during the second quarter. Downstream refining capacity utilization decreased to an all-time low. Rig counts dropped in the quarter as drilling operations work was curtailed. Overall, it was a tough quarter for the business as both the pandemic and the price of oil generated headwinds for rental revenues. Despite these headwinds, the business generated healthy cash flow for the enterprise. In looking at the demand picture for the rest of the year, much depends on our ability as a nation to get the coronavirus under control. Barring a more significant impact from the pandemic at Mobile Modular, we are not expecting project disruptions in education as customers have remained steadfast in their plans, and commercially, we are seeing more stable conditions than a year ago. Our pipeline remains strong in Enviroplex, and we're expecting to close out the year with projects as planned. At TRS-RenTelco, we're hopeful that 5G fieldwork will pick up during the second half of the year and that demand for our general-purpose equipment will remain steady. At Adler, we are not expecting much uptick in rental activity until oil and gas demand improves. We are hopeful that we have troughed at Adler, but we expect market conditions will remain soft in that business for the foreseeable future. It is important to know what we accomplished in the quarter and our ability to weather economic storms. I'm proud of our execution as we navigated an unforeseen and unprecedented economic shutdown and operated effectively. We're fortunate to have the experienced leadership and employee base that we do. Their professional instincts and solid relationships were vitally important as we made necessary adjustments to support our customers, many of whom have been loyal for years. In addition, our business demonstrated its resilience in challenging times as our strong cash flow generation enabled us to pay an increased dividend, repurchase stock, and reduce debt. Finally, we delivered improved profitability on a year-over-year basis, despite one of our divisions experiencing significant headwinds. As most are aware in today's business environment, access to capital has become more challenging for some companies, and going forward, it may be more difficult. In these situations, renting equipment becomes an even more attractive alternative when reduced capital budgets preclude new equipment purchases. McGrath RentCorp is well-positioned to supply our customers and markets. Despite an uncertain economic backdrop, we are hopeful that conditions will improve as the remainder of 2020 unfolds. Now, let me turn the call over to Keith, who will take you through our financial review.

Thank you, Joe. Picking up on Joe's comments, since the COVID-19 pandemic began, our teams have done a great job in moving quickly to adapt to the new operating norms. They did all this while also delivering good second quarter results. For the second quarter of 2020, total revenues increased by 8% to $137.7 million from $127.4 million a year ago. The company's 12% operating profit increase for the quarter was driven by a $5.1 million increase in gross profit from sales revenues, partially offset by a $0.8 million and $0.7 million decrease in gross profit on rental revenues and rental-related services revenues, respectively. Net income increased by 16% to $22.5 million from $19.5 million, and earnings per diluted share increased by 16% to $0.92 from $0.79. Now, I will break the results down by reviewing rental division operating results and performance compared to the second quarter of 2019. Mobile Modular total revenues increased by $9 million or 13% to $76.8 million on higher sales and rental revenues, partly offset by lower rental-related services revenues. Rental revenues for the quarter increased by 4% from a year ago, which was driven by 3% higher average equipment on rent and a 2% improvement in average monthly rental rates. Sales revenues more than doubled to $8.6 million, primarily on higher new equipment sales to educational customers. We achieved rental revenue growth across our commercial and education markets, as well as in our portable storage business, despite the softer business conditions that Joe described. Equipment preparation costs, included in other direct costs of rental operations, decreased by 13% to $12.4 million due in part to lower shipment activity levels during the quarter. As a result, rental margins increased to 61% from 56%. Average modular rental equipment for the quarter was $823 million, which was an increase of $36 million. Average fleet utilization for the second quarter decreased to 77.7% from 79.2%. At TRS-RenTelco, total revenues increased by $0.8 million or 2% to $33.1 million on higher sales and rental revenues, partially offset by lower rental-related services revenues. Rental revenues for the quarter increased by 2%, primarily driven by 8% higher average equipment on rent, which was partly offset by 6% lower average monthly rental rates. The lower average rental rates reflect a mixed shift towards more general purpose equipment rentals that tend to have longer-term transactions compared to communications equipment rentals. Rental margins decreased to 41% from 44%. We saw growth in rental revenues from general purpose test equipment, partly offset by lower revenues from communications test equipment customers. Average electronics rental equipment for the quarter was $339 million, which was an increase of $42 million. Average utilization for the second quarter decreased to 63.9% from 67.2%. At Adler tank rentals, total revenues decreased by $7.7 million or 29% to $18.6 million on lower rental-related services and sales revenues. Rental revenues for the quarter decreased by 27%, primarily from 23% lower average equipment on rent and 6% lower average monthly rental rates. The rental revenue decrease reflected weaker demand caused by COVID-19 related business disruptions and the lower price of oil and gas, with five of our six end markets having lower rental revenues compared to last year's second quarter. Rental margins decreased to 51% from 58%. Adler's average rental equipment for the quarter was $315 million, which was an increase of $1 million. Average utilization for the second quarter decreased to 44.3% from 57.5%. Moving on, the remainder of my comments will be on a total company basis. Total company equipment sales revenues increased to $30.7 million from $13.7 million a year ago. This increase was due to higher sales revenues at Mobile Modular and Enviroplex, reflecting strong demand for education projects. The timing of sales revenues can fluctuate from quarter to quarter and year to year, depending on customer requirements, the availability of used equipment for sale, and other factors. With a significant number of sales projects already completed during the second quarter, we currently expect total company sales revenues for the third quarter to be lower than a year ago, and total full year sales to be comparable to 2019. Selling and administrative expenses decreased by $0.3 million or 1% to $30.5 million, primarily due to lower travel and meeting costs. Interest expense was $2.2 million, a decrease of 30% as a result of 28% lower average interest rates and 3% lower average debt level. The second quarter provision for income taxes was based on an effective tax rate of 26.4% compared to 24.9% a year earlier. Our 2020 year-to-date cash flow highlights include net cash provided by operating activities was $97.5 million, an increase of $5.5 million compared to 2019. The higher cash flows supported organic investment in the business, increased dividend payments, and share repurchases, while also reducing debt. These strong cash flow characteristics demonstrate the company's resilience model during a period of economic weakness. We invested $57.6 million for rental equipment purchases, mostly at TRS-RenTelco and Mobile Modular, and $6.9 million for property, plant, and equipment purchases. Partly offsetting these investments was $21.9 million of proceeds from sales of used rental equipment. Dividend payments to shareholders were $19.5 million. The company repurchased 280,000 shares of common stock, totaling $13.5 million or an average price of $48.24 cents per share. There were no repurchases of common stock during 2019. Net borrowings decreased by $21.3 million to $272.1 million during the first half of 2020. At quarter-end, the company had the capacity to borrow an additional $259.4 million under its lines of credit. The ratio of funded debt to the last 12 months actual adjusted EBITDA was 1.1:1. Second quarter 2020 adjusted EBITDA increased by 11% to $58.1 million compared to a year ago, and consolidated adjusted EBITDA margin was 42% compared to 41% a year ago. Our definition of adjusted EBITDA and the reconciliation of adjusted EBITDA to net income are included in the quarter's press release. Finally, turning to our financial outlook. For the third quarter 2020, we expect total revenue between $140 million and $160 million. Adjusted EBITDA between $54 million and $64 million, gross rental equipment capital expenditures between $10 million and $15 million. Please keep in mind the following regarding our outlook. The impact of COVID-19 on the economy and on our business is evolving, and it's difficult to assess. In addition, visibility is limited at Adler tank rentals and TRS-RenTelco because of the short rental terms in both businesses. That concludes the prepared remarks.

Thank you. And our first question comes from Scott Schneeberger with Oppenheimer. Your line is open.

Thank you very much. Good afternoon. I would like to begin with the Modular segment, please. Can we discuss the sales? What do you attribute the strong sales in the quarter to? It seems you don't expect this trend to continue into the third quarter. I’m interested in your thoughts for the fourth quarter, which typically follows a certain pattern, but this isn’t a typical year. Thank you.

So, Scott, this is Keith. I view sales in this way. As we often mention, it can be challenging to predict which quarter sales will occur. This is influenced by customer needs, and there can be site issues where a project a customer hoped to finish in June may be delayed until July, or a project expected to wrap up in September might move to October. We encounter these situations every year. However, as I noted in the prepared remarks, we anticipate total company sales for the year to be on par with 2019, indicating a similar year-over-year performance. Enviroplex and Mobile Modular play significant roles in those sales. If we evaluate the sales trends for 2020, we experienced a robust second quarter. Typically, we expect the third quarter to outperform the second quarter, and we believe this will hold true this year, though we do not anticipate reaching the substantial sales level of the third quarter of 2019. Last year, Enviroplex had a notably high concentration of sales during the third quarter. In the fourth quarter, we generally observe a decline in sales compared to the third quarter. Does that clarify the expected sales flow while also acknowledging the timing of revenue recognition? A lot depends on when the customer wants the project completed, along with the possibility of site issues causing delays in our revenue recognition in any given month.

Thank you, Keith. That was very insightful. My question is whether there is anything related to COVID or social distancing that might lead to increased sales this year. I understand you mentioned it would be flat compared to last year, but sales were quite strong in the second half of last year. Is there any indication that customers are more inclined to buy instead of rent? Joe noted earlier that renting can be a sensible choice for customers who might be short on capital. I hope I captured that accurately. Please correct me if I'm wrong. My next question is …

I may want to add.

We're seeing in terms of those education orders.

Yeah. Scott, I would say we're not seeing any shifts in how customers are going to procure their space that they're going to need based on COVID. We're not seeing a shift to sales or a big shift to rentals in our education customer base at this point. And so, those sale projects that we recognized this quarter and that will recognize throughout the rest of the year, a lot of these have been in the works for a while now, and they're just coming to fruition at this point.

So, Joe, would you say that you are seeing the level you expected for a normal year or maybe the education rentals are higher because of COVID and social distancing, or you don't want to go that far yet?

It's a good question. Let me explain a bit about what we've observed with school districts. In recent weeks, we've finally started getting announcements from school districts about their plans for the fall semester. This summer has been full of confusion and uncertainty regarding what actions school districts should take. Recently, some districts have changed their plans because COVID hasn't declined as expected. We're seeing public school districts leaning toward virtual classes or a blend of in-person and virtual learning. Meanwhile, private and charter schools seem more inclined to have students return to classrooms. We're getting more inquiries about classroom demand from that sector, although it is smaller compared to our public school customers. Overall, aside from modernization projects, which are progressing as expected, we don't anticipate a significant increase in demand for COVID-related classroom space. However, we're also not expecting a decrease in demand or returns. It appears that school districts will retain their classrooms for now, as the situation remains uncertain. Therefore, I expect things to remain relatively neutral for the rest of the year.

Thank you for that. I have a similar question regarding the commercial vertical and modular segments.

Yeah. So, in that part of the market, what we're seeing is once clients got back into the field, once shelter-in-place restrictions were lifted, many projects resumed, and we're seeing those projects continue throughout the rest of the year. And so, we think that demand will be there. It won't be as strong as it was last year, but we anticipate that those projects that have been in the works are going to finish. I think the question is in future quarters, past 2020 really what's the pipeline going to look like for additional projects that are planned, and that's just unknown at this point.

All right. Thanks. And what I infer from that statement is that you're really not seeing much on the return front whatsoever. Near term, the new rentals pipeline is active and fine. It's looking out three or four quarters and beyond where you're a little uncertain. Is that a fair summary?

Yeah. I think that's fair.

Thank you. I'll move on to my last couple of questions. In TRS-RenTelco, you experienced elevated sales. I'm curious about that. Additionally, what trends did you observe each month, and what insights do you have regarding the progression of sales and rentals in that segment? How has that influenced your outlook for the second half?

Sales at TRS-RenTelco were relatively stable from quarter to quarter, without any significant increase. However, demand from our general purpose and communications customers remained strong. General purpose customers held onto their equipment while continuing to place orders, leading to a solid level of demand throughout the quarter. Technicians took test equipment home to conduct tests during shelter-in-place orders, allowing projects in aerospace, defense, and semiconductors to continue. On the communications side, field workers were initially affected by shelter-in-place regulations but have gradually returned to work as restrictions eased. We remain optimistic that this trend will persist throughout the year, particularly since major carriers are committed to their 5G rollout plans. This ongoing demand for bandwidth and connectivity suggests a promising outlook for future growth.

Thanks. I'll just ask one more question and then pass it over to Adler. It wasn't long ago that most of your end markets were performing better year-over-year, but that seems to have changed. I'm curious about which one of your six end markets is still doing well. Is the slowdown mainly due to the oil and gas sector, or does it also relate to COVID? I would like to understand how much the situation is influenced by oil prices outside of the upstream market and how the other sectors are being impacted. Thank you.

Sure. I'll start by addressing which end market showed some growth. You're correct that it was a contrast from last year. Growth was noted primarily in our catchall category or other, while our main markets, including upstream oil and gas, refinery, construction, environmental services, and industrial services, all experienced declines compared to last year. The other category saw a slight increase, and upon investigating, many of the projects contributing to this growth were related to COVID-19. For instance, some hand sanitizer producers required additional tanks and equipment for their operations. We also encountered unique projects, such as a craft brewery needing assistance to dispose of excess beer that wasn't being consumed, which our equipment facilitated. Thus, the other category was the only segment that saw a slight uptick, much of which was related to COVID.

Okay. Thanks. Appreciate that, Keith. And tragic, they had to throw it up there. I'll turn it over.

Thank you. And our next question comes from Sam England with Berenberg. Your line is open.

Hi, guys. Thanks for taking the questions. Just a couple for me. The first one in Adler. I was just wondering if you're thinking that's doing anything around cost-cutting in that business, or perhaps even in TRS over the second half of this year, or were you just waiting to see how demand recovers in Q3 at this stage?

Yeah. Let me address Adler. First thing I'd like to say is we run that business very, very lean. And there's not a lot of overhead or areas that we have to be able to cut costs out of that business. I will say that we have clamped down on virtually everything that we can to adjust our rate of spend in the business. And through attrition, we're operating with about 10% less personnel at this point. And so, we're at a place where we can kind of comfortably run the business and we'll just have to see what happens over the next timeframe. As I said in my prepared comments, we think we've troughed in that business. And so, hopefully, we'll see some upside here as projects and demand for oil and gas and projects may resume at some of our clients.

Okay. Great. Thanks. And then the next one, you've seen the monthly rental rates dropping a bit in TRS and in Adler. I just wondered what the pricing strategy is heading into the second half in those two bits of business.

Yeah. This is Keith. In Adler, there are new opportunities for the business, especially with spot projects that arise each quarter. It's a competitive landscape. The challenges we've mentioned are also being faced by others in the industry. We're up against both large and small competitors, and pricing is generally competitive. In regions with an oil and gas presence, the competition is even more intense. This reflects the competitive environment and lower demand. In contrast, at TRS, pricing remains fairly stable on a like-for-like basis. Our rental rate metric showed a shift in the mix. Overall, we experienced rental revenue growth of 2%. When separating the general-purpose business from the communication side, the general-purpose segment grew by about 12%, while the communications segment saw a decline of around 12%. Since communications is a smaller part of our overall mix, this shift resulted in a lower weight for the business as a whole, indicating less of a market price change and more of a reallocation between our two main segments.

Okay. Great. Could you provide some insights on the capital expenditure for the third quarter? Is the business poised for expansion in specific areas or asset classes? I assume you are planning to expand within Mobile Modular during the third quarter.

Yeah. A good question. And I would say we're being very selective and our teams are very collaborative and try to make good choices in this environment. And just to really set the scene for you a little bit, the gross CapEx guidance that we gave in the $10 million to $15 million range, that number compares with a number in the first quarter that was $35 million and a number in the second quarter that was $22 million. And so you can see it's really coming down over the course of the year. And again, $10 million to $15 million in the third quarter. And the business that generally sees some needs for CapEx first is the electronics business. And that all relates to technology trends, new product introductions, and replacing older technology with newer technology. And that may well account for half or more of what we spanned. Outside of that, it will be very selective for particular product categories that are still in high demand in particular regions. But it's clearly a much lower level of gross CapEx than we would typically see. And another thing I'll point out is if you look at us over the last few years, we've typically generated in the neighborhood of $40 million a year in proceeds from used equipment sales. So, if we're any work towards the lower end of that, $10 million to $15 million that's in the outlook, we may have a net CapEx, if you will, from a rental equipment point of view, that's zero or could even be negative under some circumstances.

Okay. Great. Thanks for much for taking the questions, and I'll pass it over.

Thank you. And our next question comes from Marc Riddick with Sidoti. Your line is open.

Hi, good evening.

Hi, Marc.

Hey, Marc.

I wanted to start by asking for your thoughts on the funding environment, including any updates or changes we should be aware of, particularly in relation to investor concerns about potential issues with state and local funding in the future.

Yeah. I'm assuming you're mostly kind of concerned about how that's going to affect the education business.

Correct. Correct.

Different states fund education facility projects in various ways. California primarily uses bonds for funding, while Florida relies on sales tax revenues. Each state's approach to funding facilities is unique. In California, as long as the bonds are available and market conditions permit, selling those bonds is an effective means for districts to finance their projects. Thus, we are optimistic that projects in California will proceed. Conversely, in states that depend on sales tax revenues, the situation is less certain and presents more risks. Currently, school districts are primarily focused on returning students to school and figuring out how to do so rather than discussing funding issues. There's minimal conversation about the funding environment at this time. States are hopeful that they can count on some form of funding, such as potential federal support in California. As schools prioritize reopening, discussions regarding funding are not prominent. We expect to gain clearer insights in the coming quarters as we assess the effects of possible budget shortfalls in state finances, but it's still early to definitively address this matter.

Okay. I appreciate the information on that. It's really helpful to discuss. I wanted to mention that it seems Mobile Modular now constitutes about 9% of…

Portable storage is 9% of McGrath RentCorp total.

And the commentary earlier I think you said it was up 3% on revenue?

Correct.

Rental revenue.

Was that primarily driven by pricing or the price-volume mix? And can you share if there are any stronger industry customers, particularly in construction, or what you might be observing there?

It was up year-over-year. However, compared to the first quarter, it was a tougher quarter. We observed weaker demand conditions early in the quarter, but things started to improve as we progressed through the second quarter. These were some of the dynamics we experienced.

Okay. Great. You mentioned the steps taken to update your operating procedures in response to the pandemic. I'm curious about your current status regarding further adjustments. Do you feel you are in a good place for now, considering the ongoing changes? Could you elaborate on that process and whether you anticipate more changes or if you're satisfied with the current situation?

We follow CDC guidelines for the protocols necessary in our business, and in many cases, we exceed those guidelines. As the guidelines change, we will adjust accordingly. At this moment, I do not expect many additional changes. Most of the pandemic issues stem from people not practicing social distancing outside of work and in social gatherings, which continue to spread the virus. Therefore, I do not foresee significant changes to our current operating protocols, which are already quite strict.

Okay. Great. Thank you very much for the color.

Yeah. Thank you.

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.

All right. Well, I'd like to thank everyone for joining us on a call today and for your continuing interest in our company. We wish you all health and safety in the months ahead. And we look forward to speaking with you again in late October to review our third quarter results.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.