WillScot Holdings Corp Q2 FY2021 Earnings Call

Welcome to the Second Quarter 2021 WillScot Mobile Mini Earnings Conference Call. My name is Catlin, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Nick Girardi, Director of Treasury and Investor Relations. Nick, you may begin.

Good morning, and welcome to the WillScot Mobile Mini second quarter 2021 earnings call. Participants on today's call include Brad Soultz, Chief Executive Officer; and Tim Boswell, Chief Financial Officer. Today's presentation material may be found on the Investor Relations section of the WillScot Mobile Mini website. Slide 2 contains our safe harbor statement. We will be making forward-looking statements during the presentation and our Q&A session. Our business and operations are subject to a variety of risks and uncertainties, many of which are beyond our control. As a result, our actual results may differ materially from today's comments. For a more complete description of factors that could cause actual results to differ and other possible risks, please refer to the safe harbor statement in our presentation and our filings with the SEC. With that, I'll turn the call over to Brad Soultz.

Thanks, Nick. Good morning, everyone, and thank you for joining us today. I'm Brad Soultz, CEO of WillScot Mobile Mini. I want to start by extending my gratitude to our entire team for their strong performance in yet another quarter. I also want to thank our customers for their continued support. We appreciate and value your business, and we take pride in delivering on our commitments to you. Before I get into this quarter's outstanding results, I'm excited to announce that we'll be holding an Investor Day on November 8 in New York. We look forward to seeing many of you there. Our second quarter results demonstrate accelerating trends across our diversified portfolio and corresponding superb outcomes. Delivery volumes improved in all of our segments, while rates improved at record pace. We also achieved a major step in WillScot Mobile Mini's maturation process by successfully migrating the legacy WillScot business onto Mobile Mini's SAP platform in May. In turn, I'm pleased to raise guidance again this quarter after our increase last quarter. Our latest outlook indicates 9% to 12% revenue growth and 10% to 13% adjusted EBITDA growth relative to 2020 on a pro forma basis, which again is a function of accelerating KPIs across our business and implies a stronger run rate for 2022. Our strong free cash flow continued with a margin of 20% over the last 12 months and supports continued execution of our capital deployment strategy as we've repurchased $251 million of our shares over the last three quarters. Starting on Page 8. The progress that we saw in March for deliveries continued throughout the second quarter. We increased deliveries across all four products and across most of our end markets on a year-over-year basis. In construction, a strong Architectural Billing Index, or ABI, greater than 50, which began in February and has continued each month since, confirms a significant rebound in activity since March 2020 and indicates growth in nonresidential starts. This is a nine- to 12-month positive leading indicator, and we expect this trend to continue in the near and medium term. I'll note that where we go, our customers go, and our customers are building everything from warehouses to data centers to the Virgin Hyperloop in Las Vegas. Commercial and industrial had the largest increase in deliveries this quarter, up 49% year-over-year. There's certainly more opportunity than risk in this segment. The biggest mover in the bucket was arts, media, hotels and entertainment, where we increased deliveries by between 40% and 80%. Retail store remodels returned to more normal levels as evident in the storage deliveries. This activity is augmented by the return of special events as COVID restrictions relax. You can see great examples of these contracts on Page 14 with units for media at a Major League Baseball All-Star game in Denver and temporary complexes for production of an upcoming miniseries on HBO. Other customers include Facebook, where we're helping to build data centers, and Amazon, where we provide flexible warehousing for inventory, distribution and infrastructure. Energy and natural resources, which is a smaller component of our customer base, also saw rising deliveries. This segment correlates with both GDP and energy prices, both of which were strong throughout the quarter. And we'll continue to monitor the passage of an infrastructure bill in the United States. However, for our 2021 outlook, we do not assume any significant impact from incremental spending by Congress. As I've stated previously, the current draft of the infrastructure bill would provide tailwinds across almost all of our end markets. And keep in mind, it will take roughly 12 to 18 months following passage before shovels hit the ground on any of these infrastructure-related projects. So we'd expect any associated tailwinds to occur in 2022 and beyond. Regardless of additional stimulus, we expect a continuation of strong market demand. Page 15 breaks out deliveries by segment. Modular space deliveries in our North America Modular segment increased in the quarter at a rate of 12%. As we expected in our outlook earlier this year, deliveries accelerated in the second quarter, as the economy improved and what are typically stronger seasonal months for project starts. We expect this trend to continue in the third quarter. Deliveries in our North America Storage segment increased 42% year-over-year and now exceeded 2019 levels. This rebound reflects strong demand across all of our end markets that I previously discussed. In the second quarter, following our successful ERP migration, the North America Storage segment began delivering all container deliveries. So the North America Storage segment is managed in both legacy Mobile Mini portable storage, as it previously had, as well as the legacy WillScot portable storage units in most of our geographic markets. Consolidating all of our container rental activity into the legacy Mobile Mini branch network will have numerous benefits in the form of improved customer service, operating efficiencies, logistics and utilization, among others. Turning to slide 16. In our North America Modular segment, the increase in deliveries resulted in stable modular space units on rent sequentially from the first quarter. As a function of our long-duration leases, which average 34 months in North America Modular, unit on rent growth will lag delivery volume. So stabilization is the first step on the path toward volume growth, and I'm highly encouraged by the order and delivery activity in this segment. And at 68% utilization, we have ample inventory with which to grow without thinking of near-term fleet expansion. Portable storage and modular units on the bottom left in the North America segment increased 6% sequentially from the first quarter, 10% year-over-year and compared to 2019 average unit on rent increased 6.5%. A testament to the strength we're seeing across end markets. North America Storage recovered faster than North America Modular, thanks in part to the return of store renovation in our retail, wholesale and trade end market. You can see an example of these types of remodels back on page 14, where we delivered 17 storage containers for a major retailer remodel, which is representative of the services we provide to most major non-mall-based retailers. Shifting gears to rates on slide 17. North America Modular average monthly rental rates increased nearly 20% year-over-year in the second quarter, smashing the previous record of 15%. Roughly half of the $132 year-over-year increase was driven by continued VAPS penetration on newly delivered units in the last 12 months. The remainder of the increase came from core pricing with a larger-than-normal impact from the return of shorter-duration events relative to Q2 2020. Looking back on the last 18 months, our markets and pricing expanded rapidly heading into the pandemic. As discussed in prior quarters, the growth trajectory for both pricing and VAPS on new deliveries slowed a bit in Q2 and Q3 of last year, largely mix-related. We're now seeing a continuation and further acceleration of the pre-pandemic trajectories as price and VAPS performance has been phenomenal. Our VAPS monthly rate on new units delivered in the last 12 months, as depicted on page 10, is up 31% to $360 per unit per month. So we're now setting our sights higher in this area. Rates also increased dramatically in our North America Storage segment, up 10% year-over-year in the second quarter. Our team is very focused on optimizing rate for new storage activation and the focus is evident in our results. In parallel, we're starting to provide value-added products in our ground-level office fleet, and we've identified a VAPS offering for containers, which is now under development. Our U.K. segment continued its brilliant progress with another tremendous quarter. Rates are up 40%. Units on rent are up 13%, and adjusted EBITDA is up nearly 80% year-over-year. We're thrilled with our progress. And our Tank & Pump segment is also inflecting strongly as end markets recovered. However, we're clearly outperforming the market and capturing share here. Our OEC utilization is into the mid-70s, which is now above 2019 levels. Revenue and EBITDA are up year-over-year in Q2. So while outperforming our peers in Q2 2020, our Tank & Pump business is now also contributing to our increased run rate, which is fantastic. We have a very exciting technology roadmap coming together, which will further underpin and support these results in all segments for coming years. And before I pass the call over to Tim, I want to spend some time on our ERP migration. As I mentioned previously, we migrated the legacy WillScot business onto Mobile Mini's world-class SAP platform on time earlier this quarter. We went live in SAP across the entire company the first week of May. So we've now been operating on a single ERP platform for three months. A year of planning and several months of intensive training and change management led up to that successful cutover. Many of our colleagues worked days, nights and weekends to make this transition a success, and for that we have our internal gratitude and appreciation. No ERP transition is easy, but our team's dedication, meticulous attention to detail and collaboration across the various segments resulted in a minimally disruptive implementation. There's really been no change for the legacy Mobile Mini branch as we've been operating SAP there for years, but it's been a massive change for our legacy WillScot branches. While we're still learning how to efficiently navigate the new system and refining our reporting and analytics, it hasn't distracted us from serving our customers, as you can see from our delivery, pricing and value-added product trends. This successful system migration is a critical enabler on four fronts. First, it enables the $50 million cost synergy premise in the merger between WillScot and Mobile Mini. Second, it enables us to advance the next phase of our technology roadmap, which in the near term will include refinement of inventory management, harmonization of our CRM platform, development of stronger business intelligence and data science capabilities. Third, now that the migration is complete, I'm excited to redirect the team to our host of multiyear growth levers that continue to expand: price optimization, value-added products, cross-selling, operational efficiencies — each and together represent opportunities in all four of our operating segments. And fourth, we'll be able to more seamlessly integrate any acquisitions going forward, continuing our strategy to compound robust organic growth with highly accretive M&A. We executed the cutover flawlessly, and I'm humbled to be associated with such an outstanding team. We are one of a very small group of great companies that can use the terms on time, success and SAP in the same sentence. With that, I'll hand it over to Tim.

Thank you, Brad, and good morning, everyone. Jumping to Page 19, it presents a high-level summary of the quarter. While it is last on the page, our top priority in the quarter, as Brad mentioned, was to successfully migrate the legacy WillScot operations into Mobile Mini's SAP platform. We accomplished that consistent with the timeline we established about 17 months ago when we announced the merger. I won't repeat Brad's observations other than to say thank you again to the team. This was the highest-risk undertaking related to the merger, so to have it largely behind us clearly increases our confidence in the outlook. More importantly, the ability to execute a project of this complexity across all functions, both in the field and in our shared service centers, proves the capability of this organization when we collaborate. And frankly, it creates a huge competitive advantage as we redeploy these resources to other commercial and operational value drivers. While all of that was going on, our operating results were outstanding. Leasing revenues increased 18% year-over-year, with acceleration across all leasing KPIs and in all segments. And I'll remind everyone that this is on top of growing our lease revenues every quarter last year on a pro forma basis. So our platform is not simply recovering from the pandemic; we are compounding growth through the pandemic and not many companies in our space can say that. On a pro forma basis, adjusted EBITDA increased 14% over the prior year to $176 million. Adjusted EBITDA margin contracted 130 basis points to 38.1% versus prior year on a pro forma basis as we expected and discussed on the prior two quarterly calls. Accelerating deliveries drove a higher mix of lower-margin transportation revenues and increased variable maintenance costs, which is playing out pretty much as we expected. And we still expect margins will expand approximately 200 basis points year-over-year as we get to Q4 and head into 2022. We generated $82 million of free cash flow during the quarter. In the 12 months since the merger, we've generated a 20% free cash flow margin despite the integration cost headwinds. The completion of our ERP migration will bring integration costs down and allow us to start realizing other cost savings. So our free cash flow trajectory is very much on track. We maintained leverage at 3.7 times this quarter, as we repurchased $135 million of common stock and warrants, mostly in conjunction with the secondary offering from TDR Capital. Our confidence in the outlook as well as the ERP migration obviously impact our view of capital allocation. Since closing the merger last year, we've reduced our economic share count by 2%, including the elimination of the 2015 warrants, which we announced in May, simplifying our capital structure. And the outlook itself continues to improve, both as the markets pick up and as we gain traction from all of the organic initiatives that we've been organizing over the past 12 months. EBITDA will be between $710 million and $730 million for the year, up 10% to 13% versus 2020 and putting us on an exciting trajectory heading into 2022. Altogether, it was a fantastic quarter with a lot of reasons to be excited about the future. Page 20 details some of the other financial metrics from the quarter. We delivered $461 million of revenue, up 18% on a pro forma basis. Again, revenues were up in all segments. So the run rates across the board heading into the second half of the year are quite strong. We generated $176 million of adjusted EBITDA, which is a 14% year-over-year increase, again with growth in all segments. We ended up with approximately a $23 million increase in our variable leasing costs impacting gross margin this quarter relative to prior year due to the increase in delivery volumes. About half of that increase was in the modular segment, but we saw the same dynamic in all segments, and it's a normal mechanic of the business in periods with significant volume fluctuations. And we, of course, benefited from this variability in our cost structure last year when volumes were down. Normalizing for these cost fluctuations, flow-through to EBITDA would have been north of 60%. So it's easy to see that the long-term margin expansion trend is on track. This dynamic will continue in Q3. Adjusted EBITDA margins should be down year-over-year and flat sequentially as delivery volumes accelerate into Q3. Then as deliveries normalize in Q4, we still expect 150 to 200 basis points of margin expansion in the fourth quarter headed into 2022, which is consistent with our commentary for the past six months. So the business performed exactly as we expected, actually a little better relative to our original outlook with continued acceleration of commercial KPIs and strong cash generation, which you can see on Page 21. Cash from operations grew both year-over-year and sequentially, in line with our lease revenue and EBITDA trends. I think this was a company record, actually. Net CapEx increased sequentially to support the normal seasonal increase in delivery activity. You can see free cash flow margin in the bottom right has been in a predictable range for the last 12 months and averaged 20% over that period. So while the metric will fluctuate a bit mostly due to CapEx timing, we have long-term upside here through growth, synergy realization and the completion of the integration. Turning to Page 22. We maintained leverage at 3.7 times while repurchasing $135 million of share equivalents. The largest driver of the repurchase activity was the secondary offering by TDR Capital. Over the last 12 months, we've reduced our economic share count by about 2% to just over 230 million shares as of June 30 using the treasury stock method. I'll note that had we redirected funds used for share repurchases in Q2 toward deleveraging, our leverage ratio would have been 3.5 times, which is consistent with our leverage target for year-end and readily achievable. As a reminder, we have $249 million remaining in our share repurchase authorization. We also executed some tactical refinancing in the quarter, which reduced our weighted average interest rate to 3.8%, and our annualized cash interest to $98 million. Given our predictable growth trajectory, the balance sheet is in great shape, and I don't see any constraints from a capital allocation standpoint. Speaking of the strong growth trajectory, Page 23 shows the revised outlook for 2021. We now expect revenue between $1.8 billion and $1.85 billion, with adjusted EBITDA between $710 million and $730 million. This is a 2% increase at the midpoint relative to our previous outlook, driven simply by the improving leasing fundamentals. Again, margins are on track to expand 150 to 200 basis points in Q4 as variable costs normalize and should expand again meaningfully in 2022. So no change to those expectations. Our CapEx range increased slightly to reflect the strong market environment and fleet constraints in certain markets. We are planning to increase the spend sequentially into Q3 and our guidance assumes that Q4 will be above prior year levels. And lastly, I'll point out that tax expense in Q2 implied a 54% effective tax rate compared to the 25% to 27% range that we would typically expect. This was driven by an $8 million noncash expense due to the statutory rate increase in the United Kingdom, which went from 19% to 25%. So we had to revalue our deferred tax liability in the UK and recognized an additional $8 million of noncash expense. Again, no material cash impact from that over the next couple of years. For the 2021 fiscal year, we expect our effective GAAP tax rate will normalize to the 27% to 28% range. So this had no material change to our long-term cash tax outlook, although it created some noise in Q2. As I stated on previous calls, on Slide 24, our capital allocation framework is unchanged. We have excellent visibility in our business and numerous organic growth levers which we are completely focused on now that the ERP migration is complete. We are on track to delever to less than 3.5 times by the end of 2021 and could have easily achieved that target ahead of schedule in Q2. Completion of the ERP integration derisks our outlook and unlocks synergy opportunities, bringing us an important step closer to the $500 million free cash flow milestone, which we envisioned 17 months ago. And that, in turn, gives us more confidence to use the balance sheet for M&A and repurchases. On the one-year anniversary of our merger, I am more excited than ever about the progress that we've made as well as the portfolio of commercial and operational value drivers that we are beginning to execute. I and our team look forward to seeing you all at our Investor Day in New York on November 8 and discuss all of that in more detail. Brad, back to you.

Thanks, Tim. We're frugal and smart with the capital we employ. We can transact quickly on M&A. And now that the ERP system is up and running, we can add other businesses to our platform with ever-increasing efficiency. I expect our continued execution to support shareholder value creation for years to come. I wish all of you listening today continued safety and good health. This concludes our prepared remarks. Operator, would you please open the line for questions?

The operator provided instructions. Your first question comes from the line of Scott Schneeberger from Oppenheimer. Your line is open, sir.

Thanks very much. Good morning everyone. I noticed a big step-up in North American portable storage container pricing, and I'm curious on the rationale and the roadmap for that going forward, and if you could speak to core containers versus ground-level offices in that category. Thanks.

Scott, what you're seeing is continuation of the ground-level office performance with a step-up and also continued improvement in new rates on all containers themselves. We're simply deploying the playbook we've used for years. As far as the roadmap, we're still yet to deploy all the rate optimization goals that we have on the modular and VAPS side to that portfolio, nor have we significantly begun to see traction from VAPS with either ground-level offices or the storage units. As I mentioned in my remarks, we have started to deliver the ground-level office furniture bundles that WillScot had in place, and that's starting quite well. We've also architected a VAPS portfolio for storage containers themselves, which is now under development, and I expect we'll be rolling that out in 2022.

Excellent. Thanks. And then staying on pricing, swinging over to North America Modular — 19.7% is obviously the biggest increase we've seen in a while. You said this wasn't necessarily against an easy comp. That was a very robust number. You've said in the past you can go out a few more years with double-digit increases regarding rate and VAPS contribution, but we seem to have achieved a new tier here. What are reasonable expectations for the coming quarters in this category?

Scott, I wouldn't extrapolate 20% too far out into the future, but we're extremely pleased with how rates and value-added products are progressing in North America Modular and in the U.K. as well. They are leading the charge from a year-over-year rate growth perspective. On Page 10, our delivered rates to contracts in the last 12 months show value-added products recurring revenue is up 31% year-over-year. We have clearly seen an acceleration of adoption with our sales force and customers. We've maintained that $130 million-plus organic revenue growth opportunity we've discussed, while growing delivered rates. That's a big contributor — about 45% of the year-over-year increase in AMR in North America Modular. The remainder of the AMR increase comes from core rate increases, which we continue to push. There is a mix element from last year when we had virtually zero short-term special events due to COVID, and we are seeing some of those start to come back. So a bit of mix is contributing to the 19.7% number. Fundamentally, the underlying trends are strong, and we expect to continue pushing pricing and VAPS penetration.

Thanks, Tim. Just a quick follow-up on the short-term: is that anything that's going to disrupt your 34-month average? Could that pull it down, or is that just a little above normal trend and nothing to get concerned about?

No, it's not that it's an above-normal trend. It's that those short-term events didn't happen last year. This is normal recurring business we service every year, mostly in Q2 and Q3 — PGA golf tournaments, NASCAR races, music festivals, community fairs, those types of events. They are typically shorter duration. We do have duration-based pricing, at least in modular, and that's a technique we may test in other segments, which is an example of cross-pollination of commercial best practices we're exploring.

Understood. Great job. I'll turn it over. Thanks.

Your next question comes from the line of Kevin McVeigh from Credit Suisse. Your line is open.

Great. Thanks so much. Congratulations as well. Brad, Tim, you spent a lot of time on SAP. Is there incremental potential synergies as you work through that process? And does it give you more opportunity on the M&A side? Any thoughts on M&A strategy now that you've worked through SAP, and related to existing synergies as well?

We've been successful with M&A over the last four years and integrating acquisitions. This will make it quicker and easier. We now have the SAP platform; many target companies will have storage and office products, and it allows us to be even more swift on integration. Regarding cost synergies, we expect incremental operating efficiencies. Mobile Mini had been expanding EBITDA margins by realizing efficiencies with SAP, and we expect continuation of that as we refine reporting and analytics.

Kevin, the completion of the SAP migration is really an enabler that allows us to progress our technology roadmap, which is the most exciting part. Two big ones: harmonization of our CRM and customer data — we now have the largest repository of transaction data in North America for our markets, which is a huge competitive advantage. We're actively recruiting business intelligence, data science and pricing capabilities to leverage that. Second, by moving into SAP, we've started down the path toward a more sophisticated perpetual inventory management system for the modular side. If you think about cost containment and efficiency with inventory and VAPS, that's a focus going into 2022. Those are tangible examples of where we're focusing time now that SAP is complete.

Does that give you an opportunity to increase utilization overall? Or would you still expect peak utilizations to be in the normal to high range?

Both projects are opportunities to drive returns — utilization, pricing, and being more efficient with the balance sheet. We're focused on driving growth and returns across those levers.

Got it. And then just one quick follow-up: the seasonal business has been flexing up nicely. How about some of the more COVID-related demand you had? Has that extended out a little bit, or has that been as expected? Given the revenue trends, is it the seasonal coming back and COVID-related work leveling off?

That's a fair characterization. As demand for COVID testing and vaccine distribution ebbs, we're seeing recovery across the other end markets.

Awesome. Thanks so much.

Your next question comes from the line of Justin Hauke from Baird. Your line is open.

Can you hear me now? Sorry. There was a question earlier on pricing in portable storage. I wanted to drill into that more because you talked about VAPS on the ground-level offices driving a lot of that. But if you strip that out, the base units were up 5% to 6% and that had been kind of flat. Is anything changed in how you're pricing core units without the VAPS on the ground-level offices? How should we think about pricing there?

Apologies for any confusion earlier. The 10.3% increase is predominantly core pricing. We've started to implement VAPS for ground-level offices, but you're just beginning to see that in the numbers. Historically, Mobile Mini was driving roughly a 3% to 3.5% rate CAGR largely from ground-level offices; that performance has continued and accelerated. Now you're seeing new rates for containers also pull that up. The playbook is optimized rates on new deliveries. Going forward, we'll see further benefits from expanded penetration of VAPS on ground-level offices and the VAPS portfolio for containers under development, which should benefit results in 2022. We'll discuss more at Investor Day in November.

I appreciate the clarification. Second question on margins in modular specifically. You talked about some pressure from putting more deliveries out in Q2 and Q3, but volumes were kind of flat and you got a lot of pricing. Were there a lot of returns or other variable cost increases that weighed on margins? Anything to think about for Q3 and Q4 on margin trajectory for modular space?

Units on rent in North America Modular were sequentially flat from Q1 to Q2, so delivery volume equaled return volume. Deliveries did accelerate 12% year-over-year, although not to 2019 levels, and we expect them to sequentially increase into Q3. Unit on rent is a lagging indicator because of the long lease durations. Our original guidance expected modest modular volume growth by year-end, which requires several quarters of year-over-year delivery growth for the portfolio turnover to drive unit on rent growth. Delivery volumes drive variable maintenance and some selling costs; we saw margin compression as expected on a pro forma basis in Q2. I'd expect EBITDA margins to stay sequentially flat into Q3, still down year-over-year, and then in Q4, as delivery volumes normalize, we expect 150 to 200 basis points of margin expansion heading into 2022. This is a predictable portfolio rolling forward with a bit more pricing upside than we originally forecasted.

No surprises in Q2 from our perspective. Delivery volumes picked up, and that drives the variable maintenance costs that Tim described. The combination of volume, rate and VAPS positions us well for 2022.

Your next question comes from the line of Ross Gilardi from Bank of America. Your line is open.

Hey. Good morning, guys. Tim, you just answered some questions, but I'm still scratching my head. You've got 20% pricing in core business, demand is picking up, and margins are down year-over-year. I don't totally get these buckets of costs coming back into the business. If volume is improving, I get that there are variable costs, but why are margins down?

Ross, remember last year we took massive variable costs out of the business after COVID. We stripped almost all variable cost out in Q2 last year on both platforms. We've been frank that those costs would come back. So you had a resumption to normal cost plus incremental demand. That was expected and straightforward to us.

Ross, we're talking about direct labor in the branch network and materials used in maintaining modular and storage equipment. We saw this dynamic across every segment. We expected delivery volumes to pick up across the business, which is what happened. In our guidance going back to Q4, we said margins would contract sequentially and year-over-year for Q2, stabilize in Q3, and then pop again heading into 2022 as noise normalizes. This is the normal mechanics of how the business turns over, amplified by the cost reductions we had last year and their return this year.

Okay. Maybe I'll follow up afterwards. One more: can you talk more about the relationship between fleet utilization and rate improvement? In Modular, utilization has been range-bound at 67% to 68% for several quarters. I'd expect utilization to go up sharply with rate acceleration. Can you explain?

Remember, 45% of the AMR increase year-over-year comes from value-added products. So regardless of utilization movement, AMR can grow as units that were rented years ago come back to branches and are re-rented with recurring revenue from VAPS. In a volume-neutral environment, you still get over $130 million of revenue growth from VAPS. We also test price-volume elasticity, which isn’t as pronounced as you might think. Utilization is interesting but not the only variable when deciding rates.

If you look at delivery and rates together this quarter, you saw significant improvements in delivery rates on both modular and storage, as well as rates. The big step between modular and storage is really VAPS.

Now that costs are coming back and things normalize, what incremental EBITDA margin should we expect on VAPS-related pricing versus core pricing?

In a normal environment, you get roughly 90% flow-through from pricing, about 75% from value-added products and services, and about 60% from volume on modular. Those can be higher on storage. For Q3, expect a similar dynamic to Q2 but perhaps less pronounced, and then north of 60% flow-through in Q4 heading into 2022. Exact quarter-by-quarter flow-through will vary due to cost fluctuations, but the direction is clear: margin expansion into 2022.

Your next question comes from the line of Steven Ramsey from Thompson Research. Your line is open.

Hi. Good morning. On modular stabilization, how long do you expect this stabilization period to last before getting to growth again? Is this taking longer than normal or is it expected?

As we looked into the year, we initially expected modular volumes to recover by year-end because of the long lease duration. As you increase deliveries, it takes time for the portfolio to turn. Unit lease revenues are slightly ahead of our expectations now. The simple combination of volume, rate and VAPS puts us in a strong position today and heading into 2022. It takes time to turn a large portfolio with a 34-month average lease duration.

Thanks. Given labor and material shortages on residential, are you seeing longer project times in commercial that would lead to longer lease time frames over the next one to three years?

I don't expect anything material right now. We'll keep an eye on it, but we haven't seen significant impacts. Lease durations have been stable over time. We are typically first on site and last off, representing a small portion of project costs, so I don't expect a material change.

Your next question comes from the line of Sam England from Berenberg. Your line is open.

Hi guys. Thanks for taking the question. First, what's the timeline for delivering on the revenue synergies from the Mini deal now that the ERP integration is done? Particularly around national account overlap and cross-selling. Given what you've said, when do you expect to realize these revenue synergies?

We'll discuss more in November. At the time of the merger the only quantified revenue synergy was putting the WillScot furniture portfolio into Mobile Mini's ground-level office fleet. We've started that in more than a dozen branches and are expanding rapidly. That was a $50 million revenue opportunity across North America and the U.K., and it flows through to about $35 million of EBITDA as we've characterized before. That's well underway. With the ERP cutover complete, we can focus on cross-selling, lifting storage market share, rate optimization across the portfolio, and VAPS into storage containers, among other initiatives. We'll share more detail in November.

Okay. Great. On VAPS, you're close to that internal $400-per-unit target for LTM VAPS. Is $400 still the longer-term target, or is that moving up over time? Will you talk about another target?

When we marketed the company back in 2017, we set our sights on $400 per unit. At $360, we're approaching that. That target is moving up; we intend to eclipse milestones like that and will discuss more in November.

Great. One more: what are you seeing on replacement unit cost inflation? Are you delaying purchases, and what dynamics are at play?

On containers, there's temporary pressure on new and used container pricing, whether imports from abroad or units from ports. Shipping costs and timelines are up. Some modular units are imported as well. However, we're not buying many modulars now given where utilization is; we'll refurbish existing equipment. That's a luxury for us and gives cost control. We handle refurbishment in-house at scale in our larger branches, which is a competitive differentiation. So while there are supply constraints, we control our destiny more than many others.

Your next question comes from the line of Phil Ng from Jefferies. Your line is open.

Hey guys. Congrats on another great quarter. I hopped off the Q&A earlier for a little bit, so apologies if you've answered this. M&A has been a big part of your growth strategy. There have been a few deals in the space for both modular and portable. Are you seeing more competition on the M&A front? How are multiples shaping up and any color on the pipeline would be helpful.

The pipeline's robust. While we were laser-focused on the ERP, we said we wouldn't miss smart deals nor be compelled to do anything unfavorable. We don't think we've missed anything we should. M&A will continue to compound organic opportunities with accretive acquisitions. It's part of our DNA and will continue.

It's hard to generalize on valuations. Market valuations have been up over the last 12 months. We are still seeing very interesting, accretive opportunities and expect to be active in the next six to 12 months.

The U.K. portable business has been a home run. Is this a business you want to invest more capital in organically or inorganically since it fits nicely?

It's more than storage; it's a nice blend of modular and storage like what we do in the U.S. Great alignment and outstanding performance by the team there. We are deploying capital to support their growth and are pleased with the business. It's a strong asset to have post-merger.

Your next question comes from the line of Stanley Elliott from Stifel. Your line is open.

Hey. Good morning everyone. Thanks for taking the question. On VAPS and legacy Mini products: VAPS has historically grown at a steady clip. As you're moving into that market, is the opportunity mainly on new rentals going forward, or is there upside to go out to the existing field to sell VAPS? How quickly can this ramp?

It's our expectation we will penetrate both ground-level offices and eventually containers on new deliveries. There's limited opportunity to go out to units already in the field and sell furniture after customers have already solved their own needs. The upfront transaction is the real opportunity — making it simple so customers are ready to work day one when our assets arrive. We expect continued building at roughly the consistent 20% CAGR that you saw in North America Modular over the last nine years.

Great. When you talk about incrementals, you mentioned roughly 60% flow-through. Looking at the $23 million in variable costs this quarter, when you look into next year, is there a reason why incrementals wouldn't be better than 60% given a more normalized environment plus lower diesel costs and better logistics?

North of 60% flow-through feels like the right ZIP code, and I absolutely see margins expanding meaningfully into 2022. The exact flow-through in any given quarter varies due to the fluctuations in variable costs. We appear to be having a solid delivery season heading into Q3, and seasonality is taking shape as in a normal year. If that continues into next year, you would not have the level of flow-through variation we saw in Q2 and Q3, which had last year's anomalies.

Your last question comes from the line of Brent Thielman from D.A. Davidson. Your line is open.

Thanks. One more on North America Modular volume: if we theoretically see another couple of quarters of 10%-plus delivery growth and given your average lease duration above 30 months, can we expect units on rent to grow meaningfully into 2022? Is that simple math and directionally correct?

Heading into 2022, assuming neutral Q4 relative to last year, getting into low single-digit volume growth in 2022 and beyond is a good target. That reflects the portfolio turnover dynamics.

Bigger-picture: are supply chain constraints and other market frictions helping your business from a delivery or new orders perspective?

On net, it's helping. Any friction we've encountered we've been able to pass through in rate. They haven't been constraining to us. Part of that is our scale: if there's a shortage in one geography, we can address it from another to ensure we don't let customers down.

We are the largest marginal supplier of this equipment. Our supplier relationships and existing fleet capacity make us more likely to deliver the right asset in the right place and time than anyone else in the market. All else equal, supply constraints support pricing and should allow us to be more competitive on volume as well.

One last question: you've been deemphasizing unit sales. Is the difficulty of acquiring new units causing customers who would traditionally buy to convert to leasing? Is that a trend you're seeing?

Our sales run about 10% of revenues with about half being used sales. That's typically maintenance of fleet or accommodation to existing customers. When fleet is constrained, we dial sales back. Anything we sell is at a great return because we replace the unit with another new one. New sales are the exception, especially in modular where customers want something unique or know they need it for many years. We tweak those dials as demand and utilization ebb and flow, but don't expect a material strategic shift.

We have now reached the end of today's call. I will now turn the call back over to Nick.

Thank you, Catlin. Thank you all for your interest in WillScot Mobile Mini. If you have additional questions after today's call, please contact me. Thank you.

Thank you. Ladies and gentlemen, this concludes today’s conference. You may now disconnect.