Logo of jester cap with thought bubble with words 'Fool Transcripts' below it

Image source: The Motley Fool.

McGrath RentCorp (NASDAQ:MGRC)
Q4 2018 Earnings Conference Call
Feb. 26, 2019 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the McGrath RentCorp fourth-quarter 2018 conference call. [Operator instructions] This conference call is being recorded today, Tuesday, February 26, 2019. Before we begin, note that the matters that 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 2019 total company operating profit outlook as well as statements relating to the company's expectations, strategies, prospects or targets.

These forward-looking statements are not guarantees of future performance and involve significant risks and uncertainties that could cause our actual results to differ materially from those projected. Important factors that could cause actual results to differ materially from the company's expectations are disclosed under Risk Factors in the company's Form 10-K and other SEC filings. Forward-looking statements are made only as of the date hereof. Except as otherwise required by law, we assume no obligation to update any forward-looking statements.

In addition to the press release issued today, the company also filed with the SEC the earnings release on Form 8-K and the Form 10-K. Speaking today will be Joe Hanna, chief executive officer; and Keith Pratt, chief financial officer. I would now like to turn the call over to Mr. Hanna.

Go ahead, sir.

Joe Hanna -- Chief Executive Officer

Thank you, Murielle. Good afternoon, and thank you for joining us on today's call. I will start the call with some comments on our fourth-quarter and 2018 full-year performance, and then Keith will provide additional detail in his financial-review and outlook comments. Our 2018 performance capped off another year of delivering impressive results for our shareholders.

Our focus was clear: get more performance from the fleet we already own, deploy new capital for the right opportunities and sell underutilized inventory. Key to driving that performance were our employees who I would like to personally thank for their spirit, dedication and hard work. Everyone helped us achieve success in meeting our objectives for the year. For the fourth quarter, the company's 10% increase in rental revenue reflected growth across each of our divisions, with particularly strong growth at Mobile Modular.

The company's 31% operating profit increase was driven by a $9 million increase in gross profit from rental revenues. At TRS-RenTelco and Adler, we had tough comps compared to 2017's seasonally strong finish. We finished 2018 on a solid note and both businesses delivered in the fourth quarter, with 5% and 27% operating profit increases, respectively. The strength of the economy continued to be a tailwind, and we were well-positioned to benefit from growth in the major industry segments and geographies where we operate.

At Mobile Modular, we have been experiencing a good funding environment for public-school construction, both to facilitate growth and modernize facilities. The public has been receptive to pass bonds and support local tax initiatives to bring older classrooms up to date. The average age of public school classrooms across the U.S. is over 40 years, and our modular classroom fleet is used extensively to help districts house students on a temporary basis during renovations.

This dynamic is occurring in all of the geographies where we are located and Mobile Modular is considered to be the industry expert. Our work to improve performance from our fleet bore fruit during 2018, which was evidenced by an impressive 22% improvement in overall company ROIC to 8.2% from 6.7% in 2017 on a normalized 27% tax rate. We are a transaction-intensive business, so pricing opportunities at optimum levels to reflect customer needs, utilization and the competitive environment has been a priority. Our sales teams have better tools to set price.

And together with our focus on targeting the right types of customers and transactions, we have improved the financial returns of each of our rental businesses over the year. At the same time, we have made fleet investments in the right areas. In 2018, we purchased $134 million of new rental fleet, representing a 37% increase, compared to 2017. Most of the investment went to Mobile Modular and TRS-RenTelco.

Our financial hurdles remain at the forefront of our decision-making processes, and we thoughtfully challenge ourselves about each and every dollar we invest to ensure it is going to the right kind of application and transaction. Our skill at capital allocation has improved, and we are very pleased with the progress we have made. Overall, the fleet grew 5% during the year, which reflects an intense focus on selling underutilized assets as we continue to spend sensibly for the right applications in the right geographies. Today, we also announced the 10% increase in our annual dividend.

McGrath RentCorp is one of a select group of companies that has consecutively increased its dividend for over 25 years or more than a quarter of a century. We are also one of an even smaller group of companies our size that has managed to accomplish this for its shareholders. 2019 marks our 28th year of a dividend increase, and the 10% increase reflects the underlying strength of the McGrath RentCorp portfolio. Turning to 2019.

We have several areas where we will be making investments. We are expanding Mobile Modular and Portable Storage into some new geographies. We are implementing a new logistics platform for our Portable Storage business to improve sales force efficiency and the customer experience. We are also planning some additional spend on fleet repairs at Mobile Modular to further improve utilization and support growth, while reducing the need to buy new equipment.

Entering the first quarter of 2019, market conditions continue to be highly competitive and our visibility is limited because of the shorter rental terms of typical Adler and TRS-RenTelco transactions. However, underlying market conditions are encouraging. Our businesses are well-positioned, and we will be working hard to build upon our solid 2018 performance. I want to conclude my opening remarks by conveying my sense of confidence that our McGrath RentCorp team will continue to deliver solid growth to the benefit of both our customers and shareholders in the coming year.So now, let me turn the call over to Keith, who will take you through our financial review.

Keith Pratt -- Chief Financial Officer

Thank you, Joe. For the fourth quarter of 2018, total revenues increased 9% to $133.1 million from $122.2 million for the same period in 2017. The company's 31% operating profit increase for the quarter was driven by a $9 million increase in gross profit from rental revenues. Net income decreased 79% to $24.2 million from $117.7 million and earnings per diluted share decreased to $0.99 from $4.82.

The fourth quarter of 2017 included a net-income benefit of $102.5 million or $4.20 per diluted share associated with the enactment of the Tax Cuts and Jobs Act. The fourth quarter of 2018 includes a net income benefit associated with the lower U.S. federal tax rate of 21%, which contributed $0.18 to earnings per diluted share. Now let's review rental division's performance compared to the fourth quarter of 2017.

Mobile Modular total revenues increased $8.5 million or 15% to $66 million on higher rental, rental-related services and sales revenues. Rental revenues for the quarter increased 13% from a year ago, primarily driven by an 8% improvement in average rental rates and 5% higher average equipment on rent. Sales revenues increased $1.3 million or 18% on higher used-equipment sales. Rental revenue growth continued to be healthy across our commercial and education markets as well as in our Portable Storage business.

Equipment preparation cost or other direct costs of rental operations decreased $2.6 million or 22% to $9.3 million. The decreased other direct costs in 2018 was partly attributable to a $1.6 million impairment of rental assets deemed beyond economic repair in the Southern California region in 2017. Rental margins increased to 66% from 54%. The combined result of higher rental revenue and higher rental margin was a 37% increase in gross profit on rents.

Finally, average modular rental equipment for the quarter was $770 million, which was an increase of $20 million. Average fleet utilization for the fourth quarter increased to 79.2% from 77.3%. TRS-RenTelco total revenues increased $3.2 million or 11% to $32.1 million on higher rental revenues and sales revenues. Rental revenues for the quarter increased 8%, primarily driven by 9% higher average equipment on rent, which was partly offset by 1% lower average rental rates.

Rental margins decreased to 45% from 46%. The combined result was a 5% increase in gross profit on rents. Test equipment rental revenues for general purpose and communications increased by 9% and 4%, respectively. We continue to invest in general-purpose test equipment for growth opportunities.

Finally, average electronics rental equipment for the quarter was $285 million, which was an increase of $25 million. Average utilization for the fourth quarter decreased to 63.1% from 63.6%. Adler Tank Rentals total revenues increased $0.6 million or 2% to $25.8 million on higher rental and rental-related services revenues, which were partly offset by lower sales revenues. Rental revenues for the quarter increased 3%, primarily driven by higher-average equipment on rent and 1% higher-average rental rates.

Rental margins increased to 61% from 60%. The combined result was a 16% increase in gross profit on rents. Adler's rental revenue growth was broad-based with increases in four of our six vertical markets. Upstream oil and natural gas rental revenues accounted for 11% of total rental revenues.

While our average fleet size was up only 1% year over year, we continue to focus on better utilization of the existing fleet. Now with this division review complete, the remainder of my comments will be on a total-company basis. Selling and administrative expenses increased $2 million or 7% to $29.9 million, primarily due to increased salaries and employee-benefit costs across all divisions. On a consolidated basis, interest expense for the fourth-quarter 2018 increased $0.3 million or 9% to $3.2 million.

Higher net average interest rates were partly offset by lower average debt levels. As discussed earlier, the fourth-quarter 2018 provision for income taxes was based on an effective tax rate of 24.3%, compared to a large tax benefit in 2017. The primary driver of the increase was the passage of the Tax Act. Next, I would like to review our 2018 full-year cash flow highlights.

Net cash provided by operating activities was $142.7 million, an increase of $20.3 million, compared to 2017. The 17% increase was primarily attributable to improved income from operations and other balance sheet changes. We invested $123.1 million for rental equipment purchases compared to $94.6 million for the same period in 2017 due to higher purchases at TRS-RenTelco and Mobile Modular. In addition, we invested $7.5 million in cash to purchase the assets of a Blast Resistant Module rental business.

Property, plant and equipment purchases increased $1.1 million to $15.7 million. Dividend payments to shareholders were $30.9 million. Net borrowings decreased $4.8 million from $303.4 million at the end of 2017 to $298.6 million at the end of 2018. At quarter-end, the company had capacity to borrow an additional $233.4 million under its lines of credit and the ratio of funded debt to the last 12 months adjusted EBITDA was 1.47:1.

Fourth-quarter 2018 adjusted EBITDA increased 16% to $57.6 million compared to the same period in 2017. Consolidated adjusted EBITDA margin was 43% and 40% in the fourth quarters of 2018 and 2017, respectively. Our definition of adjusted EBITDA and a reconciliation of adjusted EBITDA to net income are included in our press release for the quarter. Finally, turning to our 2019 financial outlook.

For the full-year 2019, we expect rental revenues to increase between 6% and 9% over 2018; sales revenues to be comparable to 2018; rental-equipment depreciation expense to be between $75 million and $78 million; other direct costs of rental operations, primarily for rental equipment maintenance and repair, to be between $72 million and $75 million; selling and administrative costs to be between $123 million and $126 million; operating profit to increase between 5% and 10% over 2018; full-year interest expense to be between $12.1 million and $12.5 million; the effective tax rate to be approximately 27%; and the diluted share count to be between 24.6 million and 24.7 million shares. That concludes the prepared remarks on our quarterly results. Murielle, you may now open the lines for questions. 

Questions and Answers:

Operator

[Operator instructions] Our first question comes from Scott Schneeberger from Oppenheimer. Your line is now open.

Scott Schneeberger -- Oppenheimer -- Analyst

Thanks very much. Good afternoon, guys. Hey, guys. My first question is in Mobile Modular.

I'm just curious to get a little bit more in depth on the classroom business versus the construction business and just a general question on going a little deeper on both, please. Thanks.

Joe Hanna -- Chief Executive Officer

Sure. Scott, we're -- I mean, the funding environment for the classroom part of our business has been good in 2018 and it continued that trend into Q4. We've experienced healthy bookings levels in Q4 for classrooms in virtually all of the markets that we operate in. And it appears as though this year, school districts are placing orders a little bit earlier than normal.

And we experienced some of that in Q4, and that's actually spilled over in Q1. So we feel very good about that market or that part of our business. And over on the construction side, we're still seeing very good demand there. The associated builders and contractors have recently reported 67% of contractors are expecting sales increases in 2019.

And we have not seen any indicators that it would be different from that so far in our pipelines. So across the business, it appears to be healthy.

Scott Schneeberger -- Oppenheimer -- Analyst

Great. Thanks. The -- you mentioned new geographies. Could you expand a little bit on where you're going and the financial impacts of the move? Thanks.

Joe Hanna -- Chief Executive Officer

Sure. We're going to expand in the south central part of the U.S. We'll announce specific locations in the near future. And as far as a drag on performance, obviously, when we're opening up a location, there is a slight upside down there as we get operations moving, but it's not significant and really won't affect our results.

We're only opening, really, three locations. And so we don't expect that to materially move things in 2019.

Keith Pratt -- Chief Financial Officer

Yeah, there could be a little bit of a drag in the first year. But again, it's all built into the plans we built and the outlook comments that we've made for the year. And I think, it positions us very well going forward.

Scott Schneeberger -- Oppenheimer -- Analyst

All right. Thanks. Just a couple more for me, guys. One being TRS rental revenue growth, nice acceleration in fourth quarter.

Could you speak a little bit to the end market dynamics a little bit more and discussion of 5G considerations? Thanks.

Joe Hanna -- Chief Executive Officer

Sure. 5G is -- we all hear in the news, it's -- different carriers are announcing different programs with 5G. It really hasn't made it onto the towers yet. Most of the 5G work is through backhaul and bandwidth expansions up through the networks and into the towers, but not so much tower work at this point.

That 5G bandwidth expansion work, we're actually -- we're capturing work from that. And so that's helped with our communications rentals. And also over on the GP side, robust demand in aerospace and defense, and semiconductor industries has also helped us there. And we're experiencing healthy growth.

Utilization for our GP equipment recently was at 75%, which is really healthy for us, and we're actively buying equipment to meet demand. And it's going out on rent.

Keith Pratt -- Chief Financial Officer

And Scott, I would add, if you look at the 8% growth in rental revenues, as I remarked in my comments, that's comprised of 9% growth on the general purpose side, 4% growth on the communications side. A portion of that 9% growth on the general-purpose side, we believe, is tied to R&D work related to device design for 5G. So it's not so much in the network build-out, but it's more devices and equipment that are being designed and need use of general-purpose equipment. So we are seeing that as a positive in that part of the business.

Scott Schneeberger -- Oppenheimer -- Analyst

Great. Thanks, guys. I appreciate that color. My last one, you may have partly already answered, but I think there may be more to it.

The guide for next year looks good. Rental revenue growth guidance, 6% to 9% and then operating growth profit guidance of 5% to 10%, so not a lot of operating leverage there. Looks like it's, versus our model, more in G&A than anywhere else. So I guess, Keith, could you elaborate on -- is that cushion? Is that some of the geographies' expansion spending? Or is there something else in there that's affecting that -- the G&A, I guess, and just the leverage overall? Thanks.

Keith Pratt -- Chief Financial Officer

Sure. Let me make a couple of comments. The first comment I would make is, in our business, here we are in February, it's very difficult to give full-year guidance, as you can imagine. And I think, we put a lot more information out there for you to work with than some other companies.

Keep in mind that in our Adler and TRS-RenTelco businesses, the rental terms are short, and that business is turning over a lot. So we certainly have plans and ambitions for the year, but there's a limited amount we can see today and sort of be sure of. And then the other comment I would make in trying to assess the profile for the full year and in particular, the rental growth for the full year, keep in mind that last year, 60% of our EBIT occurred in the second half of the year. So really, the second half is a very important part of the year.

And starting the year in February, we just don't have as much information on that, so that influences how we position the guidance. I think, relating to the operating leverage, you're right, we're making some investments in the SG&A area. If you look at the range we've given and take the midpoint of that range and just look at where the increases are occurring, I'll give you sort of three broad categories that are driving the increase. About 30% of the increase is really just related to normal salary and benefits increases for the existing workforce, and that's fairly typical inflationary pressures that I think a lot of companies face year over year.

About 40% of the increase is related to hiring, both related to the kind of expansion initiatives that Joe described and also in some of the support functions, where our teams are supporting a larger and growing business. And then the remaining 30% or so, I would kind of call it miscellaneous items. Some of it's in the IT arena, marketing, facilities, rents and again, other aspects of supporting a business that has become larger and is continuing to grow. So as with every year, we start the year with an initial view.

Our goal is to work hard and accomplish as much as we can in 2019.

Scott Schneeberger -- Oppenheimer -- Analyst

All right. Great. Thanks. Appreciate the guidance.

I'll turn it over.

Operator

[Operator instructions] Our next question comes from Marc Riddick from Sidoti. Your line is now open.

Marc Riddick -- Sidoti and Company, LLC -- Analyst

Hi. Good evening.

Keith Pratt -- Chief Financial Officer

Hi, Marc.

Joe Hanna -- Chief Executive Officer

Hi, Marc.

Marc Riddick -- Sidoti and Company, LLC -- Analyst

I was wondering if you could share a little and forgive me, I was sort of back and forth a little bit. I did want to follow up on the progress around the testing equipment that you're seeing. And I'm sorry, I didn't hear the mix as far as general purpose versus the rest as far as the growth over the quarter. But I did also -- but I did hear the plans on investing more in the general purpose testing area, and I was wondering if you could sort of give a little bit more color on what we might see there and if that might be front-end loaded during the year.

What will we might expect to see on that front?

Keith Pratt -- Chief Financial Officer

Sure. Marc, just to recap, rental revenues for the quarter at TRS-RenTelco were up 8%. And when you break that into the two major segments, the general purpose and then the communications, general purpose was up 9% overall and communications up 4%. So we've been talking on these calls now for probably over a year that we saw opportunities in the general purpose arena.

We've invested and grown the size of the fleet there. And we've been successful in putting a lot of equipment out on rent, and we're very pleased with the progress. There's -- I mentioned a moment ago, there's a portion of that growth that we can also tie to R&D work for devices that are tied into the whole 5G network evolution. So there is some benefit there.

And then on the communications side, we continue to look for opportunities. And some of what we're deploying or helping deploy are really the feeder networks and more fiber going into the networks that will support the wireless 5G as it's deployed over time.

Marc Riddick -- Sidoti and Company, LLC -- Analyst

OK, great. And then I wanted to switch gears a little bit and follow up on, I guess, Portable Storage. I was curious as to whether or not Portable Storage growth in the quarter was in line or above or below the pace of Mobile Modular's growth, because, if I remember correctly, you're sort of approaching about -- I mean, close to 10% of those revenues, correct?

Joe Hanna -- Chief Executive Officer

Yeah. I'm assuming you're speaking about Portable Storage's total revenues being 10% of McGrath RentCorp's revenues. I'm assuming that's what you mean.

Marc Riddick -- Sidoti and Company, LLC -- Analyst

Yes.

Joe Hanna -- Chief Executive Officer

Yep, they're not there yet. But I would say that the business was growing very nicely. As a matter of fact, in Q4, Portable Storage rents were up 12.5%, and so it's right in line with our expectations and right in line with what we've been experiencing during the year. And so they're doing quite well.

Keith Pratt -- Chief Financial Officer

Yeah. And Marc, the Portable Storage as a percentage of total McGrath RentCorp revenues was 8% of the total for the year.

Marc Riddick -- Sidoti and Company, LLC -- Analyst

OK, so there's still a little room before you get to 10%. OK, that's helpful. And then I was wondering -- I mean, it seems as though that the opportunities are broad-based. But also, I'm wondering if there were any particular geographies that maybe we should be thinking about as -- if there were any that were problematic or kind of leading the ways a little bit more as far as geographic mix, if there was anything that we should be thinking about there.

Thank you.

Joe Hanna -- Chief Executive Officer

Marc, are you referring to Portable Storage or one of Modular's or another business?

Marc Riddick -- Sidoti and Company, LLC -- Analyst

Oh no. Mobile Modular, I'm sorry. It should be Mobile Modular, right. I'm sorry, Mobile Modular.

Thank you.

Joe Hanna -- Chief Executive Officer

Sure. Yeah, business activity has been good in all of the geographies that we operate in. Our Texas region, we saw a small dip in utilization, but that was due to returns. And our bookings have been very, very healthy all through the year.

And so aside from just that we consider to be kind of a small blip there, we're operating at -- with good metrics in all of the locations that we're in.

Marc Riddick -- Sidoti and Company, LLC -- Analyst

OK. And then I guess, maybe you -- you mentioned the strength of the economy and being helpful, the funding environment certainly. So wondering if you could -- was there any commentary or any thoughts that we should be looking at as far as maybe what you're seeing within construction?

Joe Hanna -- Chief Executive Officer

Well, we hear, and when we look at data -- I mean, we try to make our decisions based on as much information as we can, and then we listen to our customers. The information that we see and things that we hear right now are that, perhaps, construction activity could slow in the last half of 2019. That's what we're hearing in Q4. But now that we've actually entered Q1, we're hearing a lot of confidence from the indicators that we're getting from the data, from associated builders and contractors and economic activity.

I mean, we're going to announce the GDP growth here on the 28th, and we're expecting that to be not quite as high as it was in the fourth quarter, but still very good. And we're not actually hearing from our customers that there is any planned slowdown in activity, and that goes across the industry segments that we operate in, including oil and gas and refinery work and our school districts and our construction for nonresidential and residential. I mean, it's been pretty good across the board.

Marc Riddick -- Sidoti and Company, LLC -- Analyst

That's certainly encouraging. I appreciate it. Thank you very much for the color.

Joe Hanna -- Chief Executive Officer

You're welcome

Operator

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.

Joe Hanna -- Chief Executive Officer

Well, I'd like to thank everyone for joining us on the call today and for your continuing interest in our company. We look forward to speaking with you again in late April to review our first-quarter 2019 results.

Operator

[Operator signoff]

Duration: 34 minutes

Call Participants:

Joe Hanna -- Chief Executive Officer

Keith Pratt -- Chief Financial Officer

Scott Schneeberger -- Oppenheimer -- Analyst

Marc Riddick -- Sidoti and Company, LLC -- Analyst

More MGRC analysis

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

10 stocks we like better than McGrath RentCorp
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*

David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and McGrath RentCorp wasn't one of them! That's right -- they think these 10 stocks are even better buys.

See the 10 stocks

*Stock Advisor returns as of February 1, 2019