Keith Pratt - Chief Financial Officer, Senior Vice President Joe Hanna - Chief Operating Officer, Senior Vice President.

Joe Box - KeyBanc Capital Markets Scott Schneeberger - Oppenheimer & Co. Marc Riddick - Sidoti & Company.

Welcome to the McGrath RentCorp third quarter 2016 conference call. At this time, all conference participants are in a listen-only mode. Later we will be conducting a question-and-answer session. [Operator Instructions]. This conference is being recorded today, Tuesday, November 1, 2016.

Before I turn the conference over to Keith Pratt, Chief Financial Officer, I will read the company's Safe Harbor statement and provide a few other reminders.

The matters that company's management will be discussing today that are not truly historical are forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, including statements regarding the company's expectations, beliefs, intentions or strategies regarding the future.

All forward-looking statements are based upon information currently available to the company and the company assumes no obligation to update any such forward-looking statements. Forward-looking statements involve risks and uncertainties which could cause actual results to differ materially from those projected.

These and other risks relating to the company's business are set forth in the documents filed with the Securities and Exchange Commission, including the company's most recent Form 10-K. 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 for the quarter.

Please note that this call will be available for telephone replay for up to seven days following the call by dialing 1-855-859-2056 for domestic callers and 1-404-537-3406 for international callers. The passcode for the call replay is 92917895.

This call is also being broadcast live via the Internet and will be available for replay purposes in the Investor Relations section of the company's website at mgrc.com. With these formalities out of the way, I will now turn the call over to Mr. Keith Pratt. Please go ahead, sir..

Thank you Christy. Good afternoon and thank you for joining us on today's call. We are here to discuss McGrath RentCorp's third quarter 2016 results, which were reported today after the market closed.

Before I review the company's results, I would like to share some comments regarding Dennis Kakures, McGrath RentCorp's President and CEO who is currently on medical leave of absence and how the business is operating in his absence. The company announced on October 5 that Dennis had suffered a stroke.

He was initially hospitalized but is now at home and his recovery is progressing. As a result of Dennis's medical leave, the company's Board of Directors established an interim office of the CEO to provide support and guidance as needed to the company's leadership.

The company has clear operating plans in place that are being executed by an experienced group of divisional leaders. While we all miss Dennis, the company is operating on a business as usual basis. For this call, I am going to give the prepared remarks. And I have asked my colleague, Joe Hanna, our Chief Operating Officer, to join me during the Q&A.

So now, let's get started with a review of the quarter's results. For the third quarter 2016, total revenues increased 8% to $122 million from $113 million for the same period in 2015. Net income decreased 5% to $12.9 million from $13.6 million and earnings per diluted share were flat at $0.54 compared to the same period in 2015.

Reviewing the third quarter results for the company's Mobile Modular division compared to the third quarter of 2015. Total revenues increased $10.6 million or 20% to $63.7 million due to higher sales and rental revenues, partly offset by lower rental related services revenues. Rental revenues increased $3.1 million or 10% to $33.2 million.

Gross profit on rents increased $0.4 million or 3% to $18.2 million due to the higher rental revenues, partly offset by a decrease in rental margins to 55% from 59%. Lower rental margins were a result of $2.3 million higher building preparation expenses and $0.4 million higher depreciation.

Sales revenues increased $8.2 million or 96% to $16.7 million due to higher new and used equipment sales. Gross profit on sales increased $2.1 million to $4.1 million.

Selling and administrative expenses increased 13% to $13.4 million, primarily as a result of increased employee headcount, salaries and benefit costs and higher allocated corporate expenses.

The higher gross profit on sales and rental revenues, partly offset by lower gross profit on rental related services revenues and higher selling and administrative expenses resulted in an increase in operating income of $0.5 million or 4% to $12.7 million. Average modular rental equipment for the quarter was $730 million, an increase of $52 million.

Equipment additions supported growth across all regions and our portable storage business. Average utilization for the third quarter was flat at 76.7%, compared to the same period in 2015. Mobile Modular portable storage continued to make good progress during the third quarter and grew rental revenues 18% compared to the same period a year ago.

Turning next to the third quarter results for the company's TRS-RenTelco division, compared to the third quarter of 2015. Total revenues decreased $3 million or 10%, due to lower rental, sales and rental related services revenues.

Rental revenues decreased $2.2 million, or 10% to $20.4 million driven primarily by lower communications test equipment business activity and a continuing highly competitive environment. Gross profit on rents decreased $1 million or 11% to $8.3 million.

Rental margins were flat at 41% as depreciation as a percentage of rents decreased to 42% from 44% and other direct costs as a percentage of rents increased to 17% from 15%. Selling and administrative expenses decreased 6% to $5.1 million, primarily due to lower marketing and administrative costs and lower corporate allocated expenses.

The lower gross profit on rental and rental related services revenues partly offset by higher gross profit on sales revenues and lower selling and administrative expenses resulted in a 10% decrease in operating income to $6.4 million.

Finally, average electronics rental equipment at original cost for the quarter was $252 million, a decrease of $16 million. Average utilization for the third quarter increased to 61.2% from 61% in the third quarter of 2015. Turning next to the third quarter results for the company's Adler Tanks division compared to the third quarter 2015.

Total revenues decreased $4.2 million or 17% to $20.3 million primarily due to lower rental and rental related services revenues. Rental revenues decreased $3.2 million or 19% to $14.2 million. Upstream oil and natural gas rental revenue declined from 17% to 9% of total Adler rental revenues.

Gross profit on rents decreased $2.3 million or 23% to $8 million. Rental margins decreased to 56% from 59% as depreciation as a percentage of rents increased to 28% from 23% and other direct costs as a percentage of rents decreased to 16% from 18%.

Selling and administrative expenses decreased 4% to $6.6 million primarily due to lower corporate allocated expenses. The lower gross profit on rental and rental related services revenues partly offset by lower selling and administrative expenses resulted in a decrease in operating income of $2.4 million or 48% to $2.7 million.

Finally, average rental equipment for the quarter was $308 million, an increase of $2 million. Average utilization for the third quarter decreased from 58.6% to 49.4%. Third quarter average utilization and average equipment on rent were both flat compared to the second quarter of 2016.

On a consolidated basis, interest expense for the third quarter of 2016 increased $0.5 million or 20% to $2.9 million from the same period in 2015 due to the company's higher average interest rates, partly offset by lower average debt levels. The third quarter provision for income taxes was based on an effective tax rate of 39.5% in 2016 and 2015.

Next I would like to review our 2016 cash flows. For the nine months ended September 30, 2016, highlights in our cash flows included net cash provided by operating activities was $106.2 million, an increase of $5.6 million compared to 2015.

The increase was primarily attributable to an income tax refund received and increased deferred income taxes, partly offset by a lower decrease in prepaid expenses and other assets and other balance sheet changes.

We invested $64.3 million for rental equipment purchases compared to $104.9 million for the same period in 2015 consistent with a more selective deployment of capital for new rental assets. Property, plant and equipment purchases increased $2 million to $10 million in 2016.

Net borrowings decreased $36 million from $381.3 million at the end of 2015 to $345.3 million at the end of the third quarter 2016. Dividend payments to shareholders were $18.3 million.

At quarter end, the company had capacity to borrow an additional $226.6 million under its lines of credit and the ratio of funded debt to the last 12 months actual adjusted EBITDA was 2.11:1.

For 2016, third quarter adjusted EBITDA decreased $1.9 million or 4% to $45.1 million compared to the same period in 2015, with consolidated adjusted EBITDA margin at 37% in 2016 compared to 42% in 2015. Our definition of adjusted EBITDA and a reconciliation of adjusted EBITDA to net income are included in our press release for the quarter.

Turning next to 2016 financial outlook. The company expects income from operations and earnings per diluted share for the fourth quarter 2016 to be comparable to or slightly below the same period in 2015, which should result in full-year earnings per diluted share slightly ahead of 2015. Now a few closing comments.

We have continued to work to drive long-term improvement in return on invested capital. This work includes exploring options to improve rental rates, shifting business mix towards more attractive transactions and applying additional rigor to assessment of new rental equipment purchases.

While there is much work still to be done, we are fully engaged in the effort.

Despite very challenging end market conditions throughout the year for Adler Tank rentals and to a lesser extent TRS-RenTelco, positive results at Mobile Modular and Enviroplex enabled the company to grow year-to-date income from operations to $56.6 million from $55.5 million a year ago.

Strong year-to-date cash flows have enabled the company to reduce debt by $36 million while paying dividends of $18.3 million and selectively deploying new capital to increase the size of the modular division rental equipment fleet by $26.9 million. That concludes the prepared remarks on our quarterly results.

Before I turn the call back to the operator for questions, let me thank all of you on behalf of the entire McGrath RentCorp family and most particularly on Dennis's behalf your well wishes. Joe Hanna and I are working closely together and with the office of the CEO as well as the Board to carry on during Dennis's absence.

We couldn't be more proud of all of our team members across the businesses and we greatly appreciate all their hard work and dedication. All of us are wishing Dennis the best for his recovery. Out of respect for Dennis's personal privacy, we ask that you keep your questions focused on our company performance.

Also, please direct your questions to me and then Joe and I will respond as appropriate. Christy, you may now open the lines for questions..

[Operator Instructions]. Our first question is from the line of Joe Box of KeyBanc Capital Markets. Your line is open..

Hi. Good evening guys..

Hi Joe..

So the sequential ramp in Mobile Modular revenues and utilization, it looks a little bit less pronounced in 3Q versus some of the past quarters we have seen.

Can you maybe give us a little more color on that 3Q versus 2Q ramp? If that is really just a function of tougher comps now? Or if you guys being more methodical with your rentals? Any color there will be helpful..

Sure, Joe. I think the first thing I would point out is, the pace at which we are adding capital into the business is different compared to a year ago. And I think that has an impact on the sequential changes that you have seen.

Just to give you the numbers, in the first nine months of last year for the modular segment we added $60 million of new equipment and this year it was almost half of it, it was $35 million. So that definitely has an impact on the business.

The other comment I would make is across all regions, we saw growth in rental revenues, but we did see a tougher environment in Texas compared what we would have seen one, two or three years ago. So those were some of the factors at play. Business is still progressing nicely, but those were important factors for the quarter..

Actually to that point, Keith, can you maybe parse out that the Texas impact? Is it education related? Is it mobile office? Any color there will be helpful.

And I guess in aggregate, would you also say that just Texas is down year-over-year or is the growth rate just a little softer?.

Yes. Texas, for us, grew in rental revenues. I would say the commercial market is tougher. It still grew on a year-over-year basis. Education is very healthy for us..

Okay. Great.

And then I know this going to be a really difficult question to gauge but can you maybe give us a feel for what your customers are saying if we do get a bond measure in California? And maybe you how we should think about the cadence of improvement in your Mobile Modular business, if we get a bond measure versus if we don't get a bond measure?.

Let me speak to this in a couple of different ways. And I am going to talk about first of all the state facilities bond and discuss that a little bit and then I will actually let Joe comment because there are also a lot of local bonds on the ballots that will also be voted on next week.

So just as a reminder, with the state facilities bond that is the California Public School Facility Bond Initiative, known here in California as Proposition 51, that would provide $9 billion in funding and would be used over a number of years for construction of new school facilities as well as modernization of existing facilities and similarly with a lot of funding for community colleges, both for new and renovated facilities.

So it's a significant bond and the first one of its kind that we have seen since 2006. And when we look at the sort of impact that might have on the business, couple of comments. One is, it's all going to depend on the pace case of activity by local school districts.

We are certainly aware that there are some, if you will, shovel ready projects that school districts are ready to get to work on. There is a process by which the state does have to approve the matching funding and there are steps in that process that take time.

So it's partly going to depend on school districts being ready, then the state approval process mechanics to be worked through. I think the earliest we would see an impact as the bond passes is the latter half of 2017. Again, these are educational projects.

Typically, there is the most activity during the summer months and that's what we would look for.

And I would emphasize, a bond of this magnitude is really going to have an impact on the level of modernization work which is of most interest to us, probably for a multiyear period, quite possibly a three to five year window of opportunity where there would be a higher level of activity with modernization type projects..

Sure. And I can add also from the local level. There are an unprecedented amount of local bond measures out there for vote and they typically occur in two-year increments also. And this is a general election year. So these bonds typically have had an 80% to 90% approval rate.

The last bond election cycle had $14 billion on the ballot and this one has $25 billion on the ballot. So it's a sizable increase and again would contribute very nicely to both new construction work and modernization.

We are actually already seeing this work come through the system due to the local bond elections that took place in previous cycles and that's one of the reasons why Enviroplex as an example, is having a very good year this year.

So we are very pleased with this activity, both at the state level and at the local level and it should pan out to be very nice for us...

Actually to that point on Enviroplex, obviously there was a strong year from the sale standpoint.

Have you seen any sort of change in mentality from your customers relative to the own versus rent proposition after modular units?.

Actually, no. It does depend on where the funding comes from. Typically operating funds pay for rentals and capital funds will pay for new construction. And these bonds are typically designated one way or the other and it just depends on the project the districts have. But we haven't seen any overall, large-scale changes in spending habits..

Got it. Okay. That's it for me. And glad to hear that Dennis is progressing. Take care guys..

Thank you..

Thank you Joe..

Thank you. Our next question is from the line of Scott Schneeberger of Oppenheimer. Your line is open..

Thanks. Good afternoon..

Hi Scott..

Hi Scott..

Can you guys address, Modular has been very strong, could you talk a little bit about in rental revenues, what type of volume price you are seeing? And Keith, maybe run that back since this upturn began and jus the trend on what you are seeing in pricing? Thanks..

And that's for the modular business?.

Yes. Totally the modular..

Yes. I think if you start with pricing, the pace of improvement in pricing has been fairly consistent over the last couple of years. On a fleet-wide basis, the metric you can see that we publish is our average monthly rental rate and that was up 3% for the third quarter of this year compared to a year ago.

We have seen similar percentage increases fairly steadily over the last few years and that's speaking to just a general overall improvement in the pricing environment. It takes time for pricing to work its way through our fleet. We make price adjustments, typically in commercial units as they complete the initial rental term.

Education units, the handling there can be a little bit more varied by region and by school district. But the general trend and it's evident in that metric that we report has been a good healthy movement in price.

And then I would tie back to our discussions over the last few quarters, where the lot of the work we are doing on return on invested capital and pricing is something we are looking at hard in all businesses, but definitely hard in Mobile Modular. We are looking at that individual regions.

We are looking at it for both commercial and educational transactions and making sure when we look at the term of a project that when we look at the costs we incur to supply the unit and get it ready for the customer, that it's still economically attractive for us. So pricing continues to be a very important area for us.

I think we are making good progress in many areas and we continue to hone and refine our thinking in that whole area..

Okay. Thanks. Just going around the segment. In Adler, obviously you are shrinking your upstream exposure if it's occurring. Could you speak a little bit more specifically to the business development activities you are doing on the non-upstream verticals? Thanks..

Sure. I can speak to that. We actually are focusing quite a bit on non-E&P sector and market verticals and currently also on national accounts. So these are initiatives that are very real and receiving priority in the business because of the shrinking E&P revenues that we are seeing right now. So definitely a focus for us..

Okay. Thank you. And then lastly in TRS-RenTelco, could you discuss the visibility that you have looking into 2017 there? I know it can be tricky, but any commentary that you have that can help? Thanks..

Yes, it's really hard to predict 2017 at this point.

I think if you look at that business and we reflected it in the prepared remarks, the general purpose business was up very slightly in the quarter with still some softness of the communication side and the softness on communications reflects the fact there are fewer projects and where we do have projects, we are getting paid less on the deals that we do as we come to the end of that technology cycle.

So it's too early to really say what 2017 is going to look like. We would hope to see a lessening of the decline in the communication side. We would hope to see some further progress with the general purpose side.

But it's still early days and typically we are doing our work and getting our own assessment of the market trends around this time of the year through year-end and putting in place our plans for 2017..

Okay. Thanks. I appreciate it. My best to Dennis..

Thank you..

Thank you..

Thank you. Our next question is from the line of Marc Riddick of Sidoti & Company. Your line is open..

Hi. Good evening gentlemen..

Hi Mark..

Good evening..

So I wanted to touch a bit on the portable storage and maybe if you could sort of shed a little bit more light on the growth that you are seeing there and where maybe from a regional standpoint or maybe some of the areas the success that you are seeing there? And maybe what opportunities you see on the portable storage base, whether it's geographic or sort of what's working right now and what you think will continue to in the near term?.

Well, we are very pleased with that business. It's growing very nicely for us. And I would say there is no particular market verticals that we are seeing any stronger activity even than in others.

We continue to focus the business on non-construction rentals because they offer the very good benefit of typically longer terms than we see with the construction side of the business. And from a geographic standpoint, we are seeing strength and good increases in that business across all of our operating areas.

It's a little bit softer in Texas right now based on just the oil and gas situation in that market, but overall we are very happy with how the business is growing and we are very happy with the profitability that we are seeing in that business and we continue to really, really move forward there..

Okay. Great. You had mentioned in past calls the progress that you are already making in California ahead of the vote, of course.

But I wanted to get a sense of whether you could share with us, I think you had mentioned earlier in the year that you were looking at strong first month revenue booking and I just wondered if you could sort of give an update on what we saw in the third quarter and what those trends have been like?.

Yes. Bookings on the modular business for the third quarter were up 1%, so just up slightly year-over-year. And when we looked at the business, we had stronger bookings in California compared to the other regions outside of California. So California trends continue to be positive, very pleased about that.

As we touched on a little earlier, it's a little bit more challenging, particularly in the Texas market and it's more challenging in that we are putting less new capital into the business, so the rate of bookings growth went against us in the third quarter for those other regions. But California up, rest of the country, down slightly.

It nets up to being up 1% overall..

Okay. Excellent. And from a debt reduction standpoint, I guess, I think you were mentioning, you were down to about 2.1 on leverage.

I just wanted to get a sense of any updates on general targets that you are looking at for leverage levels?.

We are very comfortable with leverage where it is at 2.11. Our financial covenants limit us to a maximum of 2.75. So we have plenty of headroom. I think really through year-end, if you look at the first nine months of the year, we reduced total debt by $36 million.

So if we continue on that pace, which I think is possible, through the end of the year, we may reduce total debt for the full year by a number in the neighborhood of $50 million and that may well result in leverage being at or slightly below the level that we saw at the end of September.

So business from a cash flow generation point of view is very healthy and we actually are ahead of what we expected in terms of debt reduction in the first nine months of the year..

Okay. Excellent. And I was wondering if you could share if there are any changes in thoughts or views as far as the share repurchasing going forward? Thank you..

As we have said in the past, when it comes to share repurchases, we tend to be opportunistic. We don't broadcast ahead of time when we intend to be active. So that is certainly a tool that's available to us. We have 1.6 million shares authorized for repurchase should we have a market window where we choose to pursue that..

Okay. Excellent. Thank you very much and certainly please forward my best wishes to Dennis as well. Thank you..

Thank you..

Thank you..

Thank you. And it looks like we have a follow-up from the line of Joe Box of KeyBanc Capital Markets. Your line is open..

Thanks. Just one quick follow-up. So it looks like the building and prep costs were actually up year-over-year, but they were down nicely on a sequential basis.

Can you just talk to what the backlog looks like there? And if maybe the 2Q level was a high watermark for inventory center costs?.

Yes. Joe, third quarter, the costs were high and they were high relative to the third quarter of last year, where they were comparatively low. Those costs, as you probably appreciate, can move around a bit just based on the particular activity going on in our inventory centers.

If I look at this year and looking towards the fourth quarter, I think those costs will be down sequentially from Q3 to Q4 of this year and quite possibly below the fourth quarter level that we saw last year at or below that level. So that's what we are expecting.

And I would say on the full-year basis, those costs are in line with what we had planned and expected and should reflect improvement in rental gross margins, which are up this year to 52% from 50% on a year-to-date basis and we should continue to hold and quit likely increase those gross margins on a full-year basis by the time we get to year-end.

So overall trends moving in the right direction with those metrics and in that part of the business..

Got it.

And then actually just on next year, I mean, is it fair to think about that as being flattish for next year and you get additional gross margin expansion? Or just any color you can give us on how that might trend?.

Yes. It's a little early to be too definitive. I think we are looking very hard at the money we are spending on building preparation costs, making sure we have got the right business mix.

We have talked in the past that looking at the range of different buildings in our fleet across all regions and making sure when we have those expenses that we are getting an attractive transaction in return. So it's a little early.

We may be fine-tuning both business mix and emphasis in 2017 and that could cause those expenses to move around a little bit and we will be happy to share, if you will, our game plan when we give our full account for guidance in late February.

I would be surprised if those expenses are going up a lot from current levels but it's an area we are going to look at very hard to try and optimize..

Got it. Thanks Keith..

Ladies and gentlemen, that appears to be the last question. Let me turn the call back over to Mr. Pratt for any closing remarks..

I would like to thank everyone for joining us on the call today and for your continuing interest in the company. We look forward to speaking with you again in late February to review our fourth quarter and full-year results..

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect..