Joseph Hanna - President and CEO Keith Pratt - EVP and CFO.

Joe Box - KeyBanc Capital Markets Daniel Hultberg - Oppenheimer Marc Riddick - ‎Sidoti & Company.

Ladies and gentlemen, thank you for standing by. Welcome to the McGrath RentCorp Third Quarter 2017 Conference Call. At this time, all conference participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions]. This conference is being recorded today, Tuesday, October 31, 2017.

Before we begin, note that the matters that 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 2017 total company operating profit, 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 involves significant risks and uncertainties which 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-Q for the quarter. Speaking today will be Joe Hanna, Chief Executive Officer; and Keith Pratt, Chief Financial Officer. I will now turn the call over to Mr. Hanna. Go ahead, sir..

Thank you, Chelsea. Good afternoon and thank you for joining us on today's call. I will be providing comments on our performance for the quarter and our outlook for the remainder of 2017. Following my comments, Keith will review the financial results. After that, we will open up the call to questions.

Overall, we performed well and I am pleased with our results. Mobile Modular, Adler Tank Rentals and TRS-RenTelco each delivered significant operating profit growth compared to a year ago contributing to the company’s 25% operating profit increase. Operating profit grew 25% at Mobile Modular, 12% at TRS-RenTelco and 60% at Adler Tank Rentals.

Our company operating profit growth was driven primarily by a 6.8 million increase in gross profit from rental operations and a 1.1 million increase in sales gross profit also contributed to the strong results. Hurricanes Harvey and Irma had no material impact on our third quarter results.

Mobile Modular rental revenues for the quarter increased 9% from a year ago as rental rates and equipment on rent both increased, while average utilization declined slightly. Average rental rates increased 7% which was the key driver of rental revenue growth.

Rental revenue growth continued to be healthy across commercial and education markets, as well as in our Portable Storage business. Rental revenues declined slightly in Texas but increased in each of our other regions.

We continued to selectively invest in new modular renal equipment, primarily in regions outside California for our Portable Storage business and grew the rental fleet by 3% year-over-year. TRS-RenTelco rental revenues for the quarter increased 3% as a result of higher general-purpose test equipment business activity.

General-purpose test equipment rental revenues increased by 9%, but were partly offset by a 1% decrease for communications test equipment. While average equipment utilization increased, average rental rates declined for the quarter, primarily due to the business activity mix shift to general-purpose from communications test equipment.

As communications market demand has declined, we’ve been reducing the amount of communications test equipment we own while we have been selectively investing in general-purpose test equipment for growth opportunities. Rental revenues for the quarter at Adler increased 17% from a year ago.

We were pleased to see rental revenue growth was broad based and occurred in six of seven vertical markets that we serve and across four of our five regional markets. Upstream oil and natural gas rental revenues increased from 9% to 10% of total rental revenues at Adler.

Average equipment on rent increased 16% to 176 million from 152 million a year ago, and average utilization increased to 57% from 49%. Despite ongoing competitive price pressure, average rental rates improved slightly as a result of product mix shifts.

Our fleet size was unchanged year-over-year and we anticipate very limited new equipment purchases during the remainder of this year. Our third quarter results reflect some improvement in market conditions at Adler Tank Rentals and TRS-RenTelco.

In addition, we benefited from the various return on invested capital performance improvement initiatives across the business. I am proud of the good execution by each of our divisional teams during the quarter.

Our teams made solid progress targeting the right market segments and transactions, optimizing rental rates and selectively selling non-core equipment. We are also maintaining discipline on new rental equipment capital spending. Hurricanes Harvey and Irma presented challenges and risk during the quarter.

All of our employees in the impacted regions are safe, though some suffered hardship. Our facilities and rental equipment suffered no material damage and we were operational within days of the storms ending.

I’m really proud of our regional leaders and all of our team members who worked tirelessly to support each other, our business operations and our customers during this difficult period.

I’m also proud of our employees across all of McGrath RentCorp who contributed over $40,000 to provide assistance to their fellow employees who suffered the most losses as a result of the storms. We have a wonderful culture that shines through in times like this.

Regarding the financial impact of the hurricanes to our business, in the third quarter, we had approximately 300,000 of incremental rental revenue at Adler and Mobile Modular related to the storms, which was partly offset by some incremental equipment preparation costs, so the net impact was not significant.

While we expect both the storms and the recent fires in Northern California to result in some additional rental and sales opportunities in the fourth quarter, primarily at Mobile Modular, we do not currently think they will be substantial overall to the company’s results.

Entering the fourth quarter, market conditions continue to be highly competitive and our visibility is limited as a result of the shorter rental terms of typical Adler and TRS-RenTelco transactions.

During the fourth quarter, we expect to experience typical seasonality at TRS-RenTelco and Adler which both usually experience some reduction in business activity between Thanksgiving and year-end.

We also expect equipment preparation costs at Mobile Modular to be higher than last year and similar to the third quarter due to healthy order activity levels.

Based on our third quarter and year-to-date results and our current outlook for the remainder of the year, we are raising our financial outlook and expect 2017 total company operating profit to increase 15% to 18% above 2016 compared to our prior expectations of a 9% to 12% increase.

I’d like to turn the call over to Keith now for his financial review..

Thank you, Joe. For the third quarter 2017, total revenues increased 11% to 135.4 million from 122 million for the same period in 2016. Net income increased 30% to 16.8 million from 12.9 million and earnings per diluted share increased 28% to $0.69 from $0.54.

Reviewing the third quarter results compared to the third quarter of 2016 for each of the company’s rental divisions starting with Mobile Modular. Total revenues increased 5.2 million or 8% to 68.9 million on higher rental, rental-related services and sales revenues.

Rental revenues increased 3 million or 9% and rental margins increased to 59% from 57%. Depreciation as a percentage of rents decreased to 15% from 16% and other direct costs as a percentage of rents decreased to 26% from 27%. The combined result was that gross profit on rents increased 2.6 million or 14% to 21.6 million.

Sales revenues increased 0.8 million or 5% to 17.5 million on higher used equipment sales. Selling and administrative expenses increased 9% to 14.5 million, primarily as a result of increased salaries and employee benefit costs and higher allocated corporate expenses.

The higher gross profit on rental, rental-related services and sales revenues partly offset by higher selling and administrative expenses resulted in an increase in operating income of 3.1 million or 25% to 15.8 million. Finally, average modular rental equipment for the quarter was 749 million, an increase of 19 million.

Average fleet utilization for the third quarter decreased to 76.3% from 76.7%. Turning next to TRS-RenTelco. Total revenues increased 1 million or 4% to 27.3 million on higher rental, rental-related services and sales revenues. Rental revenues increased 0.7 million or 3%.

Rental margins increased to 45% from 41% as depreciation as a percentage of rents decreased to 39% from 42% and other direct costs as a percentage of rents decreased to 16% from 17%. The net result was an increase in gross profit on rents of 1.1 million or 13% to 9.4 million.

Selling and administrative expenses increased 7% to 5.5 million due to increased salaries and employee benefit costs. The higher gross profit on rental and rental-related services revenues were partly offset by lower gross profit on sales revenues and higher selling and administrative expenses.

The net impact was a 12% increase in operating income to 7.1 million. Finally, average electronics rental equipment at original cost for the quarter was 254 million, an increase of 3 million. Average utilization for the third quarter increased to 63.4% from 61.2%. Turning next to Adler Tanks rentals.

Total revenues increased 3.1 million or 15% to 23.4 million on higher rental, rental-related services and sales revenues. Rental revenues increased 2.3 million or 17% and rental margins increased to 60% from 56% as depreciation as a percentage of rents decreased to 24% from 28% and other direct costs as a percentage of rents was flat at 16%.

The net result was a 24% increase in gross profit on rents to 9.9 million. Selling and administrative expenses increased 10% to 7.3 million due to increased salaries and employee benefit costs.

The higher gross profit on rental and rental-related services revenues partly offset by higher selling and administrative expenses resulted in an increase in operating income of 1.6 million or 60% to 4.2 million. Finally, average rental equipment for the quarter was 308 million, which was comparable to 2016.

Average utilization for the third quarter increased to 57.1% from 49.4%. On a consolidated basis, interest expense for the third quarter of 2017 increased 0.1 million or 2% to 3 million. Higher net average interest rates were partly offset by lower average debt levels.

The third quarter provision for income taxes was based on an effective tax rate of 38.7% in 2017 compared to 39.5% in 2016. The third quarter effective tax rate included a $360,000 excess tax benefit related to the implementation of ASU 2016-09. Next, I'd like to review our 2017 year-to-date cash flows highlights.

Net cash provided by operating activities was 81.1 million, a decrease of 24.1 million compared to 2016. The decrease was primarily attributable to an 11 million income tax refund received in 2016 and by a lower increase in deferred income taxes, accounts payable and accrued liabilities and other balance sheet changes.

We invested 73.2 million for rental equipment purchases compared to 64.3 million for the same period in 2016. Property, plant and equipment purchases increased 2.8 million to 12.8 million in 2017. Net borrowings decreased 3.1 million from 326.3 million at the end of 2016 to 323.1 million at the end of the third quarter 2017.

Dividend payments to shareholders were 18.6 million. At quarter end, the company had capacity to borrow an additional 228.8 million under its lines of credit and the ratio of funded debt to the last 12 months actual adjusted EBITDA was 1.88 to 1. Third quarter 2017 adjusted EBITDA increased 12% to 50.7 million compared to the same period in 2016.

Consolidated adjusted EBITDA margin was 37% in both periods. Our definition of adjusted EBITDA and a reconciliation of adjusted EBITDA to net income are included in our press release for the quarter. That concludes the prepared remarks on our quarterly results. Chelsea, you may now open the lines for questions..

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

Hi, guys.

Can you hear me okay?.

Yes..

Yes, you’re clear..

Great, okay. So my math on your new guidance has implied operating income of about 23 million to 26 million for 4Q, but it is obviously down sequentially from – it’s down sequentially 15% to 23%. It looks like in normal years that typical sequential step down is something in the tune of, call it, high-single digits to maybe 10%.

I hear you that inventory center cost at Mobile Modular could be flattish sequentially, but I guess is there anything else in 4Q that could cause maybe more than normal seasonality?.

Yes, Joe, just a couple of comments. One is, it’s very hard to know what normal seasonality is. We’ve looked over the fourth quarter of last year both at TRS and Adler and they held up surprisingly well through pretty much year end.

I would say that was not as typical and we wouldn’t bank on that being the case when we look at our projections for this year. Other comment I would make is we’ve pretty good sales in the third quarter. That can be another item as you move from third quarter to fourth quarter, a lot of variability there.

We have some sales in the pipeline but some of those sales could equally well slip into the first quarter of next year. So it’s not a perfect science but what we can see and taking into account those slightly higher level of inventory center cost at Mobile Modular, we feel comfortable with the updated guidance..

Got it, okay. Thanks for that, Keith. And then I want to dig into utilization at Mobile Modular. I certainly get that the ROIC strategy may mean a little bit less utilization but more price, but I’m a little bit surprised it’s down sequentially and year-over-year, especially when you guys aren’t really spending a ton on CapEx.

Can you maybe talk to this trend? And then give us a sense for what could happen in utilization as we move into next year, because it sounds like you guys are prepping up a lot of equipment in 4Q to get it ready for next year?.

Sure, Joe. What I can say about that is as we have embarked on our ROIC work, we’ve got some dials that we can turn here that affect our performance. We’ve implemented a number of changes with our pricing guidance that we’ve given to the business.

And what we’ve done over this last year is we’ve pushed the envelope in some areas on pricing and we’ve tested the market in some areas. And we haven’t gotten as many deals overall that we thought that we would in a few of our regions on a year-over-year basis.

And so we expected that to happen and even though utilization hasn’t moved much, we’re very happy that pricing has moved. And what we’re going to do going forward is we’re going to continue to adjust those dials to optimize our pricing and optimize utilization increases as we go forward.

I think the most important thing is that we’ve significantly dialed back our CapEx. And so we have real clarity in terms of these two dials that we need to turn and how we can both maximize – we can maximize both of them. So I think overall we’d like to see utilization improve over the next year and we’ll be working to make that happen..

And Joe, the only thing I would add to Joe’s comments, if you again listen to the prepared remarks from Joe, we did see rental revenues in Texas as a region drop slightly year-over-year. So while the business is very healthy overall, when you have a large region like that take a step back on rental revenue, that doesn’t help utilization. It hurts it..

And you know, Keith, that was actually going to be one of my follow ups. So would you attribute that solely to the hurricane? Because it sounds like you had a couple of small positives there on the rental revenue side, even more on Adler.

But was that solely hurricane or was that something else?.

No. Actually not very much hurricane related..

Okay, got it..

Does that answer your question?.

Yes, it does..

Okay..

So on the rate side, obviously really good rates at Mobile Modular.

Can you maybe just talk to what the delta is between the units coming off rent and back to you versus maybe where spot market rates at?.

That’s not an easy metric to speak to, because as you know Joe in the modular business there is more rent diversity depending on the rental term for the transaction being considered. And then there’s also some range of rate according to both regions and product types.

Obviously, the metric we quote is a fleet-wide average and it’s a general indicator of where pricing has been moving. And obviously it’s been a focus area and our team has made very significant progress over quite a number of quarters now. Some of that can be affected by how long the units have been on rent.

If they went out five years ago when rents were significantly lower and they come off rent, you’re going to see a larger delta than something that’s been out on a shorter term that went out last year..

Of course. Okay. All right, guys. Thank you. Good quarter..

Thank you..

Our next question comes from the line of Scott Schneeberger with Oppenheimer. Your line is open..

Hi, guys. It’s Daniel stepping in for Scott.

Can we switch to TRS for a little bit and discuss the growth opportunities you alluded to in general test equipment and overall discussing the outlook and visibility for both general test equipment and communications test equipment please?.

Sure. We’ve executed well over this past year with our general purpose equipment and we’ve bought additional fleet to support that growth. Our general purpose equipment in several market sectors that we serve has improved very nicely. Defense spending is up, semiconductor spending is up and we’ve seen growth in those two market segments.

And we expect to see healthy activity in those segments going forward. As far as communications equipment goes, still no real developments on wireless 5G. We believe that – I think that we’ve troughed essentially and I don’t really see further declines in our communications business.

You may have seen in the news recently Verizon gave a contract for $1 billion to Corning for installation of fiber, 7.7 million miles of fiber per year over the next 30 years. And so we see – somebody’s got to support the testing of that as that is backhaul preparation for 5G infrastructure that’s going to go in.

And so we believe that the communications piece of our business will be relatively solid and not in a continued decline as we’ve seen over the past few years. So we’re cautiously optimistic..

Got it. Thank you. Switching to Adler, you alluded to continued competitive pricing pressures. Can you just give us an overall view of the pricing environment in Adler across the end markets now versus three months ago? And how do you see that developing going forward as well? Thanks..

Yes. So pricing – well, let me back up. Utilization has started to improve and I think that’s industry wide, we’re seeing more units on rent. The price of oil has stabilized and actually hit $60 recently for the first time in a long time.

There are quite a few number of additional rigs that are in active drilling situations right now compared to same time last year. And so that’s good. More equipment’s being deployed. And as utilization increases, we anticipate that that will also be a positive wind in our sails for rates.

It hasn’t really materialized much yet but we believe that if these trends continue with those market segments that pricing should stabilize and also show some improvement over the next year. I don’t think it will be significant but hopefully again we’re cautiously optimistic on that front..

Got it. Thank you. Good quarter..

Thank you..

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

Good evening..

Hi, Marc..

Hi, Marc..

I wanted to touch on the general – maybe if you could share some thoughts on the general funding environment that you’re seeing out there and – not just in general, if you could share that, but also if you’ve seen any additions to funding in some of the storm damaged or higher damaged areas?.

Sure. I’m assuming you’re referring to California.

Is that correct?.

Yes..

Okay..

And if to a lesser extent in the south as well, if appropriate..

Okay. Let me address the general funding environment for education facilities work. There’s been – as we know from past conference calls we’ve shared that there’s been a significant amount of local bond monies that have been deployed in the market from 2014. Those monies are flowing right now.

And I’ll say that we have had a better bookings season in California than we thought we would. And so our business activity levels with education, classroom demand has risen quite nicely.

The state in September sold 443 million in state bonds and so some of those bond monies are going to go to reimburse districts who have already spent money or be provided for new projects.

Because the funding situation has been somewhat flush in the state for the past year, we don’t really anticipate a significant increase in the amount of money that’s going to be available in the market over the next year.

And so we project that classroom demand will be robust but will not – I don’t think it’s going to be a significantly different booking situation than we had in 2017. So that’s the classroom funding environment. As far as funding for the fires out here, still very early to say. There’s FEMA money that has been flowing both in California and in Texas.

We’ll take advantage of any of those funding situations as they come up. And some of that goes to school districts that need to repair their facilities. There could be some projects in Texas that come online here and out to bid over the next several months as school districts are in a state of assessment and repair.

But no super state bond level funding dynamics or anything that we’re seeing at this point in either of those locations..

Do you get – and maybe it’s too early to know an answer to this but I guess maybe this is part of the assessment that these localities are going through, but do you get any sense that this may have accelerated damage of existing facilities not just ones that were really significantly damaged, but even ones that were kind of hanging in there, if you will, that maybe much older than they should be that may end up accelerating the pace of longer dated activity for you, or is it maybe a little too early in the process of assessing?.

Yes, it’s tough – that’s a tough one to answer. I don’t really believe that that’s going to be a material impact to our results. I don’t – I’m not sure that school districts would go down that road unless there was significant damage to the facilities. So I don’t see that really being a driver..

Okay. I appreciate the color. Thank you very much..

You’re welcome..

Thank you. I’m showing no further questions at this time. I would now like to turn the call back to Mr. Joe Hanna for closing remarks..

Thank you very much. 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 February to review our fourth quarter results..

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