McGrath RentCorp — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. The interim financial statements are unaudited; Grant Thornton performed a review and reported no material modifications were needed. McGrath RentCorp rents modular buildings, electronic test equipment, and containment tanks and boxes, and also sells equipment and manufactures classrooms.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $143.1 million | $135.4 million | $365.2 million | $339.8 million |
| Gross profit | $64.1 million | $58.8 million | $168.1 million | $151.7 million |
| Income from operations | $35.8 million | $30.3 million | $82.3 million | $68.0 million |
| Net income | $24.8 million | $16.8 million | $55.2 million | $36.2 million |
| Diluted EPS | $1.01 | $0.69 | $2.25 | $1.50 |
| Adjusted EBITDA | $57.3 million | $50.7 million | $145.6 million | $128.9 million |
Margins: Gross margin was approximately 44.8% in Q3 and 46.0% year to date, versus 43.4% and 44.6% in the respective 2017 periods. Operating margin was approximately 25.0% in Q3 and 22.5% year to date; net margin was approximately 17.3% and 15.1%. Adjusted EBITDA margin was 40% in both 2018 periods, compared with 37% for Q3 2017 and 38% for the first nine months of 2017.
- Q3 revenue rose 6%, while net income rose 48%; nine-month revenue rose 7%, while net income rose 52%. Rental operations drove growth; Q3 sales revenue declined year over year.
- The lower effective tax rate materially boosted earnings: 23.9% for Q3 and 24.1% for the nine months, compared with 38.7% and 39.2% in 2017. Management attributed the decrease primarily to the federal rate reduction under the Tax Cuts and Jobs Act.
- Operating cash flow was $96.8 million for the nine months, up from $81.1 million. Investing cash outflow was $74.7 million, including $84.7 million of rental-equipment purchases and $7.5 million paid for an acquisition. Financing cash outflow was $20.1 million. Cash ended at $4.4 million.
- Rental-equipment purchases and property, plant and equipment purchases totaled $97.2 million in the period. Proceeds from used-equipment sales were $30.1 million.
Balance sheet, debt and liquidity
- At September 30, 2018, total assets were $1.202 billion, notes payable were $309.0 million, total liabilities were $647.3 million, and shareholders’ equity was $554.5 million.
- The company had $209.0 million outstanding under its unsecured credit and sweep facilities, with capacity to borrow a further $223.0 million. The revolving facility matures March 31, 2021.
- Senior notes outstanding were $40 million of Series B notes at 3.68% due 2021 and $60 million of Series C notes at 3.84% due 2022. The final $20 million Series A payment was made in April 2018.
- Debt covenant compliance was reported. The fixed-charge coverage ratio was 6.62 versus a 2.50 minimum; leverage was 1.58 versus a 2.75 maximum. The company reported no anticipated trend toward noncompliance, while noting significant deterioration could affect compliance.
- The majority of debt is variable-rate. The filing estimates annual debt service would rise about $2.1 million for each 1 percentage-point increase in average rates, based on $209 million of variable-rate debt.
Material changes and segment trends
- Mobile Modular: Nine-month revenue increased 9% to $188.6 million and pretax income rose 24% to $38.1 million. Higher rental revenue, rates and utilization were key contributors. Q3 average utilization improved to 78.6% from 76.3%.
- TRS-RenTelco: Nine-month revenue increased 9% to $86.5 million and pretax income rose 13% to $20.9 million. Q3 average utilization declined to 61.9% from 63.4%; rental rates were also lower.
- Adler Tanks: Nine-month revenue increased 6% to $70.2 million and pretax income rose 43% to $10.4 million, supported by higher rental utilization. Q3 average utilization increased to 62.5% from 57.1%.
- On August 1, the company acquired DropBox, Inc.’s blast-resistant module rental business for $7.9 million; results are included in Mobile Modular from the acquisition date.
- The board declared a quarterly dividend of $0.34 per share, up 31% from the comparable prior-year quarter. Nine-month dividends declared were $1.02 per share.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management says nine-month results should not be considered necessarily indicative of full-year results.
- Management identifies demand and pricing risks from economic downturns, customer funding and public-school budgets, seasonality, competition, and the cyclical industries served by test-equipment and containment rentals. It also notes risks from equipment obsolescence or residual values, supply constraints, customer credit, and the ability to redeploy returned equipment.
- Environmental, health and safety, product-liability, and property risks are relevant to the company’s equipment and operations. Management said ordinary-course legal proceedings are not expected to have a material adverse effect; no material off-balance-sheet arrangements were reported.
- Lease accounting standard adoption was expected on January 1, 2019. Management anticipated higher reported assets and liabilities from lessee accounting, but was still evaluating the magnitude; it did not expect lessor operating-lease revenue accounting to be materially affected.
- Revenue recognition guidance adopted January 1, 2018 had no impact on the financial statements. Disclosure controls were reported effective, with no significant changes in internal control over financial reporting.
Important facts for investors to verify
- Whether rental revenue growth and utilization gains continue, particularly across Mobile Modular and Adler Tanks, and whether TRS-RenTelco utilization stabilizes.
- How much earnings growth reflects sustainable operating performance versus the lower tax rate, and the expected tax rate for subsequent periods.
- Rental-fleet investment needs, cash generation after capital expenditures, and the company’s ongoing reliance on borrowing to fund growth and dividends.
- Variable-rate debt exposure, available credit capacity, and continued compliance with financial covenants.
- Integration and contribution of the DropBox acquisition, and the effect of lease-standard adoption on reported assets and liabilities.
- Exposure to public-school funding, equipment resale values, environmental and product-liability claims, and changes in competition or market demand.