McGrath RentCorp — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017; comparisons are with the corresponding 2016 periods. The interim financial statements are unaudited and were reviewed by Grant Thornton, which reported no material modifications were needed. McGrath RentCorp rents modular buildings, electronic test equipment, and containment tanks and boxes, and also manufactures classroom buildings.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $109.6m | $103.1m | $204.4m | $196.8m |
| Gross profit | $49.2m | $43.8m | $92.9m | $84.4m |
| Income from operations | $21.8m | $18.1m | $37.7m | $32.3m |
| Net income | $11.5m | $9.1m | $19.4m | $15.6m |
| Diluted EPS | $0.48 | $0.38 | $0.80 | $0.65 |
| Adjusted EBITDA | $41.9m | $39.3m | $78.2m | $75.4m |
| Adjusted EBITDA margin | 38% | 38% | 38% | 38% |
Gross margin was approximately 44.9% in Q2 and 45.4% for the six-month period, compared with approximately 42.4% and 42.9%, respectively, in 2016. Selling and administrative expense rose 7% in Q2 and 6% year to date, primarily on higher headcount, salaries, benefits, and corporate costs. Interest expense was $2.9m in Q2 and $5.7m year to date; the six-month decrease of 12% reflected lower average debt and slightly lower average rates.
Cash flow and investment: Six-month operating cash flow was $49.4m, down from $72.4m. The filing attributes the decline principally to a tax refund received in 2016, increased prepaid and other assets, and other balance-sheet changes. Investing activities used $39.7m, including $46.1m of rental-equipment purchases and $9.6m of property and equipment purchases, partly offset by $16.1m of proceeds from used-equipment sales. Financing activities used $8.7m; cash ended at $1.9m.
Balance sheet and liquidity: At June 30, 2017, total assets were $1.15bn, notes payable $330.3m, total liabilities $747.8m, and shareholders’ equity $402.4m. The company had $210.4m outstanding under its unsecured credit and sweep facilities, with $221.6m of additional borrowing capacity. The revolving facility matures March 31, 2021. Current-asset/current-liability totals are not presented in the supplied filing text, so a current ratio is not stated.
Changes versus prior period
- Q2 revenue increased 6%, net income 26%, and diluted EPS 26%; for the first six months, revenue increased 4%, net income 24%, and diluted EPS 23%.
- Mobile Modular was the principal growth contributor: six-month segment revenue rose 11% and pretax income rose 29%, supported by higher rental and sales revenue and improved rental margins.
- TRS-RenTelco six-month revenue declined 7%, but pretax income increased 20%, reflecting improved gross profit and lower selling and administrative expense.
- Adler Tanks six-month revenue grew 2% and pretax income 18%. Utilization improved, while average monthly rental rates declined 5%.
- Used-equipment sales and margins contributed to growth in several segments; management cautions that sales and related margins can vary with customer needs, equipment availability, and funding.
- Rental-equipment acquisitions were $49.6m in the first half, versus $42.4m in 2016. The quarterly dividend declared was $0.26 per share, up 2% from the prior-year quarter.
Outlook, risks, contingencies, and notable items
- No specific revenue or earnings guidance is provided. Management says it believes liquidity will remain adequate through operating cash flow, used-equipment sales, and borrowing capacity, and expects continued access to financing, though it gives no assurance.
- The company was in compliance with its debt covenants at quarter-end: fixed-charge coverage was 3.75x against a 2.50x minimum, and leverage was 1.99x against a 2.75x maximum. Management warns that significant deterioration in performance could affect compliance.
- Most debt is exposed to variable interest rates, with no interest-rate hedges. The filing estimates annual debt service would rise about $2.1m for each 1 percentage-point increase in average rates, based on $210.4m of variable-rate debt.
- Key business risks include school funding and policy changes affecting modular demand; cyclical demand and technology obsolescence in test equipment; oil-and-gas and construction weakness affecting Adler Tanks; competition, equipment utilization and resale values; supplier constraints; and environmental, safety, and product-liability exposure. The company also identifies economic downturns, financing access, and seasonality as risks.
- Management reported no material off-balance-sheet arrangements, no material change in market-risk exposure, and no expected material adverse effect from ordinary-course legal proceedings. Disclosure controls were considered effective at June 30, 2017.
- The company adopted share-based payment guidance in Q1 2017, recognizing $0.1m of excess tax benefits for the six months as a reduction in income-tax provision. New revenue and lease accounting standards were still under evaluation; management did not expect a material revenue-standard impact, but anticipated lessee adoption would increase reported assets and liabilities.
- The risk factors discuss the transition from Dennis C. Kakures to Joseph F. Hanna as CEO and the importance of managing that transition. The filing does not identify this as a new quarter-specific event.
Investor verification priorities
- Assess whether Mobile Modular’s rental growth, utilization, and rental-rate improvements can persist, and how much reported growth depends on variable used-equipment sales.
- Reconcile the year-over-year operating-cash-flow decline, especially the prior-year tax refund and the 2017 increase in prepaid and other assets; compare cash generation with fleet investment and dividends.
- Review the maturity and interest-rate profile of debt, available credit capacity, covenant headroom, and the effect of further rate increases.
- Monitor segment-level trends: TRS-RenTelco revenue and rental rates, Adler Tanks’ rental rates and end-market exposure, and modular demand tied to public-school funding and facility projects.
- Track the CEO transition, potential environmental or product-liability developments, and the eventual quantified balance-sheet effect of lease-accounting adoption.