Business context and reporting period
McGrath RentCorp filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2014. Its businesses rent and sell modular buildings, electronic test equipment, and liquid and solid containment equipment; it also manufactures classroom buildings. Rental operations generated about 82% of nine-month revenue. The interim financial statements received an independent accountant’s review, not an audit.
Financial performance
Amounts below are in millions of dollars, except per-share data and percentages.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $113.0 | $108.8 | $296.3 | $284.7 |
| Gross profit | $49.3 | $45.2 | $130.0 | $124.4 |
| Income from operations | $25.1 | $22.8 | $58.6 | $58.6 |
| Net income | $13.7 | $12.6 | $31.8 | $31.6 |
| Diluted EPS | $0.53 | $0.48 | $1.22 | $1.23 |
| Gross margin | 43.6% | 41.5% | 43.9% | 43.7% |
| Operating margin | 22.2% | 21.0% | 19.8% | 20.6% |
Q3 revenue rose 4%, net income 9%, and diluted EPS 10% year over year. For the first nine months, revenue rose 4% and net income was nearly flat, while diluted EPS declined 1%. Nine-month Adjusted EBITDA, a company-defined non-GAAP measure, increased 3.1% to $122.7 million; the filing cautions it is not a substitute for GAAP results or cash flow.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $85.0 million, down from $99.9 million. Investing cash use was $96.7 million, including $113.0 million of rental-equipment purchases; proceeds from used rental-equipment sales were $22.9 million. Financing provided $10.9 million. Cash ended at $0.8 million.
- At September 30, total notes payable were $322.3 million, versus $290.0 million at December 31, 2013. The company reported $202.3 million drawn on its unsecured credit lines and $227.7 million of additional borrowing capacity. Senior notes outstanding comprised $80.0 million of Series A notes and $40.0 million of Series B notes.
- Credit metrics were within covenant limits: fixed-charge coverage was 3.95x against a 2.50x minimum; leverage was 1.96x against a 2.75x maximum. The company reported covenant compliance.
- The quarterly dividend declared was $0.245 per share, 2% above the prior-year comparable quarter.
Material changes and management commentary
- Mobile Modular was the strongest growth contributor: nine-month revenue increased 19% to $117.2 million and pretax income increased 93% to $9.3 million. Management cited higher rental volume, services and sales; average utilization rose to 71.4% from 67.6%.
- TRS-RenTelco nine-month revenue decreased 5% to $94.5 million and pretax income decreased 7% to $24.6 million, reflecting lower rental and sales revenue. Average utilization declined to 59.6% from 63.3%.
- Adler Tanks nine-month revenue increased 4% to $74.0 million, but pretax income decreased 8% to $17.7 million. Average utilization declined to 62.2% from 65.7%; management cited lower rental rates and higher selling and administrative costs.
- Selling and administrative expense increased 9% for the nine months, mainly due to higher headcount, salaries and benefits. Interest expense increased 6%, alongside higher average debt.
- In June, the company sold an excess property for net proceeds of $2.5 million and recorded an $0.8 million gain. It issued $40 million of 3.68% Series B notes, due in 2021, and extended the shelf-note issuance period to March 2017.
Outlook, risks and contingencies
The filing provides no specific revenue or earnings guidance. Management said the nine-month results should not be considered indicative of full-year results and expressed confidence in access to financing, while noting that performance deterioration could affect covenant compliance. Key disclosed risks include economic weakness and credit-market constraints; public-school funding, bond approvals and classroom demand; cyclical or seasonal demand and equipment utilization; competition and pricing pressure; used-equipment resale values; variable interest rates; supplier availability; customer credit and collections; environmental, product-liability and other litigation exposure; and regulatory changes affecting hydraulic fracturing and containment-equipment demand. The company said ordinary-course legal proceedings were not expected to have a material adverse effect, and reported no material off-balance-sheet arrangements or material changes in market-risk exposure.
New accounting standards discussed include revenue recognition, effective for the company after December 15, 2016, which was still under evaluation; management did not expect significant effects from the other standards described. Disclosure controls were reported effective as of September 30, 2014.
Investor verification points
- Track whether Mobile Modular’s utilization and rental growth persist, and whether TRS-RenTelco and Adler Tanks recover utilization and profitability.
- Assess cash conversion: operating cash flow fell while rental-equipment purchases increased; review receivables growth and ongoing capital needs.
- Verify debt, interest-rate exposure, available credit capacity and covenant headroom; $202.3 million of variable-rate borrowings was outstanding, and the filing estimates annual debt service rises about $2.0 million for each 1% rate increase.
- Evaluate the sustainability of the earnings trend: nine-month net income was nearly flat and diluted EPS declined despite revenue growth; the property-sale gain also contributed to pretax results.
- Monitor school funding and bond measures, oil-and-gas activity, environmental or product claims, and used-equipment resale values as potential drivers of demand and asset risk.